Banc One Corp.: Asset and Liability Management – Case Solution

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Banc One Corp.: Asset and Liability Management Case Answers

1. If Banc One Corp. wanted to manage its interest rate exposure without using swaps, what could it do? Specifically, how could it move from being asset-sensitive to either neutral or mildly liability-sensitive without using swaps? What are the pros and cons of using swaps v. these other means of adjusting the bank’s interest rate sensitivity? What impact do they have on the bank’s interest-rate sensitivity, liquidity, accounting ratios, and capital ratios?

Banc One Corp. can manage the interest rate exposure by matching the maturity of its assets and liabilities. Banc One could manage its interest rate exposure (like it did in the early 1980s) by simply adding balancing assets to its portfolio until the fixed-rate investments were enough to offset the fixed-rate liabilities.

For example, these balancing assets could be treasury securities issued by the Fed. If Banc one followed this method of perfectly matching the amount of fixed-rate assets and liabilities, it would move to being neutral.

If Banc One wanted to be mildly liability-sensitive, it could buy fixed-rate bonds and sell floating-rate securities, or it would have to make fewer floating-rate loans compared to its floating-rate liabilities.

In this way, fluctuations in the interest rate would have a greater effect on the interest that would need to be paid than the interest earned (the liabilities reset faster than the assets in this case).

Pros

An advantage of using swaps is that they increase the bank’s liquidity as opposed to conservative investments. Banc One Corp. can invest in short-term liquid securities and use a receive-fixed swap to ensure high yields and high liquidity.

Swaps also decrease the bank’s capital requirement compared to the conservative investments because the swaps contributed nothing to the risk-adjusted weightage of the assets.

Swaps are off-balance-sheet transactions and do not appear as an asset or liability on the balance sheet as would conservative investments. However, the net income or loss would appear on the income statement, which could ‘artificially’ increase or decrease ROA. This could be a pro to the bank if there were a profit from the swaps.

Cons

Using swaps would make it difficult for analysts to interpret the firms’ financial reporting that use them. This is because the use of swaps creates sizable distortions in return on assets, earnings, margins, and other ratios as swaps are off-balance-sheet transactions. This would also make it difficult for the investors to estimate the firm’s risk profile if swaps are being used.

In the case of Banc One Corp., the use of swaps helped transition the bank from…