THE NEW ERA OF GLOBAL BANK

RELATIONSHIP MANAGEMENT

James Gilligan, CTP, FP&A – Great Plains Energy, Inc. (Kansas City)

Stephan Ireland -- Redbridge Debt & Treasury Advisory (Houston)

Every component of the banking relationship can strengthen it or weaken it

Banking relationships are complex and subtle

• HISTORICAL and LONG STANDING relationship

• HUMAN based relationship

• Evolved with MUTUAL TRUST and CONFIDENCE

• Sometimes (often?) POLITICAL

• ADMINISTRATIVE …

• A CHOSEN…

• …or ENDURED relationship

• ALL of it?

2

But it is ALWAYS a relationship based on performance, risk and profitability KPIs

3

AGENDA

3

• 1 Regulatory background

• 2 Bank reactions

• 3 RAROC & economic capital

• 4 Taking advantage of the new rules

• 5 Questions

Basel III changed banks forever

• Basel III establishes a minimum Common Equity Tier 1 (“CET1”) ratio

• Rules require more stringent adjustments to the calculation of CET1

• Non-cumulative perpetual preferred stock classified as Tier 1 capital

• Subordinated debt classified as Tier II capital

• Minority interests receive significantly reduced capital treatment

Capital requirements for banks were substantially increased

• Banks will be required to hold 2.5% of risk-weighted assets (RWA) in Common Equity Tier 1, above the

minimum ratios, to satisfy this requirement and avoid restrictions on discretionary capital distributions

Basel II

Minimum

Basel III

Minimum

(Effective Jan

2015)

Capital

Conservation

Buffer

(Effective Jan

2019)

Total

Minimum

Ratios

Maximum

G-SIB Buffer

(if applies)

Potential Minimum

Ratios for

Large Banks

Common

Equity

Tier 1

(“CET1”)

2.0% 4.5% + 2.5% = 7.0% + 2.5% = 9.5%

Tier 1

Capital4.0% 6.0% + 2.5% = 8.5% + 2.5% = 11.0%

Total

Capital6.0% 8.0% + 2.5% = 10.5% + 2.5% = 13.0%

Common

Equity

Tier 1

Non-Common

Regulatory

Capital

Capital

Conservation

Buffer

4

G-SIB surcharges

• Systemically important banks are viewed as being

riskier

• Global Systemically Important Banks (G-SIBs) are

allocated to surcharge buckets corresponding to the

higher loss absorbency requirements they would be

required to hold

• Systemic importance is determined by computing a

score based on the equal weighting of 5 factors:

• Cross-jurisdictional activity (Banks with significant

global operations)

• Size (Banks with large balance sheet assets and/or

exposure)

• Interconnectedness (Banks with significant exposure

to wholesale funding and counterparty exposure to

other financial institutions)

• Substitutability (Banks with large custody, clearing

and/or underwriting operations)

• Complexity (Banks with significant capital markets

exposures and illiquid investments)

Surcharge

Bucket

G-SIBs(effective Jan 2017)

G-SIBs(effective Jan 2018)

3.5% (Empty) (Empty)

2.5%HSBC

JP Morgan Chase

Citigroup

JP Morgan Chase

2.0%

Barclays

BNP Paribas

Citigroup

Deutsche Bank

Bank of America

BNP Paribas

Deutsche Bank

HSBC

1.5%

Bank of America

Credit Suisse

Goldman Sachs

Mitsubishi UFJ FG

Morgan Stanley

Barclays

Credit Suisse

Goldman Sachs

Industrial and Commercial Bank of

China Limited

Mitsubishi UFJ FG

Wells Fargo

1.0%

Agricultural Bank of China

Bank of China

Bank of New York Mellon

China Construction Bank

Groupe BPCE

Groupe Credit Agricole

Industrial and Commercial

Bank of China Limited

ING Bank

Mizuho FG

Nordea

Royal Bank of Scotland

Santander

Societe Generale

Standard Chartered

State Street

Sumitomo Mitsui FG

UBS

Unicredit Group

Wells Fargo

Agricultural Bank of China

Bank of China

Bank of New York Mellon

China Construction Bank

Groupe BPCE

Groupe Credit Agricole

ING Bank

Mizuho FG

Morgan Stanley

Nordea

Royal Bank of Scotland

Santander

Societe Generale

Standard Chartered

State Street

Sumitomo Mitsui FG

UBS

Unicredit Group

G-SIBs have even higher capital requirements

U.S. Banks highlighted in red

5

Basel III also seeks to limit leverage

Basel III pressures RWAs and lending capacities

6

CCF Commitment Type

100%

• Standby Letters of Credit serving as financial guarantees for loans

and securities

• Sale and repurchase agreements and asset sales with recourse

• Lending of banks’ securities or the posting of securities as

collateral by banks

• Forward asset purchases, forward deposits and partly-paid shares

and securities

50%

• Commitments with an original maturity > one year

• Certain transaction-related contingent items (e.g.: performance

bonds, bid bonds, warranties)

• Note issuance facilities (NIFs) and revolving underwriting facilities

(RUFs)

20%• Commitments with an original maturity up to one year

• Short-term self liquidating trade letters of credit arising from the

movement of goods

10% • Commitments that are unconditionally cancellable

• Basel III establishes a minimum 3% Leverage Ratio:

• Exposure calculation utilizes Credit Conversion Factors (CCF) to

convert undrawn commitments to a measure of exposure

* U.S. G-SIBS subject to a 5% minimum

3% Minimum*: Tier 1 Capital / Total Exposure

(Effective January 2018)

4% U.S. Minimum: Tier 1 Capital / Avg on-balance sheet assets

(Currently Effective)

• United States has more stringent Leverage Ratio

• Basel III minimum still applies as “supplementary”

• U.S. rules also have Liquidity Coverage Ratio (LCR) test

High Quality Liquid Assets (“HQLA”)

Total Net Cash Outflows Over the Stress Horizon

(Currently Effective)

LCR = > 100%

• Applies in full to depository institutions and holding

companies with > $250 billion in assets or $10 billion in

international exposure

• Net Cash Outflows defined as the highest daily cumulative

net outflow occurring over a 30 day period

Basel III effect is passed on by banks to their clients

Banks may no longer find your business profitable

7

Risk-Based Capital

Ratio (%)

Regulatory Capital

Risk-Weighted Assets

=

“The Shrinking Bank Portfolio Teepee”

Possible

investment

banking

portfolios

Liquidity

Basel 3: LCR / NSFR

8

AGENDA

8

• 1 Regulatory background

• 2 Bank reactions

• 3 RAROC & economic capital

• 4 Taking advantage of the new rules

• 5 Questions

Banking industry is adapting its business model to the new environment

BANK REACTIONSCONSEQUENCES FOR

CORPORATES

Increase in bank fees

Unsustainable funding policy

Core Clients

Service Quality & Coverage

Rethink your bank relationship?

Targeting the AAAs?

Funding Scarcity?

• Re-pricing credit facilities

• Increasing pricing on side Businesses

• More Stringent documentation

• Reducing credit exposure & concentration limits

• Stricter credit approval processes

• Less flexibility

• Redefining Core clients list

• Devoting more or fewer resources to clients at specific levels of size or profitability

• Rationalization of branch structures

• Product rationalization

• Reducing resources (Improving C/I ratios)

Pricing

Optimization

Effective Customer

Management

Strategic Cost

Reduction

Effective Risk

Management

Consequences for corporates can be dramatic

Many factors can explain why your business might not be attractive to a particular bank at a specific time

10

Client’s Attraction

Bank Core capabilities

Capital constraints

Liquidity constraints

Business Sector

Risk Profile

Global Profitability

What makes your business attractive OR NOT to banks?

Global

Transaction

Services

Medium

Long term

Financing

Asset

Management

Capital

Markets &

Advisory

Trading

activities

Co

mm

erc

ial

Ba

nkin

g

Inve

stm

en

t

Ba

nkin

g

• Short term lending

• Trade Finance

• Cash Management

• Credit or Liquidity Facilities

• Leasing & Asset Based Credit

• Structured & receivable Finance

• Custody (administrative)

• Short & Long term Investments

• Debt Capital Market

• Equities Capital Market

• M&A / Advisory

• Rates / FX

• Equity

• Commodities

Historical averages collected over the last 15 years

Study based on 15 companies in the Global Fortune 1000

11

320

6

78

-

100

200

300

400

Bank fees (in $m)

Average

86%

40%

57%

0%

20%

40%

60%

80%

100%

Efficiency Ratio (%)

Average

30%

5%

14%

0%

10%

20%

30%

40%

RAROC (%)

Average

104

13

44

0

50

100

150

# of Banks per company

Average

How many banks do you need?

Bank Concentration

12

0%

10%

20%

30%

40%

50%

60%

70%

80%

A B C D E F G H I J K L M N O

Top 5 Banks vs. Total RevenuesTop 5 banks

represent

59% of total

business

0%

10%

20%

30%

40%

50%

60%

70%

80%

C B A F J D I N M H K L E G O

Top 5 Banks vs. Total Economic Capital

Top 5 banks

represent

50% of

total EC

13

AGENDA

1

3

• 1 Regulatory background

• 2 Bank reactions

• 3 RAROC & economic capital

• 4 Taking advantage of the new rules

• 5 Questions

RAROC is a tool used by banks to create and protect value based upon their IRR requirements

14

Revenues – Operating Costs – Liquidity Costs - Expected Loss

Economic Capital

Risk-adjusted performance measurements encompass multiple sets of concepts

• Revenues (Credit

margin, arrangement

fees, side business…)

• Revenues on Economic

Capital

• Cost to Income Ratio

• Refinancing costs

• Depend on maturity

• LCR & NSFR Costs

• Cost of Risk

• EAD x LGD x PD

• Ex-ante loan loss

impairments

RAROC =

• Unexpected Loss, capital required to absorb losses up to a chosen probability of failure (usually 95% to 99%)

• EC = Basel III Advanced Approaches Risk Weight (K%) x EAD

• Function of EAD, PD, LGD & M

• We can add Operational & Market risk too (not chosen in our methodology)

Four major risk parameters are key in assessing Economic Capital and the bank’s profitability

RAROC: Behind the words are risk parameters

15

Exposure

Less:

Collateral

Loss

Counterparty

Risk

Internal

Rating

Probability of

default over

next year

Bank

Exposures

Maturity

On/Off Balance

Sheet (CCF)

Exposure at Default: What is

the Bank’s Actual Exposure a

the time of default?

Loss Given Default: How much

will the Bank actually lose if

you default? (Will the bank

recover some of it?)

M

PD

EAD

LGD

Maturity: What is the

duration of the Bank’s

commitments?

Data collected over the last 15 years

Have You Heard About The Business Case?

16

Infinite

41% 36%

20%

6%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

AssetManagement

Advisory andCapitalMarket

Tradingactivities

Short TermFinancing

GlobalTransaction

Banking

Long termFinancing

Average RAROC per product category

46%

54%

Revenue Distribution

Credit

Side business

87%

13%

Revenue Distribution

Recurrent revenues

Nonrecurrent revenues

74%

26%

Revenues distribution by BU

Commercialbanking

Investment banking

Analyze the impact of banking services on profitability

Understand What Matters

17

6,1%

13,7%17.5%

32.4%

24.2%

3066%

Infinite

0,0%

2,0%

4,0%

6,0%

8,0%

10,0%

12,0%

14,0%

Long term Financing Short TermFinancing

Trading activities Global TransactionBanking

Advisory and CapitalMarket

Asset Management Total

6.1%

7.7%

8.7%

11.2%

13.2%13.7%

RAROC can help corporates more accurately price financial operations and adequately measure side business amounts

And the sensitivity to all risk parameters

18

7,41%

10,46%

14,50%

19,63%

25,79%

0%

5%

10%

15%

20%

25%

30%

BBB- BBB BBB+ A- A

RA

RO

C

Rating

28,58%

19,60%

14,50%

11,29%9,12%

0%

5%

10%

15%

20%

25%

30%

35%

3 4 5 6 7

RA

RO

C

Initial Maturity (years)

13,99%

14,25%

14,50%

14,76%

15,02%

13%

14%

14%

14%

14%

14%

15%

15%

15%

15%

100 110 120 130 140

RA

RO

C

Spread (bp)

15,02%

14,50%

13,99%

13,47%

12,5%

13,0%

13,5%

14,0%

14,5%

15,0%

15,5%

#N/A 10 bp 20 bp 30 bp 40 bp

RA

RO

C

Cost of Liquidity

Banks use Economic Capital & RAROC in different ways to create value for their shareholders

RAROC & Economic Capital are strategic tools for banks

• Depending on existing Capital & RWA,

banks can calculate their maximum risk

budget (Economic Capital)

Defining Risk Budget

• Allocation of EC per Business Unit, Desks,

Products, Transactions…

• Allocating per Counterparty (PD)

Allocating Risk Budget

• Used in approval processes (yearly

analysis / transaction request)

• Subject to business judgment

Decision Making

• Use selectively in pricing

• Link To EVA: If RAROC > Cost of CapitalPerformance

19

20

AGENDA

2

0

• 1 Regulatory background

• 2 Bank reactions

• 3 RAROC & economic capital

• 4 Taking advantage of the new rules

• 5 Questions

Transparency is the foundation of a fair and long standing relationship

21

If your bank tells you “We are not meeting our rate of return, We need more business! »

• Ask for bank fee reporting

• Always compare with the

market and your peers

• Check how compares to other

banks

• BUT: How and what to

accurately compare?

• Be aware that each business /

transaction has its own EBIT

structure (Efficiency ratio)

• ASK your bank for average

cost/Income ratios

• Check annual reports (cost to

income ratios)

• Is your bank using an internal

rating process?

• What is your rating?

• Check what financial ratios

your bank uses to assess

your company

• What qualitative information

does your bank assess?

(Management, Industry, etc.)

• Sell your credit: organize annual bank meetings and sell your risk profile! Ask your bank to share their Internal rating in return

• Optimize bank capital by using less greedy economic capital instruments (securitization, factoring, receivables), by implementing a commercial paper

program or issuing Private Placements.

Cash or receivable collateral reduce significantly RWAs. Make sure you benefit from the reduction in your pricing / margin!

• Be careful when assessing the amount of liquidity lines. They tend to be the highest cost of capital to the bank. Do you have a liquidity policy? How

often do you review it?

• Typically the longer the maturity, the better for your company (not for your banks)! Longer = expensive! Diversify your liquidity profile by issuing several

bilateral credit lines with different maturities instead of a global RCF. You might even have better rates!

• Ask what is your bank’s hurdle

rate (RAROC / RoRWA) ?

• Does your bank have a

profitability issue, fee issue, or

both ?

If you don’t ask, you don’t get!

Rank your banks to decide how to distribute business

Measure & quantify revenues, Economic Capital & RAROC

22

Revenues 2013 Revenues 2012 EC 2013 EC 2012

(in M EUR) (in M EUR) (in M EUR) (in M EUR)

BNP Paribas 32,8 26,1 24,8 23,1 39% 33%

HSBC 20,1 15,0 12,4 12,6 40% 9%

Société Générale 14,3 9,1 16,0 19,5 26% 13%

Société Générale 14,2 9,1 16,0 19,5 26% 13%

Crédit du nord 0,1 0,0 0,0 0,0 25% -

BPCE 12,0 21,3 7,1 10,0 25% 38%

Bred 4,2 11,4 0,2 0,5 -207% 229%

Natixis 7,8 9,9 6,9 9,4 31% 28%

Intesa Sanpaolo 11,5 9,7 15,4 19,4 20% 14%

Crédit Agricole 10,1 5,7 16,4 14,6 21% 13%

RBS 9,7 4,6 8,9 11,8 24% 10%

CITI Bank 9,6 2,0 4,2 4,3 62% 12%

Morgan Stanley 6,3 9,7 2,5 3,6 63% 58%

Barclays 6,0 4,6 9,6 14,0 15% 8%

Goldman Sachs 5,8 2,7 3,6 4,4 39% 14%

Crédit Suisse 4,9 2,3 3,5 4,1 37% 14%

Deutsche Bank 4,7 6,2 4,8 2,8 23% 50%

Lloyds 4,7 1,8 4,7 5,9 30% 9%

Bank of America 4,0 1,7 7,0 6,7 16% 8%

Nomura 3,4 1,5 2,2 2,6 40% 13%

Santander 3,1 1,7 6,7 5,7 15% 10%

CM-CIC 2,7 2,9 5,1 5,5 21% 20%

ING 2,6 1,9 6,7 6,1 14% 10%

Unicredit 2,3 2,0 11,1 10,5 6% 6%

La Banque Postale 2,1 3,8 2,0 2,6 47% 76%

Commerzbank 1,8 1,2 5,4 4,9 11% 9%

BoTM 1,4 1,3 7,7 7,6 7% 6%

Royal Bank of Canada 1,4 0,2 4,8 2,6 8% 3%

Mizuho 1,3 0,2 4,5 4,1 9% 2%

SMBC 0,7 0,3 2,3 2,7 10% 3%

JP Morgan 0,6 1,4 0,9 1,0 18% 41%

Wells Fargo 0,3 0,2 0,0 0,0 Infini Infini

ANZ 0,1 0,3 0,1 0,3 15% 17%

Nordea 0,1 0,3 0,0 0,0 323% 142%

Total 180,5 141,8 200,5 212,6 24,45% 16,70%

2013 RAROC 2012 RAROC

Identify which banking relationships are profitable

Bank Fees are not enough

23

Hurdle rate

Opportunistic or Banks in danger

You are in danger!

24

AGENDA

2

4

• 1 Regulatory background

• 2 Bank reactions

• 3 RAROC & economic capital

• 4 Taking advantage of the new rules

• 5 Questions

Stephan Ireland – Managing Director

Redbridge Debt & Treasury Advisory

Houston, TX

832-321-2754

sireland@redbridgedta.com

James Gilligan, CTP, FP&A – Assistant Treasurer

Great Plains Energy, Inc.

Kansas City, MO

816-556-2084

jim.gilligan@kcpl.com

THE NEW ERA OF GLOBAL BANK

RELATIONSHIP MANAGEMENT