Banc one Case Solution

Group Member:

Tianhui Yao, Longji Liu

1. What is Banc One’s problem?

The share price of Banc One was falling from $48 to $36 in 7 month. The impact of falling share price will effect pending acquisitions. Banc One will either terminate acquisition or pay with undervalued stock.

The main reason of falling share price was that investors concern over Banc One’s large growing interest rate derivatives portfolio. Investors are uncomfortable with so much derivatives exposure, and they didn’t know how swaps could hedge risks because swaps were new tool to many of them.

Banc One already had attempted to pre-empt concern over its growing derivatives portfolio. Another one of Banc One’s problem is “ uncommon partnership”, which means decentralized the people side of the business and centralized the paper side consisting with the strategy of economic scale. Although it was an extremely complicated and highly decentralized organization, Banc One had one of the best financial track records in the country with highest average ROE, ROA and with string of 24 years of increasing EPS.

Other risk exposure was an issue with Banc One. The basis risk is that offsetting investments in a hedging strategy will not experience price changes in entirely opposite directions from each other.

The credit risks were 1. Counterparties were rated no lower than single-A. 2. The total exposure to any entity was limited by clear policy guidelines. 3. It required its counterparties to post collateral in the form of bank-eligible securities or cash. 

The liquidity risk refers to the risk that a financial institution will be unable to raise the cash necessary to roll over its debt, fulfill the cash, margin, or collateral requirements, meet capital withdrawals.

The swaps used to hedge various risk are 1. IFRS enjoy high yields in exchange for taking on prepayment risk; 2. AIRS hedge the risk of prepayment.

And last the basis swap to counter basis risk would be use swaps to shift sensitivity and hedge some disadvantage of its conventional fixed-rate investment.

1. How does Banc One manage its interest rate exposure with derivatives?

In the early 1980s, it managed its exposure to interest rate risk by adding balancing assets to its investment portfolio until it felt it had enough fixed-rate investments to offset its fixed rate liabilities. It invested in US Treasuries and high-quality municipals bonds. 1981-Banc One began measuring its interest risk exposure by maturity gap. Maturity gap is used to predict how bank’s net interest margin would be affected by changes in interest risk. In 1983, Banc One began using interest rate swaps as part of its investment portfolio. The bank’s net cash flow from the investment and swap resembled a floating-rate investment with an above-market yield. During 1983-1984, Banc One became increasingly comfortable with the use of interest rate swaps as a tool to tailor individual investments to suit its needs. 1984-Banc One began using asset and liability simulations, it created an on-line balance sheet that contained up-to-date information on its asset and liabilities. In 1986, Banc One began to use MBSs due to the Tax Reform Act.