Operation Strategy

Falling share price April 1993 of $48 to November 1993 of$36

The impact of falling share price will effect pending acquisitions,
Liberty National Bancorp
terminate the acquisition
pay with undervalued stock

Banc One's asset and liability

Acquisition Strategy
completed 76 acquisitions involving 139 banks
largest pending acquisitions, Liberty National Bancorp
as paid for stock --dilutive or terminated
Business Stragegy
three-proged growth strategy
Concentrate on retail and middle-market commecial customers
Use technology to enhance customer service to assist in the
management of banking affiliates
Grow rapidly by acquiring profitable banks.
Why share price is falling
The main reason was that investors concern over Banc Ones large
and growing interest rate derivatives portfolio(CMO AIRS)
Investors are uncomfortable with so much derivatives exposure
Banc One already had attempted to pre-empt concern over its
growing derivatives portfolio
Investors did not know how swaps could hedge risks because swap
was a new tool to many of them
Banc One Introduction
headquarteredin Columbus, Ohio
the largest bank based in Ohio and the eighth largest in the US
$76.5 billion in assets
totally control 78 banking affiliates
10 nonbanking organization
Banc Ones Problem
uncommon partnership means decentralized the people side of
hte 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.
Asset
Floating-rate assets
Fixed-rate assets

CMO and MBSs

Treasuries. municipal bonds
Liability
Floating-rate liabilities
retail deposits, wholesale deposits and additional wholesale deposits
fixed-rate mortgages and securities
Fixed-rate liabilities
certificates of deposit
large time deposits such as federal fund borrowings
Balancing Assets
Conserve the funds principal value and provide a reasonable rate of
return through conventional investment.
Allow the bank to react quickly to demands for cash in liquidity
investment
Decrease the earning sensitivity to interest rate exposure.
Minimum the banks capital requirement for derivative investment.
How Banc One measure interest rate exposure
Before 1980-Banc One did not precisely measure is exposure to
changes in interest risk.
1981-Banc One began measuring its interest risk exposure by
maturity gap. Maturity gap is used to predict how banks net interest
margin would be affected by changes in interest risk
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.
1993-Banc One redesigned the on-line balance sheet which include
a discrete asset and liability database on each customer that
included prepayment, optionality and convexity estimate
How they hedge the interest rate exposure
Early 1980s-Banc One 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.
1981-13% and 21% of Banc Ones earning assets were money
market investment and long-term securities.
1983-Banc One began using interest rate swaps as part of its
investment portfolio.
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.
Prior to 1986-Banc One invested in short and medium-term U.S.
Treasuries and high-quality municipal bonds
Earlier in the 1980S, two-thirds of investment portfolio was held in
CMOs with high yields associate with bearing prepayment risk.
1986-Banc One replaced many of its municipal investments with
MBSs
Late 1980s-Banc One using a synthetic CMO to get high yields in
exchange for taking on prepayment risk. And developed a product

called AIRS
other risk exposure
Basis Risk
risk that offsetting investments in a hedging strategy will not
experience price changes in entirely opposite directions from each
other
Credit risk
Its counterparties were rated no lower than single-A.
Its total exposure to any entity was limited by clear policy
guidelines.
It required its counterparties to post collateral in the form of bankeligible securities or cash.
Liquidity risk
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
swaps used to hedge various risk
IFRS enjoy high yields in exchange for taking on prepayment risk
AIRS hedge the risk of prepayment
Basis swap to counter basis risk
use swaps to shift sensitivity and hedge some disadvantage of its
conventional fixed-rate investment
Solution
The first is they could do nothing and wait for the stock price
recovering over time as investors realized that derivatives were
helping the bank manage interest rate and basis risk.
The second solution is Banc One should abandon or severely limited
their use of derivatives.
The third method is to educate investors about how they use
derivatives.
Our Recommandation
Banc One should not abandon their use of derivatives unless Banc
One find alternate non-derivative safer methods in order to manage
their interest rate risk exposure.
Main Reasons
comparison between Banc One and one hypothetical Banc One
Swap can shift earning sensitivity from asset sensitive to liability
sensitive
hedge their interest rate exposure
Banc One Corporation
Asset and Liability Management