Three papers for loan drawdowns found their way into the desk of Briana Schalling, the CFO of a small bank. Her corporate lending salespeople were able to secure three new to bank clients with funding requirements. All three papers were already approved by the chief risk officer and the probability of default was close to nil for all three companies.

The only thing remaining before the loan proceeds are released is for the bank to agree to the amount of funds they will allow for drawdown and more importantly, the acceptability of the lending rates that the clients are asking for.

Lending Request

Briana quickly gave Ramon Villaruz, the head of corporate lending sales, a call and asked if they can still back out of the three deals. Ramon quickly answered, no, they cannot back out as the lines have already been committed. They can however still adjust the pricing as the contract. While the corporate clients can draw on the line at any time and the said line cannot be cancelled unilaterally by either the bank or the corporate client, the bank can unilaterally decide on the pricing or loan rate at any point and time. Ramon also reminded Briana that the CEO and CRO have both signed off on the contract. The clients would like to draw already, and have proposed a pricing agreed upon by Ramon, just pending the CFO’s decision.

Ramon then comments that he has a lending target to bear in mind. If the borrowers do not drawdown, might not be able to meet his target. His target for the year is to increase the lending book by 5B. If there are any declines from previous clients, he will have to replace those clients with new ones.

Briana then asked Ramon how much the margin Ramon expects from these deals. Ramon then said that his basis for his expected margin was the Fund Transfer Pricing [FTP] cascaded by their treasury team. Briana thanked Ramon and prepared Annex A, summarizing the funds requested for drawdown by each borrower and the corresponding FTP cost for each one at every point of drawdown.

Not satisfied by this, Briana also asks Ramon to list down his clients which he gives the lowest rates to and who’s only relationship with the bank is lending. Unsure as to why Briana would ask for such a thing, Ramon obliges and add this information to Annex A.

Deposit Costing

Briana felt that she was missing a major component in the equation and decided to call the deposit team to see how they can possibly raise funding. She knows that her equity and liabilities are stretched and she will have to reach out to big name corporate clients in order to facilitate the transaction.

Her deposit team shared with her Annex B, showing to her the average funding cost of the entire funding pool. Not yet satisfied with this answer, she asked her team what kind of rate she will be facing in the event that she has to raise 10B at increments of 1B each and her deposit team happily obliged to share with her Annex C.

Knowing full well that there are certain tax and regulatory requirements, Briana brings in her tax expert and he tells her that indeed she will be facing three additional costs. Her tax expert said that she will have to pay deposit insurance cost of 0.20% and documentary stamp tax of 0.75% for every PHP of deposit she brings in based on Annex C. She was also well aware that she had to think about reserve requirements.

Transfer Fund Pricing and Targets

Briana was still confused as to what the head of corporate lending meant by he was facing the fund transfer price cost as cascaded by the head of treasury and she calls the head of treasury next. He explains that their fund transfer pricing mechanism is based on a flat rate. This flat rate, across all tenors based on the rate of the overnight deposit facility, a risk free asset with a 100% HQLA weight.

The head of treasury then explains that the basis of this was that the policy was based the concept of opportunity cost. For every PHP that he gave to the head of corporate lending, he would have less PHP to place in the overnight facility of the BSP.

She then asked how the treasury team gives credit to the deposit team via FTP. The treasurer then replied that they use exactly the same rate, based on the same principle. Briana was shocked and knew this may cause some problems. But she had little time left and a change in FTP policy could take months to implement. For now, she just needed two more bits of information from the head of treasury. She asked what the cash outflow assumption was for wholesale big ticket deposits and what the best rate was for HQLA assets was with a 100% HQLA weight. The head of treasury then happily answers 40% for cash outflow and 2.5%. Briana thanked the head of treasury and summarized what she had learned in Annex D.

Capital Cost and Requirements

Briana wanted to make sure she had covered all bases and decides to give the chief risk officer a call. She asks him what kind of expected credit loss he is seeing from the loans and he quickly brushes off her question by saying virtually none. These were top corporate clients and he was not expecting any default.

Frustrated by this answer, Briana paraphrases her question and asks how much capital the bank had to allocate to cover the exposure. To this, the CRO responded and sent her Annex E, depicting allocated capital for each level of exposure to the bank. Briana asked if the bank had a credit conversion factor, to which the CRO replied none, but they do allocate capital for undrawn exposures as if they were already drawn.

Seriously confused but short of time to make a decision, Briana thanks the CRO and ends the call. As the CFO, she knew already that the bank’s weighted average cost of capital or WACC was at 3.0%.

The management committee was going to meet the next day and Briana knew she had to come up with a decision on pricing soon. She opens her excel and begins to compute at what rate she will be comfortable to lend to each borrower. The borrower expects to drawdown next week and she has to decide quickly.

Requirements, be sure to answer the below questions

Decide on what rate Briana will agree to lend to each client, be sure to outline how you arrived at this rate. Will she lend to all clients or just a few?
Comment on the fund transfer pricing of the bank, is something wrong?
Comment on the average funding cost provided in Annex B and compare it against annex C and A.

 

New Clients that wish to drawdown Client Amount Requested [PHP B] Rate Proposed [Overnight Reprising] FTP Cost Uncancellable Line [PHP B] A 2 6.00% 1.50% 3 5.50% 1.50% 4 4.00% 1.50% Existing Loans with Low Rates Client Amount Requested [PHP B] Current Rate [Overnight Reprising] FTP Cost Uncancellable Line [PHP B] D 1 1.65% 1.50% 1 E 1.75% 1.50%