Dynamic Portfolio Management Process-Observations from the CrisisIvan MarcotteBank of America Global Portfolio Strategies Executive

February 28, 2013

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Traditional Approach to Risk Management

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Traditional Approach to Risk Management

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Traditional Approach to Risk Management

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Impact of Growth vs. Volatility on Valuation: Banks that Survived

-30% -20% -10% 0% 10% 20% 30%0.00

0.50

1.00

1.50

2.00

2.50

3.00

P/B Valuations: Growth/Vol Contributions

Wells Fargo Series6 Bank of America Citigroup JPMorgan Chase

Prior 8 Quarter Average of Net Income/Sales

Pri

ce/B

oo

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Bubble size repre-sents prior 8 – quar-ter average of the standard deviation of Net Income/Sales

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-80% -60% -40% -20% 0% 20% 40%0.00

0.50

1.00

1.50

2.00

2.50

3.00

P/B Valuations: Growth/Vol Contributions

Merrill Lynch Wachovia Lehman

Prior 8 Quarter Average of Net Income/Sales

Pri

ce/B

oo

k

Bubble size repre-sents prior 8 – quar-ter average of the standard deviation of Net Income/Sales

Impact of Growth vs. Volatility on Valuation: Banks that Failed

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Attributes of a Desirable Benchmark through the Credit Cycle

Time

Earnings Path through Credit Cycle

Active LumpyCredit Portfolio

SystematicBenchmark

Region 1

BenchmarkUnderperformance

Region 2

BenchmarkOutperformance

Question to Consider:

Which underperformance region is worse for the stock price and PE multiple? Region 1 or Region 2

Question to Consider:

Which underperformance region is worse for the stock price and PE multiple? Region 1 or Region 2

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• Portfolio Alignment Alignment of credit risk into portfolio that is consistent with risk distribution strategy.

• Market Value Transparency Quantifies the opportunity cost associated with originating/renewing transactions relative to comparable risk available in market.

• Efficient use of Credit Risk CapitalEnsure sufficient relationship value to justify concentration risk and cost of hedging.

• GovernanceLeadership review and approval of transactions with significant opportunity costs.

• AccountabilityOpportunity costs are captured and tracked as a component of overall client relationship value and included in performance measurement processes.

Excess Concentration Management - Goals

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Held Credit

Portfolio

RebalancedCredit

Portfolio

Reduce Credit Concentration Risk

Optimize Portfolio Diversification

Improve Portfolio Risk/Return and

Liquidity

RebalancedCredit

Portfolio

Efficient Portfolio Growth

Support Business Growth / Efficiency

Opportunities

Credit Migration

Risk

Credit Correlation

Risk

Reinvestment

Credit Concentration

Risk

Reduce commercial credit portfolio concentration risk using quantitative analytics and risk distribution strategies on an end-to-end basis.

Excess Concentration Management – Conceptual Framework

Credit Portfolio Modeling - A Quantitative Link of Expected Returns and Risk Appetite

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Business Model Considerations for Credit Portfolio Models

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Expected Returns

• Book ReturnExpected return at investment horizon on an accruals basis for the portfolio. Measures include: net interest margin, risk adjusted net interest margin, net interest income plus fee revenues.

• Mark to Market ReturnExpected mark to market return for specified investment horizon. Incorporates accrual return plus mark to market effects due to credit migration or default. Can be expressed as excess return relative to risk free return.

• Par Spread The fair price (returns par value today) of a credit with respect to the default probability, correlation to the market, the market risk premium, expected recovery, and maturity.

• FeesExpected relationship revenues that would not be present if sufficient credit were not extended in primary lending markets.

Credit Portfolio Characteristics - How Do We Measure Returns?

Putting It All Together - Portfolio Modeling Process Overview

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Applications: The Quantitative Portfolio Optimization Value Proposition

Applications: Quantitative Portfolio Optimization Value Proposition

Value Proposition

• Construct forward-looking optimal credit portfolios to guide rebalancing actions through the credit cycle that are consistent with growth, revenue, and asset quality plans

• Actions• Reduce event and concentration

risks that drive earning volatility• Improve credit portfolio risk-return

Optimization methods address fundamental

strategic portfolio rebalancing questions:

• How much should we increase or reduce exposure to a sector or customer?

• What are the best rebalancing or re-pricing opportunities?

• How do we manage the P&L volatility associated with the balance sheet

• What’s the prospective cumulative impact of rebalancing, hedging, or re-pricing actions

• How are we doing ? Compared to what?

Result in:

• Risk-return decomposition and direction• Best revenue enhancement – risk reduction opportunities• Hedge construction and performance analysis• What if and sensitivity analysis• Realized performance tracking and feedback

Credit Portfolio Management Process Framework

Oversight

A repeatable portfolio management process that integrates with the yearly business planning process, incorporates monthly fundamental, market and quantitative analysis, and is managed by a governing committee.

Set Yearly Business Plans

Construct yearly Performance

Tracking Index

Develop Forecasts and

Views

Construct Optimal View

Recommend Rebalancing

Actions

Track & Report Performance

Business Portfolio Modeling & Analysis

Monthly Performance Feedback

• Establish new business plans, growth, revenue, and asset quality targets

• Use Portfolio Optimizer to establish neutrally derived achievable portfolio index consistent with business plans

• Define objective index rebalancing rules

• Economic, credit conditions, and spread forecasts

• Regional sector views and projections

• Evaluate current portfolio results under alternative views

• Construct Quantitative portfolios conditioned on views and forecasts

• Obtain Fundamental analysis

• Obtain Market analysis

• Evaluate optimal portfolio results under alternate views

• Evaluate additional market implied information on sector and customer segment performance

• Recommend rebalancing action

• Track and report actual realized risk and return performance of portfolio, index and quantitative view

• Performance tracked at portfolio, business line, sector, region, or other level as needed

• Primary drivers of over or under performance identified