Implementing Basel II and Beyond

Michael Barak SVP, Basel Capital Manager October 16, 2012

*Views expressed here are my own and do not represent those of Union Bank

1 |

• Union Bank Overview

• Current Status

• Union Bank Solution

• Risk Management: Basel II End-to-End Controls

• Current Challenges

• What Worked – Applicability for Basel III

Agenda

2 |

• Headquartered in San Francisco, CA

• Financial Highlights • Total assets: $90B • Total loans held for investment: $54B • Core deposits: $53B • Tier 1 common capital ratio: 13.78%

• 407 Branches

• Key Markets • Consumer • Small Business • Middle Market • Real Estate • Corporate

• Union Bank is a wholly-owned subsidiary of Mitsubishi UFJ Financial Group

Union Bank Overview: Financial Highlights

Source: SNL, 2Q12, end of period

3 |

Union Bank Overview: Risk Management Framework

4 |

Basel II Capital Accord

Validation, Oversight and Governance Data Integrity and Management

Pilla

r 1

Capi

tal R

equi

rem

ent

Pilla

r 2

Capi

tal A

dequ

acy

Pilla

r 3

Mar

ket D

isci

plin

e

Pillar 2 – Capital Adequacy •Validate capital calculated in Pillar 1 •Consider risks not valued in Pillar 1 •Establish Risk Appetite •Challenge capital calculation through:

– Stress Testing – Concentration Analysis – Economic Capital

Pillar 3 – Market Discipline Public disclosure of capital requirement for publicly traded companies and additional regulatory schedules for all Basel II companies

Pillar 1 – Capital Requirement Calculate capital for: •Credit Risk

– Establish Rating Philosophy – Advanced Internal Ratings Based

Approach – Retail exposure segmentation – Wholesale scorecards

•Market Risk

– Value at Risk modeling

•Operational Risk – Advanced Measurements Approach – Internal and External Loss Data – Business Environment & Internal

Control Factors – Scenario Analysis

Union Bank Overview: Basel II Capital Accord

5 |

•Union Bank entered parallel on April 1, 2011 • Leading up to the parallel run entry, UB conducted three self assessment exercises which served

as the basis for entering parallel • Parallel entry has triggered Regulatory Reviews and increased scrutiny • Submitted 5 quarters of Basel II results to the Supervisors

•Regulatory Changes

• CCAR • Basel III • Basel Standardized & Advanced

•Union Bank Changes

• Acquisitions • New Products • Supervisory Recommendations

Current Status

6 |

Deliverable

Business Solution

Documentation

Deliverable

Regulatory Gap

Documentation

Deliverable

Business Requirements Documentation

Deliverable

Data Requirements Documentation

Deliverable

Key Data Elements

Objectives Deliverables

Using the Basel II Pillar I Advanced Approach, calculate the Bank’s RWA across all exposures

Deliverable

Policies and Procedures

Implement a vendor supported risk-weighted asset and economic capital engine and data model

Integrate the risk-weighted assets results with the required Regulatory Reports

Integrate the economic capital results within Performance Reporting

Define and execute a monthly process where the results are timely and accurate (Attestation)

Union Bank Solution: Objectives & Key Deliverables

7 | Source: Basel II FP&A Process Documentation

Wholesale excl . Trading

Systems and Data Sources Data Warehouse

SAS

Limits Management System

Excel

Direct Input

Retail excl . SAS

General Ledger

Retail

Trading ( Credit )

Securitized Assets

Equities / Funds

Wholesale Securities

GL Adjustments

ARC

Counterparty Impairment

Wholesale Impairment

Fronting Committed Unissued LC’s

Wholesale Impairment

Credit Default Swaps (CDS)

Total Return Swaps (TRS)

FDIC Indem. Asset

RWA Calculator

Basel II Reporting

FFIEC 101

Electronic Submission

FFIEC 101

Other Reporting

FFIEC 031 & FR Y - 9 C

Management Reporting

Moody’s

Operational Risk

Acquisition

Data

Quali

ty, D

ata M

anag

emen

t, Da

ta Go

vern

ance

Pro

gram

• The RWA calculation is an integrated process encompassing attributes from multiple sources. A vendor tool from Moody’s is used for the RWA calculation, FFIEC 101 reports and the electronic submission.

Acquired Loan Data Mart FDIC

Acquisitions

Market Risk

Union Bank Solution: Basel II RWA Overview

8 |

Exposure Category

A

Exposure at Default

($M)

B

Wt Avg PD (%)

C

Wt Avg LGD (%)

D

Wt Avg Maturity (Years)

E

RWA($M)

F

RWA / EAD (%)

Wholesale Exposures Corporate / Bank / Sovereign 1,463 0.2 (0.6) (0.3) 554 -1% Real Estate: IPRE & HVCRE 299 1.8 (0.9) (0.0) (146) -5% Securities (3,880) 0.0 (0.1) 0.1 (389) 0% Counterparty (Derivatives) (2) 0.1 (1.6) 0.4 93 6%Retail Exposures Mortgage - First Lien 751 (0.2) (0.8) (486) -3% Mortgage - Junior Lien (1) 0.1 (1.6) (41) -1% Other Retail Exposures 513 0.0 (6.4) 188 -3%Securitization Exposures 123 (0.0) (71) -3%Equity Exposures (15) (315) -15%Other Assets (1,801) (32) 13%Acquisition (2,041) (529) 38%Excess Credit Reserves (25) Market Risk Assets 41 Operational Risk (781)

TOTAL (4,592) (1,889) 1%

Union Bank Solution: Use Test - Basel II QoQ Changes

Higher PDs due to integration of acquired assets; otherwise lower.

June sales of securities drive decrease in wholesale borrowings; proceeds fund repayment of short-term debt

Decrease in Equity RWA driven mainly by continued fund sales due to Volcker Rule

Completed integration of acquired exposures into Basel II AIRB

Annual scenario analysis resulted in increased alignment with AMA model, thus less additional capital required

HPI decrease results in lower LTVs, and thus decreased PD and LGD

>10% change, benefit to RWA 5%-10% change, benefit to RWA

>10% change, detriment to RWA 5%-10% change, detriment to RWA

<5% change, minimal RWA impact

Legend

9 |

Allocated Capital Total of Business Unit Capital Consumption is greater than Allocable Capital Pool. •“Residual” credited back reduces Business Unit Capital Consumption. Pro rata based on Consumption

Segment Capital Consumption (Basel II, Pillar 2) Risk Based Capital •Economic Capital on segment assets

•Basel II Credit EC (8.5% x RWA)

Other EC Components •Ops Risk (8.5% x RWA), market risk, pension risk, business risk, management buffer, less diversification benefit

•No ALM Market Risk

Minimum 5% TCE floor applied •Tangible floor of 5% is less than 7% bank-wide hurdle

•Represents some diversification benefit

Goodwill •Including privatization

Allocable Capital Pool (Basel I Based) GAAP Shareholder’s Equity •Represents UB capital, the base upon which a return is expected

Strategic Capital •Determined by Basel I as constraint •Undeployed capital reserved for strategic purposes •Segments not expected to earn a return on Strategic Capital

Management Reporting

Union Bank Solution: Use Test – Capital Allocation

10 |

Risk Management: Basel II End-to-End Controls

Basel II End-to-End

Controls Framework

6. Attestation 3. Documentation

1. Governance 2. Testing

4. Data Integrity 5. Operational Process

Utilize for key decisions, policy and procedures, executive milestones and result review

Process for testing Basel II as a whole covering key functionality, IT infrastructure, data sets and complete data

Defining business and data requirements; defining solution design and desktop procedures

Examines completeness, validity, consistency, timeliness and accuracy of data as it moves from source to target

Ensures on-going security, integrity and continuity of systems and data; incorporates change management

Process that requires business users to sign-off completeness, accuracy and timeliness of data; overall ownership & approval

11 |

Executive Steering Committee

• Corporate & Retail Banking Vice Chair

• CIO

• CRO-Chair / CFO Co-Chair

• CEO

Basel II PMO

• Regulatory Liaison • BTMU Liaison

• Project Managers • Budget Analysts

Workstream Leads

• Risk-Weighted Assets

• Data Integrity • Pillar II / ICAAP • Regulatory

Reporting

• Counterparty Risk • Market Risk • Operational Risk • Wholesale Credit

Risk • Retail Credit Risk • Other Credit Risk

RWA Steering Committee

• EVP, Controllers • SVP, Internal Audit • SVP, IT

• Basel PMO • EVP, FP&A • CFO, Treasury • EVP, Risk Mgt.

Board of Directors

• Risk Committee

• Utilize governance for key decisions, executive milestones, budget approval and project execution.

Risk Management: Governance Overview

12 |

Moody’s Calculator Testing

RWA Engine & FFIEC 101

Testing

Testing By Portfolio

Entire Portfolio Testing

5 Months 4 Months 7 Months 3 Months

• Verify RWA calculations

• Verify solution meets project requirements

• Obtain UA for FFEIC 101 and RWA implementation

• Verify data provisioning by major exposure type

• Verify entire portfolio data • Verify activity execution

• Create core test cases

• Fast start

• Identify and address any critical data quality issues

• Mitigate implementation risk

• Run the period close process and make necessary adjustments

• RWA engine is installed

• Test data is mapped to the RWA calculator

• UB’s parameterization and customization are performed

• UB’s specific target data elements are identified.

• Calculator testing results variances are explained

• Basel II upstream IT projects are finished

• Development of RWA data provisioning is complete

• Attestation process participants are trained; RWA data sources are in production

• Development of outbound interfaces and management reporting is complete

• Development • Mock-up data

• Test • Data for GL, Commercial

and Retail • Mock-up data for Trading,

Securitization & Equity exposures

• Test • Snapshots of real UB

portfolio data

• Production • Min. 2 monthly runs of UB

data with 1 month being quarter end

Objective

Benefits

Data & Environment

Dependencies

Risk Management: Testing Activities & Timeline

13 |

Exposure Class Parameters Tested Results Tested # of Test Cases # of Variances

Commercial

• Exposure Sub-Category • Default Flag • PD Floor • Maturity Floor & Ceiling • PD Substitution • LGD Adjustment • UB PD/LGD Combinations

• R based on exposure sub-category • K & DRBC amount based on defaulted

and non-defaulted exposures • RWA & ECL

131 0

Trading – OTC Derivatives

• Exposure Sub-Category • Default Flag • PD Floor • Maturity Floor & Ceiling • Derivative Type • Collateral Type, Issuer & Rating • Remaining Principal Payments • Holding Period • Currency Mismatch • Netting

97 14

Trading – Repo Style Transactions 65 65

Retail

• Exposure Sub-Category • Default Flag • PD & LGD Floor • Sovereign Guarantee • Segmentation

30 11

Securitization • External rating & rating type • Seniority • Granularity

• RWA & Deductions from capital 352 0

Equity • Exposure Sub-Category • RWA based on exposure sub-category 9 0

Other Exposures • DvP/PvP and Non-DvP/Non-PvP flag • Failed business days

• RWA 10 1

Retail/Wholesale Boundary • Monitoring retail-wholesale boundary • Basel II exposure class 11 4

Wholesale + Retail • Cross-default functionality • Exposure & obligor default consistency 10 3

Risk Management: Testing – Overview of Results

14 |

• Detailed requirements addressing exposure completeness, RWA calculation, reporting and input

• Defines the data elements, data structure, data owners used to determine source to target mapping and coding

• Defines all the regulatory rules, rule by rule

• Describes how the business requirements, data requirements and Basel II requirements are integrated into the comprehensive Basel II solution

• Describes the functional roles and responsibilities, the operating calendar, procedures and controls for executing the quarterly process and producing the regulatory reports and executive presentations

Business Requirements

Data Requirements

Solution Design

Gap Analysis

Objectives Deliverables

Desktop Procedures

Risk Management: Documentation

15 |

Priority

Criteria

Key Components

Examples

1

Data elements that impact the RWA calculation and asset classification

RWA calculation drivers

Asset Classification

Performing Status

Specific Allowances

Responsibility Center

PD, LGD, M, EAD, External Agency Ratings

Sovereign, Bank, Corporate, Residential Mortgage

Default

Expected Loss

Holding Company vs. Bank

2

Data elements that impact the economic capital calculation and both regulatory and management reporting

Regulatory reporting

Economic Capital

Management reporting

LTV, Lien Position, FICO Score

ZIP, Collateral type, Owner Occupied Flag

Chart of Account

3

Data elements that impact internal analysis Internal Analysis

Obligation Name, Data Source, Originating Responsibility Center, Purpose code

The process to identify the RWA data element priorities was based on the overall impact that the data elements have on the calculation and reporting functions, categorized as follows:

Risk Management: Data Integrity – Key Data Elements

16 |

Gather Data

Verify Data

Prepare Feed

Load Data in FDM

Manual Data Entry

Run DQ Checks

Prepare & Load

GL

ID Non-Matl & Other

Exposures

Perform GL

Recon Adjust

Calculate RWA

Analyze, Enter OTT Adj. Rerun

Attest

Prepare Regulatory

Reports

Analyze Rerun,

Attest and Submit

Investigate Communicate and Disclose

1. Prepare Portfolio / Data for RWA 2. Instrument Data Provisioning 3. GL Data Provisioning 4. Exposure Completeness

5. RWA Calculation 7. Post-Submission Inquiry Support

6. Regulatory Reporting

Line of Business

ITG ITG

Finance & Reg. Reporting

Finance & Regulatory Reporting Regulatory Reporting Finance & Regulatory Reporting

Key Process Primary Process Owner

Source: Basel II FP&A Process Documentation

Risk Management: Operational Process – Overview

17 |

Deliverable

KDE Quality Tracking & Reporting

Deliverable

Data Governance

Policy

Deliverable

Key Data Elements Inventory

Deliverable

End-to-End Data Process Maps

Deliverable

Roles & Responsibilities for Data & Controls

Objectives Deliverables

Establish one source of data and data process truth

Deliverable

Policies and Procedures

Create a centralized repository for documentation

Establish governance and controls around data and data processes to ensure quality standards are met

Union Bank Solution: Objectives & Key Deliverables

18 |

1. Prepare Portfolio Data for RWA

• Gather and verify data from system of record’s (SOR’s) into data repositories • General ledger (GL) asset classification including review by Controllers and Finance Team • Capital calculation parameters as defined by Credit Risk Function

2. Instrument Data Provisioning

• Load data into Fermat Data Mart (FDM) • Information technology group (ITG) and Finance Teams runs error checks for data quality

issues

3. GL Data Provisioning • Prepare and load GL data into Fermat and perform GL data quality check • May require multiple load of GL data • Identify non-material and other exposures

4. Exposure Completeness

• Reconcile GL amounts against instrument data and identify variances • Analyze and remediate variances and trigger adjustment process

5. RWA Calculation

• Calculate risk-weighted asset (RWA) • Perform comparative and variance analysis • Input over the top (OTT) adjustments from controllers (as needed) and recalculate RWA • Communicate results and obtain approvals

6. Regulatory Reporting • Collect data, including results of RWA calculation, manual inputs from the controllers • Prepare regulatory reports • Analyze, re-run, attest and submit

7. Post-Submission Inquiry Support

• Investigate and resolve feedback from the regulators following submission of regulatory reports. This step requires close cross-functional coordination

• Regulatory reporting group communicates and discloses

Source: Basel II FP&A Process Documentation

Risk Management: Operational Process – Activities

19 |

Finance

• Responsible for regulatory and economic capital calculations • Responsible for capital calculator changes when regulatory requirements

change • Attests accuracy of the risk-based capital numbers

Controllers Regulatory Reporting

• Attests accuracy of the FFIEC 101 schedules • Maintains GL account hierarchy and coordinates chart of accounts (COA)

communications

Credit Risk • Defining and maintaining policies and procedures around risk parameters

(e.g. probability of default (PD) risk rating scale, loss given default (LGD) risk rating scale, and default flags)

Data Integrity • Provides data quality support to business data owners • Defines data governance policies specifying data quality thresholds and data

resolutions

Line of Business • Attests to accuracy and completeness of data • Supports Finance in exposure completeness and GL Reconciliation

Information Technology Group

• Part of Bank’s ITG function supporting Bank’s systems • Manages data repositories and technology processes • Responsible for managing and resolving IT related issues

Moody’s Support • Support is provided under a contract between the bank and Moody’s

Risk Management: Operational Process – Roles

20 |

Business Units FP&A

Gather securitizations and equity data for electronic transfer load

Regulatory Reporting

Manually input over the top entries, capital adjustments and intercompany eliminations

KEY CONTROLS Business units attest to accuracy and

completeness of source data. Additional controls are currently being developed and put in place.

POINTS OF CONTACT Wholesale Retail Traded Products Securities Securitizations and Equities

KEY CONTROLS 1. Conduct attestation meetings with BUs

that certify to the accuracy and completeness of source data

2. Review and analyze data integrity and proxy issues

3. Reconcile GL to RWA exposures 4. Perform RWA variance analysis 5. Provide attestation to RWA calculation

to Regulatory Reporting 6. Present results to governance

committees for review

KEY CONTROLS 1. Review all workpapers and schedules

by 2 levels of managers 2. Reconcile FFIEC 101 to FRY9C 3. Obtain certifications from all BUs that

provide data 4. Resolve all data validation checks 5. Prepare reports in accordance with

regulatory instructions 6. Perform variance analysis of all line

items

Submit FFIEC 101 to regulators through IESUB

Manually input Market Risk, Operational Risk , and acquisition information

Develop and

maintain source data

Coordinate resolution of data integrity and exposure completeness issues

Generate FFIEC 101 reports, including Capital and RWA

Data Management Office

Gather data for input to

data models

Risk Management: Attestation

21 |

Data integrity is a focal point for the industry, regulators, and UB

Processing time for RWA calculations

Matters Requiring Attention (MRA)

As implementation progresses and matures, variability in results must be

understood and explained to BTMU and other stakeholders

New products

The challenges outlined below are by no means unique to UB. These are challenges that have had to be addressed by all Basel II banks whether domestic or international

Current Challenges

22 |

Proj

ect M

anag

emen

t • Teamwork

• Project Management 101 Bu

sine

ss &

Dat

a R

equi

rem

ents

• Extra time spent on gathering and finalizing business & data requirements

• Basis for change control

• Basis for Vendor communication

Staf

fing

and

Res

ourc

ing • Right resources

with subject matter expertise

• Training

• Key resources in testing / quality assurance

• Key resource in Data Analyst / bridge between IT and Business Ve

ndor

Rel

atio

nshi

p • Business knowledge

• Receptive to change / lack of bureaucracy

• Incorporated into initial planning and design

What Worked – Applicability for Basel III

23 |

Reporting capital in accordance to

Basel I general risk-based approach Basel II advanced approach

CCAR stress testing exercises and reports (FR-Y14A, FR-Y14Q, FR-Y 14M) Starting January 2015, Union Bank is required to report capital as per Basel III-Standardized Approach Report capital in accordance with BIII Advanced Approach Phase in the G-SIB initiative – FRY-15 Single Counterparty Credit Limit CCAR exercise with updated reporting requirements (FR-Y14A, FR-Y14Q, FR-Y 14M) Basel III Liquidity risk (LCR and NSFR liquidity ratios) once US rules will be defined

Changing Regulatory Landscape

Current regulatory environment

Future regulatory environment

23

24 |

Impacts due to changing regulatory landscape

CCAR and Basel calculations should be integrated to be consistent with regulatory filings to handle reconciliation issues between FRY-14 schedules and FR-Y 9C

Regulatory capital calculations: A greater data granularity is required for regulatory capital calculations

Regulatory capital optimization

– sourcing collaterals and guarantees data – optimization algorithms for Standardized approach

Regulatory capital forecasting processes become more complex since regulatory capital calculations require more granular data

FR-Y 15 requires credit and liquidity risk information

24