Banc One

Topics: Interest rate swap, Credit risk, Interest Pages: 82 (12542 words) Published: October 26, 2014
For the exclusive use of T. SPHABMIXAY

9-294-079
REV: JULY 1, 2008

BEN ESTY
PETER TUFANO
JONATHAN S. HEADLEY

Banc One Corporation
Asset and Liability Management
[Derivatives are] simply another Wall Street-developed house of cards. — Representative Joseph Kennedy1
You can call it [the use of derivatives] whatever you want, but in my book it’s gambling. — Representative Henry Gonzalez, Chairman, House Banking Committee2 Our use of derivatives is just one more step in the evolution of banking. — John B. McCoy, Chairman and CEO, Banc One Corporation

On November 15, 1993, Dick Lodge, Banc One Corporation’s (Banc One’s) chief investment officer (CIO), gathered his notes and headed for a meeting with John B. McCoy, Banc One’s chairman and CEO. On the way, he recalled the lunchtime conversation on the golf course six weeks earlier, during which McCoy had first voiced concern over Banc One’s falling share price—from a high of $48 3/4 in April 1993 to just $36 3/4 (see Exhibit 1). McCoy attributed the decline to investor concern over Banc One’s large and growing interest rate derivatives portfolio. During their discussion in September, McCoy had asked Lodge, who was responsible for managing the bank’s investment and derivatives portfolio, to think about ways to deal with this problem.

McCoy had been prompted into action not only by the continued price decline, but also by the comments of equity analysts who covered Banc One:
The increased use of interest rate swaps is creating some sizable distortions in reported earnings, reported earning assets, margins, and the historical measure of return on assets. . . Were Banc One to include [swaps] in reported earning assets, the adjusted level would be 26% higher than is currently reported. . . . Given its large position in swap[s], Banc One overstates its margin by 1.31% [and its] return on assets in excess of 0.20%. . . . Adjusted for [swaps], Banc One’s tangible equity-to-asset ratio would decline by 1.55%.3

1 As quoted by Barbara A. Rehm, “Regulators Try to Reassure Lawmakers on Swaps,” American Banker, October 29, 1993, p. 3. 2 Ibid.
3 David N. Pringle, “Swaps Revisited, or, How I Learned to Stop Worrying and Love the Derivative,” Lazard Frères Equity Research, October 26, 1993, pp. 4–14.
________________________________________________________________________________________________________________ Professors Ben Esty and Peter Tufano and Research Associate Jonathan S. Headley prepared this case. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.

Copyright © 1994, 2008 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-5457685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

This document is authorized for use only by Tony Sphabmixay in Spring 2013 Financial Institutions taught by Lin Guo from January 2013 to July 2013.

For the exclusive use of T. SPHABMIXAY
294-079

Banc One Corporation

Banc One’s investors are uncomfortable with so much derivatives exposure. Buyers of regional banks do not expect heavy derivatives involvement. . . . Heavy swaps usage clouds Banc One’s financial image [and is] extremely confusing. . . . It is virtually impossible for anyone on the outside to assess the risks being assumed.4

What made this situation more perplexing was that Banc One already had attempted to pre-empt concern over its growing derivatives portfolio. Along with its second-quarter results, it distributed a booklet detailing its asset and liability management policies and describing its derivatives portfolio, which had grown during the quarter...
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