Case Study: Banc One Corporation

Posted: August 26th, 2021

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Case Study: Banc One Corporation

Analysis of the Main Problem

Banc One Corporation faced a significant problem of falling stock prices. Specifically, the corporation suffered a threatening fall in share price from $48.75 to $36.75 in the first quarter of the year 1993. According to its chairperson and CEO, John B. McCoy, the sharp decline was influenced by the investors’ concern in the market over the fact that the company had employed extensive use of interest rate derivatives portfolio. Indeed, this kind of derivative portfolio was considered more sensitive to liability than to assets, and thus it initiated ever-growing interest rates. Moreover, the investors market sustained a harmful kind of perception on the financial image of the corporation since it considers the use of massive derivatives as a gambling trick by Banc One to cloud the assessment of the financial risks. With such a decrease in stock price, the corporate would not attract new acquisitions for the reason that their market shares would undergo both accounting and economical dilution, thus failing to grow and make profits.

Recommended Solution

Despite the fact that the top management of Banc One predominantly endorsed the derivative portfolio as a measure of regulating interest rates, I suppose that it was a wrong move. Instead, I recommend the use of asset and liability management tools as a better approach. The asset and liability portfolio manages the exposure to interest rate risk by adding balancing assets to the investment platform until the levels of fixed rat assets were more enough to offset the fixed-rate liabilities. For instance, the use of balancing assets like long-term US treasury securities and bonds has always proved useful in deducting 80% of the interest expense incurred on the principal loan amount. Likewise, the choice of asset and liability portfolio to control the risks of growing interest rates could give Banc One the advantage of gaining a sizeable after-tax spread on the treasury securities because the earned incomes could be free of both the state and federal taxes.

Description of How AIRS Work.

Amortizing Interest Rate Swaps (AIRS) is a replica of investment in mortgage securities intended to avert the risks on returns. The application of AIRS is so essential in facilitating the repayment of mortgages and protection. Therefore, it works based on the availability of low-interest rates posed in the share capital market. Mainly, with decreasing interest rates, the AIRS is useful in amortizing the notional amount of the swap. This happens at a faster pace in case the interest rates decline relatively more rapidly, thus offering the banks a chance to reinvest back at a time when the market yields are still low. Likewise, AIRS works by lengthening the maturity period of returns on investment, especially when there is an increase in interest rates. Consequently, the banks would be left with a below-market yield for investment purposes, as shown in figure 1.

Why Banc One Corp Employs the Use of AIRS Extensively

Bank One has employed extensive use of AIRS due to its continued acquisition strategy. With the increasing number of acquisitions up to 78 banking affiliates, it implies that the earnings growth relatively moves up, therefore positively affecting the asset sensitivity of the corporation. With such huge acquisitions totaling to $76.5 billion, the bank must employ the use of AIRS to help in adjusting the earnings growth. For instance, Banc One has regarded the changes in interest rate as affected by the reported earnings. With a steady 1% upward change in interest rates during the year, the base year’s profits would rise by 5%. Hence the bank recorded 5% earnings sensitivity. With a positive earning sensitivity in place; therefore, the bank would be compelled to feature in swaps that would help in regulating the interest rates on floating-rate liabilities. In other words, the interest rates on assets would reset faster than liabilities, hence resulting in increased income in case the very rates rise, as shown in figure 2.