KBC Financial Products Credit derivatives : a balanced approach

Thomas Korossy 16th June, 2003

Introduction

Agenda

Build-out of KBC Financial Products Staff and Management Business Lines

Convertible Bonds,High Yield Securities Equity Derivatives, Structured Products

Alternative Investment Management

Credit Derivatives Risk Management Synergies with other business lines

Overview of KBC Financial Products

Positioning

Specialist within the growing marketplace for equitylinked and credit-linked products
Strong Customer focus Emphasis on technology

Products
Convertibles, equity derivatives, funds and credit derivatives

Client / Market Coverage

Over 1000 institutional Clients: mutual funds, pension funds,

insurance companies, banks, securities companies, hedge funds, and private banks, fund of fund managers
Market coverage: Europe, U.S., Japan, and Asia

Overview of KBC Financial Products

Build-out of FP

Formed in 1993 as D. E. Shaw Financial Products 1994 to 1999 Build out in D.E. Shaw
Japanese Convertibles and Corporate Warrants Asian and European Convertibles Equity Derivatives in US, Asia and Japan 1999 US Convertibles

Acquired by KBC Bank 1st November 1999

January 2001 combined with KBC Derivatives (Brussels) 2001 Alternative Investment management (KBC AIM)

2001 Credit Derivatives

2002 structured products on Fund of Funds 2003 High Yield business (US)

Overview of KBC Financial Products

Organisation and Staff

Business management
Executive committee (4 Managing Directors) 16 additional Managing Directors (manage business lines) Majority of management team have worked together for ten years

Staff: 422 in 4 time-zones

Total Europe Front Office 90 Support 50 KBC AIM 39 Total 179

US
Asia Japan

75
13 45

39
9 18

28
4 12

142
26 75
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Business Lines

Convertibles and High Yield Securities

One of the largest worldwide providers of secodary market liquidity in CBs

Focus on secondary market Total Market Capitalisation : US$ 550 billion Market-makers in 2 500 convertible securities

FP's current daily turnover : US$ 400 - 450 million

Since 2003 Expansion into US High Yield market

Focus on secondary market

Total Market Capitalisation : US$ 850 billion

Market-makers in over 1 000 High yield securities FP's current daily turnover : IS$ 70 - 100 million

Business Lines

Equity Derivatives / Structured Products

Europe: Structured multi-underlying products

Indices (markets, sectors), baskets of shares Fund of Funds (mutual and hedge funds)

US: Flow products

Listed options, OTC options Multi assets: Convertibles, options, credit derivatives

Japan:
Covered warrants and Structured equity-linked products

Asia: warrants
Warrants, high yield notes Capital protected Funds

Business Lines

KBC Alternative Investment Mgt

Assets under Management: > 2 billion KBC AIM established July 2001

Launched Five single-manager hedge funds

2 Convertible Arbitrage Funds 1 Credit Arbitrage Fund, 1 Directional Credit Fund 1 Multi Strategy Fund

Launched two multi-manager fund-of-funds

Japan Long Short Equity Fund-of-Funds Asia Long Short Equity Fund-of-Funds

Rewards (Eurohedge)
2001: Best Launched Arbitrage Fund 2002: Best Convertible and Equity Arbitrage Fund

Credit Derivatives

Main Activities

Collateralised Debt Obligations (CDOs)

1 Bank balance sheet CDO 3 managed synthetic CDOs (corporates) 2 managed synthetic CDOs (corporates and asset backed)

Asset-Backed Conduit
Purchase of AAA rated assets funded by CP program

Launched July 2002, current assets US$ 2.5 billion

Average yield 45 bps; very high return on capital

Market making and flow trading

Credit default swaps, assets swaps, ASCOTS FPs daily turnover: $ 125 milion

Credit Derivatives

CDOs
Collateralised Debt Obligation __________________________ Bonds / Loan collateral Debt

Concept: to securitise debt to sell it to a wider investor base Banks move loans offbalance sheet to manage regulatory capital

AAA BB Equity

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Credit Derivatives

CDOs

Initially Bank Balance Sheet Deals (CLOs) with static portfolio Synthetic CLOs: substituting loans with credit derivatives Managed Deals: Active management of credit derivatives portfolio within parameters determined by rating agencies (S&P, Moodys) Managed Synthetic Deals Adding other underlying asset classes
Asset Backed Securities

Sovereign risk

Single Tranche CDO

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Credit Derivatives

CDOs CLO
__________________________ Bank Loans Debt AAA BB Equity Asset Backed

CDO (Synthetic)
__________________________ Credit Derivatives Super Senior swap Debt AAA BB Equity

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Credit Derivatives

CDO Deal-making

Construct portfolio that conforms with

rating requirements (S&P, Moodys) for mezzanine notes

risk appetite of note investors and senior swap provider

Liquidity in Credit Default Swaps (CDS) market (professionals,

investors)

Arrange Senior Swap

Mono-line insurance companies

Sell mezzanine notes (AAA .. BB)

Insurance companies Fixed Income managers, Hedge Funds

Sell Credit Default swaps on all names in portfolio

Hedge funds, Insurance companies, Loan portfolio manager

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Credit Derivatives

CDO Management

Execution
Align timing of note selling, senior swap arrangement and

selling of credit derivatives portfolio

Manage portfolio of credit derivatives

Avoid bankruptcies Avoid downgrades of issued debt

Realise gains if credit upgrades in portfolio

Proactive management of portfolio

Rebalancing portfolio

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Credit Derivatives

CDO Management: Risks

Execution
Timing of CDS portfolio build-up, selling notes, arranging senior swap Tenor mismatch of CDSs and CDO at
Inception Substitutions

Mark to market of all positions

P/L recognition / Reserves

P/l recognition only after deal closes and legs are booked Reserves over life of deal
Tenor mismatches

Substitutions
Other issues

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CDO Transactions: $ 8.5 billion notional*

* since DEC 2001

Number
CDO1

Name
Cygnus

Size
EUR 1bn

Description
Participation in EUR 2bn bank balance sheet CDO

CDO2

Finsbury

EUR 1.335bn

Managed public synthetic investmentgrade corporate CDO Managed public synthetic investmentgrade corporate CDO

CDO3

Broad Street

EUR 1bn

CDO4

Threadneedle

$ 2.475bn

Managed synthetic IG corporate CDO

CDO5

Holborn

$ 2.65bn

Hybrid synthetic IG corporate and ABS CDO

CDO6

tba

$ 1.5bn

In the pipeline

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Credit Derivatives

Synergies with other FP Businesses

Fulfill client demand for credit and volatility products across wide product range
CBs, Bonds (High Yield), Credit Derivatives
Listed Options, OTC Options, CBs

Stay competitive in changing market place through

Offering range of products required Competitive Market Making: Price and Hedge more efficiently

Create new Hedge Fund strategies

Existing strategies
Demonstrate experience in products traded (CBs, credit derivatives,

equity derivatives)
New Strategies
Credit Arbitrage Fund, Short Credit Fund, Asset backed Fund

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Credit Derivatives

Synergies within the KBC Group

Capital Markets
Placement of (mezzanine) notes from CDOs

FX and interest rate swap transactions

Asset management
Structured Hedge fund Products (CB Arbitrage Fund) Structured credit derivatives products

Insurance Company
Structured Hedge Fund Products Invest in tailor made CDO products (notes and senior swap)

Loan portfolio management

Balance sheet CDO (diversification) Single name exposure management

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Risk Management

Risk Management

Independent Risk management group reporting into RIS of KBC Bank Limits for FP
3 Dimensional Stress test (underlying, volatility, credit) Greeks (delta, vega, gamma, rho, dtRR, etc) Issuer limits (based on credit rating of underlying)

Limits for Credit Derivatives

Issuer limits per name
Based on credit rating (AAA .. B)

Default to Recovery Rate limit (former default to 20 limit) Part of FP wide Stress test

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Financials

Financials
2000 Total Revenues Equity Der 310 187 2001 179 59 2002 354 145

Credit Der
CB & HY AIM Operating Exp Operating Profit 179 131 122

4
108 8 194 -15

60
116 33 242 112

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