David Stunell talks about the challenges facing a treasurer in a growing financial institution.

What are you responsible for as Group Treasurer, how is the treasury organised and how are you held accountable?

Portman Treasury is responsible for managing the group’s liquidity, wholesale funding, financial risk management and capital raising.

The eighteen staff in the treasury department are organised into five different areas:

• Front Office.

  Responsible for asset and liability portfolio management and for all deal execution.

• Back Office.

  Processes, settles and confirms all deals.

• Middle Office.

  Responsible for reporting, valuations, performance measurement and compliance.

• Balance Sheet Management.

  Role includes structural balance sheet management, modelling and analysis, developing new products and wholesale credit risk analysis.

• Systems.

  We have two IT professionals within the department whose specialist skills, combined with their treasury knowledge, allow us to support, maintain and develop the technology at our disposal.

The Board delegates responsibility for the strategic management and control of Treasury to the Asset and Liability Committee (ALCO). ALCO members are the Chief Executive, Group Finance Director, Group Development Director (all three sit on the main Board), the Director of Marketing and myself. I am responsible for the day-to-day management of the department. I report to the Group Finance Director.

How do you manage your liquid assets? What are your objectives? What regulatory constraints do you face?

As a Building Society, we are regulated by the Financial Services Authority (FSA) and we are required to operate within statutory and prudential guidelines. The asset classes in which we are permitted to invest are fairly prescriptive.

Our primary liquidity objective is to comfortably meet our obligations as they fall due. Our liquidity is approximately £2.5 billion and represents over 20% of our total funding. We impose a fairly complex matrix of limits and controls on ourselves which restrict over-concentration in terms of credit, maturity, instrument and currency.

Our emphasis is on highly rated liquid instruments. We believe that we should demonstrate that our liquidity is sufficiently liquid through our daily activities, rather than relying on a nominally liquid portfolio. To achieve this, it is important to participate in the market on a daily basis. If we only go to the market when we need to realise liquid assets, the market would be alerted and any ensuing rumours may exacerbate the situation.

We aim to maintain a prudent mix of instruments in our portfolio. This can range from highly liquid instruments, such as Treasury bills and short gilts, which represent primary liquidity with minimal risk of capital loss, through CDs to less liquid instruments, such as fixed and floating Eurobonds and residential mortgage-backed securities (RMBS). Over 90% of our liquid assets are freely negotiable and over 75% have a contractual maturity of less than a year. We also have minimum limits for the most liquid instruments, such as CDs, and maximum limits for the less liquid instruments.

We do, of course, aim to maximise yield, but only within these prudential constraints.

How do you arrange wholesale funding? How often do you do so?

Our wholesale funding (currently over £2 billion) is broadly mapped out over our rolling five year planning cycle. We revisit the plan at least once a month.

We have a daily presence in the UK sterling money market which provides approximately 70% of our wholesale funding. The remaining 30% is sourced from the bond markets under our £1.25 billion EMTN programme through a mixture of public issues and private placements – there is currently £781m outstanding. Our last public senior deal was our debut €500m Floating Rate Note issue in July 2003.

Our overriding objective is to develop a deep and diverse multicurrency investor base to avoid over reliance on any one source. Pricing is also a key consideration. We will be establishing a global CP programme to access the ECP and USCP markets in the first half of next year, in furtherance of this objective.

How much time do you spend talking to new investors?

Our strong balance sheet growth and increasing utilisation of wholesale funding means that we are becoming increasingly well known to UK wholesale investors.

Our challenge now is to attract investors outside the UK. Our €FRN issue in July was very successful in that we attracted new investors in new places. We recognise that to diversify our investor base, we have to be prepared to invest time talking to potential investors. However, we are confident that we are a sufficiently attractive proposition for them. We have a solid, straightforward business model as an effective player in the strong UK housing market. We have experienced above average balance sheet growth recently through an effective distribution strategy without compromising our underwriting standards.

Have you arranged any other funding?

The senior funding I referred to earlier has been augmented over the past two years by visits to the market for Tier 1 and lower Tier 2 capital. Tier 1 capital is regarded by the regulator as permanent capital. In our case, this comes from either accumulated profits (our reserves) or the issue of PIBS (permanent interest bearing shares). Tier 2 capital is also longterm funding, and in the case of lower Tier 2, is expected to be repaid at some point in the future, and is therefore not ranked by the regulator as strongly as Tier 1 capital.

Capital funding of this nature broadly follows the same disciplines as senior term debt funding but the investors differ in that they are usually looking to match their own long term obligations, such as pension payments or annuity premiums.

How do you manage interest rate risk? What instruments do you use?

We manage interest rate risk on a total balance sheet basis. However, within this, we also focus on individual components such as treasury portfolios, subsidiaries and individual product lines, for example mortgages and savings. We often find that ‘natural’ hedges exist across these groupings. It therefore makes sense for us to amalgamate these positions and manage them on a combined basis.

Building societies are predominantly margin businesses with high quality assets and stable balance sheet components. Our basic business model is simple in that asset yields exceed operating costs and provisions and the costs of servicing our liabilities.

Treasury aims to immunise the balance sheet from any loss to this inherent profitability. Building societies generally and certainly in the case of Portman, are not in the business of large scale interest rate positioning. This does not mean that we do not position the book to reflect our view of interest rates and aim to benefit accordingly. It is just that this is a relatively minor contributor to the bottom line. Out of necessity, we are a user of OTC derivatives, mainly swaps and FRAs (forward rate agreements). This enables us to offer fixed rate and structured products to both our mortgage borrowers and savers (one reason why the Director of Marketing is a member of the ALCO).

Interest rate risk is measured and controlled by the combined use of traditional repricing gaps together with sensitivity analysis and dynamic balance sheet simulation using a range of scenarios. Specialised asset and liability management software is used to model and analyse data and positions.

How do you manage currency risk?

We currently swap any foreign currency denominated funding into sterling and will soon extend this to run closely matched non sterling asset portfolios. We have no plans to run foreign exchange positions.

How do you manage counterparty risk?

We have credit limits for over one hundred financial institutions for liquidity management and interest rate and FX derivatives. These limits are determined by reference to both external credit ratings and key balance sheet components. We limit exposures to both countries and industry sectors. Credit limits are granular. This means that we limit our exposures not only per counterparty but also per individual product with each counterparty, for products such as money market securities, bonds, interest rate derivatives and foreign exchange contracts. Derivatives exposures are calculated and controlled by using industry standard methodology.

On the funding side, we adopt strict money laundering controls and limit our reliance on individual or groups of lenders.

How do you use technology within the treasury department?

The answer to this question is, increasingly!

We have different systems for core processing and accounting, settlements, reporting and data analysis, asset and liability management and for valuations. There are a lot of linkages between these various systems. The asset and liability management system, for instance, is capable of drawing mortgage and savings data from the Society’s core mainframe system on a daily basis.

Because the markets we deal in are still predominantly voicebased, electronic trading is minimal.

How do you integrate the treasuries of the operations you have acquired?

Where a bank or building society has separate operating entities, the FSA is generally more comfortable with all treasury operations being centralised. So, for instance, when we acquired Sun Bank, its treasury was amalgamated with Portman treasury as a condition set by the regulator. We have been lucky in that for all our acquisitions, it has been relatively straightforward to integrate the treasuries.

However, I do think it is important to emphasise the context in which we operate. Unlike treasury departments in nonfinancial institutions, we have no requirement to operate multicurrency, multi-site cash management systems or spend time devising complex tax structures. At the same time, our balance sheet (and those we have acquired) is very predictable, much more so than a clearing bank, due to the nature of the products we offer.

What are the challenges ahead?

Although Portman treasury is still quite small, proportionately we have increased sharply in size over the last couple of years, reflecting the growth in the Society. Through external recruitment and in-house development we now have the foundation to support the future growth of the organisation.

Some of the challenges ahead are being forced on us by regulators. Over the next few years, treasury departments in UK financial institutions will have to comply with a raft of new regimes. The new Basel Capital Accord (Basel II) is essentially good news for us, although it will require a lot of additional work. The introduction of International Financial Reporting Standards, in particular IAS 39, will also test us. Finally, banks, building societies and investment companies will soon be starting work ahead of the FSA’s new quantitative liquidity framework if they haven’t already done so.

On top of this, although we have yet to employ them, there are increasingly innovative structures available for the use of collateral or securitisation to achieve risk transfer, capital relief or funding or a combination of these. If we use these techniques, we will need to continue to make important investments in both people and systems.

We are looking forward to meeting all these challenges head on.