Credit portfolio manager of the year: NatWest Bank

Risk Awards 2020: Big deals and big ideas have helped transform stress-test laggard to leader

L–R: Bene Fiorillo, Lorraine Warwick, Mike Slevin, Wen Yun Low, Nehal Khushal

The success of the credit portfolio management team at NatWest Bank owes a lot to a historic failure. Its parent entity, Royal Bank of Scotland, bombed the 2016 edition of the annual stress tests run by the Bank of England, missing both its post-stress CET1 capital hurdle and its leverage ratio hurdle.

The CPM team has since played a key role in propelling the bank from industry laggard to leader. In the 2018 test, published last November, RBS passed comfortably, boasting a better post-stress CET1 ratio than Barclays, HSBC, Lloyds Banking Group and Standard Chartered, and a better post-stress leverage score than all six of the other UK banks subject to the tests.

“Clearly there was a feeling of disappointment at the time within the bank, but it really galvanised us and created a sense of urgency about the transformation needed,” says Mike Slevin, head of capital management, commercial and private banking at NatWest. “From that point onwards we took things forward much more rapidly and accelerated a number of portfolio actions that were already in flight – focusing on sloppy capital in the portfolio, increased focus on risk-adjusted returns on cases, and making cultural changes to the first line.”

The results of the 2019 tests are due on December 10.

The credit portfolio function has contributed by taking the lessons of the testing regime to heart. In October last year, for example, it closed an unusual securitisation deal that cut £1.2 billion in risk-weighted assets from the commercial real-estate (CRE) portfolio – a book that had been a big contributor to NatWest’s 2016 fail.

It’s not just about fixing the problems of the past, though. Any bank that wants to keep passing stress tests has to think about the next crisis, and a lot of the CPM team’s work has been forward-looking. Upgraded technology allows it to run its own stress scenarios in near-real-time, and the bank has also been working on rebuilding the credit derivatives hedging capability it lost when the retail and commercial businesses were ring-fenced away from the trading desks of NatWest Markets.

The most eye-catching exhibit of this focus is a futuristic – but only part-built – early warning system.

“The most refreshing thing is the fact we now have a pre-emptive rather than a reactive approach to portfolio management,” says Benedetto Fiorillo, head of portfolio risk mitigation at NatWest.

Predicting trouble

An all-seeing warning system is an obvious dream for a CPM function. A data-driven ability to anticipate and manage trouble before it arrives would allow a bank to save on hedges and capital, limit the volatility of reserves and earnings – and keep a clean nose when the annual stress test rolls around, of course. For a bank like NatWest, which estimates it touches 25% of all the transactions taking place within the UK economy, it might be more than a pipe-dream.

The plan is to derive from that trove of data a better understanding of the networks that exist within the NatWest customer base, so if warning lights start flashing in one sector – or at one firm – the CPM function can be several steps ahead of the wider fall-out.

The team has already started testing this approach, drawing on a dataset that expands by around nine billion pieces of transactional payment information every single day.

In one test conducted last year, the CPM function analysed the network effect the threatened closure of a large factory would have on its partners and suppliers, discovering two particular entities rose to the top of the list: one of these companies was not an obvious supplier, but had an unusually high concentration of business with the owner of the factory; the second was a provider of training to the factory owner.

We now have a pre-emptive rather than a reactive approach to portfolio management

Benedetto Fiorillo, NatWest

“Suffice to say, the two entities most affected weren’t who we were expecting, which highlights the clear usefulness of the tool,” says Slevin.

In use already is software based on external data. Developed in conjunction with Amplyfi, a Welsh start-up that is part of an accelerator at NatWest, the tool allows relationship managers to draw on a wealth of unstructured information from the deep web, providing them with unique intelligence on sectoral risks, trends and opportunities. More than 600 people within the business regularly use it.

If the bank can combine the insights from both internal and external data, Slevin hopes it would not just be of use to NatWest’s lenders and portfolio managers, but also to customers.

“Obviously, this type of information can be very helpful in terms of how we mitigate risk in the portfolio. What’s not so obvious is how we can use this type of analysis and information to help our customers too. That’s something we’re currently in the process of defining, as we think it could prove very beneficial to them and how they think about managing their own risks,” he says.

Pricing approach

There has been more traditional work for the CPM team, as well – such as implementing a risk-based approach to pricing in places where it was not being used.

“We found overdrafts were priced exactly the same regardless of where the client sat in the risk curve. Risky and non-risky assets were all priced the same before we overhauled the framework,” says Wen Yun Low, head of capital and pricing advisory at NatWest.

The framework itself is fairly snazzy, encompassing inputs such as the liquidity of secondary markets for specific loan types – discounts are offered for positions that are easier to exit or hedge. Internal stress-testing now also plays a bigger role, with the CPM team working closely alongside its risk colleagues to analyse the way different sectors perform under different forms of stress – a UK downturn, or a broader European one, for example.  

This has required an upgrade to the bank’s analytic capabilities. The impact of a single scenario on a single book can be computed in seconds. A more complex test, involving 20 granular scenarios and a wider sweep of the business, could be complete in half a day.

It has also required the function to reach out to the front line of the business. Around 1,800 of the bank’s staff have been through a CPM-devised training scheme on pricing, risk and capital.

The business as a whole is seeing the benefit, says Andrew Cross, head of financial risk and analytics for RBS: “Mike’s team has been essential in driving changes in behaviour and approach to pricing and risk management. There are hundreds of relationship managers in lots of locations, in a massive business – so the discipline required to improve pricing returns and capital understanding has been significant.”

CRE exposure

Much of the team’s work may have been about people and processes but – at the more spectacular end of the CPM spectrum – big blocks of risk have been moved as well.

In that October 2018 deal, it capitalised on investor demand for a kind of CRE exposure that has historically been difficult for funds to access, transferring away the first 8.5% of loss on a total portfolio of £2.3 billion. The bumper 2018 deal was designed to cap NatWest’s losses on the more awkward, mid-market book – loans with a face value of between £5 million and £50 million.

“When you apply Bank of England stress testing, CRE is always one of the sectors that is most impacted under stress, so we’ve proactively sought to manage that asset class,” says Slevin. 

As well as selling a portion of the larger individual loan, the business was looking at options to reshape the portfolio. The team did so in a variety of ways – for example, adjusting loan-to-value limits, capping exposure to certain sub-sectors, and adjusting pricing to reduce new business volumes where exposure was not deemed to be at the optimal level.

“The top end of the book is very liquid so you can sell individual loans; for the bottom end of the book we’d already built a granular portfolio sales capability, and smaller loans were covered by a previous 2017 programme, so these midsize loans were the final segment of the book that needed to be tackled,” Slevin says.

CRE is always one of the sectors that is most impacted under stress, so we’ve proactively sought to manage that asset class

Mike Slevin, NatWest

There were more fireworks in a smaller deal that closed earlier this year. Return on equity at RBS’s venerable private bank, Coutts, was being hampered by a specific class of long-dated loans that rarely default, but which attract punishing regulatory capital.

The gulf between the economic reality and the capital treatment made the portfolio an obvious candidate for credit insurance, but it was not an asset with which many insurers – and their reinsurers – had much experience. To get them comfortable, NatWest had to assemble a 50-year loss history; and to get the desired capital relief, the bank had to ensure the 20-strong syndicate of insurers were all at least AA-rated. All told, the transaction took around eight months.

For Coutts, the payoff was a bump in ROE that Slevin and his team will only describe as “significant”.

James Clarry, chief operating officer at Coutts, goes a little further: “This team has made an unparalleled contribution to the increase in our shareholder value creation over the last two or three years by forensically understanding where the biggest drag on profitability has been and then targeting it in a way that doesn’t diminish the client experience or client service.”

A broker who worked with NatWest on the “relatively revolutionary” transaction says it typifies how the bank uses credit insurance.

“There are other banks that have increased their use of credit insurance, but NatWest has been a leader in moving the application of the product to asset classes that insurers have traditionally never had exposures to,” says Tom Stansfield, a director in the structured credit and investment risk solutions team at Howden Insurance Brokers.

Although its use of credit insurance is on the rise, the CPM team is still keen to have access to more traditional risk mitigation tools like credit default swaps – a product the team lost access to after the bank’s ring-fencing split in January this year.

“It’s important to be able to access all the various tools available, because not every tool is applicable to every sector or asset,” says Slevin. “We have loan sales, credit risk insurance, portfolio sales and synthetic securitisation at our disposal, so CDS is the last piece of the puzzle.”

Given the ring-fenced nature of the business, the CPM team can’t actively trade CDSs and can only use them to hedge or mitigate specific risks within their book. Since the beginning of this year, the team has been re-building such a capability within NatWest’s treasury function and expects to regain access to the market before year-end.