Table of Contents
Banc One Corporation started as First Banc Group back in 1968 with its headquarters in Bank One Plaza. The bank began it activity as a holding company based in Columbus, Ohio. Through the spirit of regional banking, Banc One acquired several small investment companies. It controlled five state banks that also managed several subsidiary bank holding companies. It had a three-branched organizational structure. The bank grew to become the leading bank holding company in the Ohio region and the eighth in the United States. The company merged with JP Morgan Chase in July 2004. Today, the headquarters of Banc One are called Chase Towers that serve as the main offices of the Chase’s Retail Banking. The paper discusses the primary problems that Banc One Corporation faced in 1993 due to its use of swaps; it also finds what makes swaps a necessary tool for the business.
Background
In 1993, Banc One Corporation faced a major problem of falling share prices. The issue of having shareholders that were uncomfortable with the firm’s use of derivatives accompanied this challenge. The problems started when this bank holding organization opted to introduce the use of swaps as a financial tool to manage the risks associated with fluctuation in interest rates. It was believed that when the corporation adopted the use of derivatives some potential investors were afraid of buying shares of this bank (Esty, Tufano, & Headley, 2008). According to K. F. Puglisi, a Chicago banking analyst, this fear was highly responsible for the declining share values of the company (Esty, Tufano, & Headley, 2008). One reason why depositors were afraid of investing in the firm was the concern they had about the speed, in which interest rate derivatives grew over a short period. Puglisi argued that potential investors were uncomfortable with the exposure of derivatives (Esty, Tufano, & Headley, 2008).
Despite the heated debate against the new idea, the management of Banc One supported its move to bring in the use of swaps as its financial tool. The company’s Chief Investment Officer offered a presentation that proved the importance of using swaps to manage contemporary risks. Thus, the management faced a dilemma of whether to eliminate the use of derivatives or to maintain it. Due to the usefulness of swaps in regulating the risks attached to fluctuating interest rates, the Chairperson and the CIO of the company decided to come up with a policy of educating investors about the importance of derivatives.
Current Problems
One of the current issues faced by Banc One Company is the falling share prices. For instance, the share price fell by a margin of $10 from a high of $48 to $36 within six months. Different bank analysts have come up with varying reasons to explain this trend in Banc One. One cause of the falling stock prices was considered the investors’ concern over the bank’s large and ever growing interest rate on the derivatives portfolio. It happened that Banc One opted to use the derivatives liberally to attain its goals when dealing with the company’s asset and liability management. In 1986, it introduced the use of swaps as a tool for managing risks related to fluctuating interest rates.
The use of swaps and derivatives became a major concern to the company’s shareholders because it was a comparatively new financial tool for the markets. John B. McCoy, the chairperson and chief executive officer of Banc One Corporation, once argued that most of the investors did not know how swaps operated, and this affected the value of the bank’s shares (Esty, Tufano, & Headley, 2008). Using derivatives also needed high-end financial sophistication and proficiency in quantitative analysis. Many bank analysts warn that achieving these qualities may be hard, thus scaring some investors (Odekon, 2015). Therefore, the value of the shares would keep depreciating as fewer people choose to invest in the company’s stocks.
Another issue that Banc One Corporation faces is the bunch of negative comments from equity analysts covering the company. Thus, K. F. Puglisi, a critic, argued that many investors were not at ease with the exposure of derivatives (Esty, Tufano, & Headley, 2008). The use of swap transactions with fixed rates exposed the company to the counterparty’s default (Esty, Tufano, & Headley, 2008). However, Banc One mitigated the credit risk in three different ways. They included the positive swap spread, using swaps investments where only the net returns faced the default risk, and having strict regulations of controlling counterparty exposure. Based on these three policies, the firm allowed such derivative exposure that, as analysts believed, had scared some investors (Fischer, Sharrott, & Calabro, 2013).
The two primary issues that this bank faces have consequences to the operations and welfare of the firm. One potential consequence of the reduced share prices is scaring off potential investors. People who are willing to become financiers of the company might be afraid of channeling their finances to a company that records poor performance indicated by falling stock prices. Apart from pushing away prospective financiers, this problem might also make some of the current shareholders sell part of the stocks and invest in other highly valued shares from other corporations (Odekon, 2015).
The falling value of shares and the lack of comfort among investors in Banc One would also make the company go through a tough time when looking for credit. Credit providers always look through the history of the business on the stock market. Some credit providers might be frightened to offer their facilities to a firm that has recorded declining stock prices.
Handling the problems of falling stock values and investors’ worries is important to Banc One Corporation. The first issue is the fact that the company’s stocks influence the amount of capital available for the firm. Declined share values would mean the business could collect little from the sale of assets to the public. Another importance attached to the declining share values is the prestige it gives the company. Banc One would not enjoy the fact that it is not ranked highly on the stock market. Finally, it is crucial for these problems to be handled professionally to avoid the possibility of the bank being taken over. If the stocks keep going down, then a competing bank may step in and decide to buy a big stake to acquire Banc One. Therefore, the problem of falling prices is critical and it needs to be handled with urgency (Odekon, 2015).
The bank’s Chief Investment Officer (CIO) and CEO work towards finding a balanced solution to these problems. McCoy, the CEO, expressed his concern that the use of swaps was beneficial but hurtful to the company. Swaps helped the business manage interest rate risks. At the same time, the derivatives scared away some investors who did not comprehend how they operated. The CIO, Dick Lodge, prepared a presentation that aimed at showing investors the usefulness of the derivatives and swaps. The company tries to educate the public on how it uses the derivatives so that prospective investors may not be frightened by the firm’s derivative exposure.
Conclusion
In this case, the option of enlightening the public on how the company operates using derivatives stands out to be the best choice. A presentation by the CIO’s team showed how swaps were useful to the company by comparing the bank to a hypothetical one that used no swaps. Getting rid of derivatives portfolio would be more dangerous since it would lead to greater interest rate exposure. Competitors might know more about the bank’s financial moves due to this exposure. Educating investors on the usefulness of derivatives would reduce the fear in potential financiers, thus creating demand for the company’s shares.