Banc One Interest Rate Swaps and Derivatives Strategy

Managing Interest Rate Sensitivity Without Swaps

If Banc One wanted to manage its interest rate exposure without using swaps, it had viable options available. The bank could attempt to match the duration of its assets with the duration of its liabilities. In addition, it would need to match the interest rate exposure of its assets and liabilities directly on the balance sheet. For example, if the assets on the balance sheet were predominantly fixed-rate while the liabilities were floating-rate, significant distortions to company performance could result if the floating rates were not properly offset on the asset side. In this scenario, in order to move from being asset-sensitive to neutral or mildly liability-sensitive, the bank would need to make more floating-rate loans to offset the floating-rate liabilities it is obligated to pay.

Through the use of interest rate swaps, this process is much easier and less time-consuming. This is particularly true for Banc One, which had a stated strategy of acquiring other banks while remaining relatively decentralized after each acquisition. The bank coordinated only its processes, reporting, and auditing standards with acquired institutions, allowing each acquired company to operate on a standalone basis. This structure made it difficult to match liabilities and assets on an individual basis across the entire organization. Swaps therefore enabled a more seamless and integrated approach to interest rate management across all subsidiaries.

The pros of using swaps over on-balance sheet adjustments include speed, flexibility, and ease of implementation — particularly important for a serial acquirer like Banc One. The cons include the complexity they introduce, the potential for investor confusion, and the regulatory and accounting treatment that can obscure the true financial position of the firm. On-balance sheet alternatives, such as shifting the loan portfolio mix toward floating-rate assets, are more transparent but slower to execute and may conflict with lending strategy or client demand.

How Swaps Affect Financial and Capital Ratios

When swaps are used, they have a positive impact on many of a company's reported financial ratios. However, in some instances, they negatively affect the underlying economic reality those ratios are meant to reflect. Swaps and other derivative contracts are considered "off-balance sheet" transactions. In many instances, companies are therefore not required to report the associated asset or liability on the balance sheet. As a result, any ratio involving debt will appear more favorable than it actually is, and capital ratios will similarly look stronger, since current capital rules favor the use of derivatives over on-balance sheet instruments.

The table below summarizes the relevant ratios with and without the use of derivatives for Banc One:

As the data illustrate, reported ratios are materially more favorable when swaps remain off the balance sheet. This divergence between reported and adjusted figures is a core source of investor concern about Banc One's true financial position.