The acronym AANA has a dual meaning to

some at the Chicago- based headquarters for

ABN AMROs North American operations. While
typically standing for ABN AMRO North America,
it can also stand for ALCO Analytics for a New
Age. The latter embodies the notion that
leading- edge analytical tools are requisite for
the management of interest rate risk in a
balance sheet with high levels of complexity.

ABN AMRO currently ranks as the 6
th
largest
mortgage originator and 9
th
largest mortgage
servicer in the world. In addition, its holdings of
mortgage loans and mortgage- backed securities
are sizable. Its ability to monitor the liquidity,
accounting, and option risk associated with
those mortgages is therefore crucial to the
success of its business.

ABN AMRO selected BancWares Convergence
solution to successfully capture and assess
many of those risks using advanced analytics.

At its Chicago headquarters, ABN AMRO North
America manages risk on approximately $90
billion in retail and commercial banking assets
through SunGard Trading and Risk Systems
BancWare solution. ABN AMRO, a long- time user
of BancWare for asset/ liability management
(ALM), added advanced analytics to the solution
early in 1999. These include: option- adjusted
valuation (OAV) modeling through the Hull and
White term- structure model, pre- payment
modeling that incorporates the Andrew Davidson
(ADCO) prepayment model, and commercial
mortgage obligation (CMO) cash flows based on
CMO data from Intex.














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As one of the top ten US banks in mortgage
originations, ABN AMRO realized that
incorporating pre- payment modeling and the
stochastic simulations of OAV were imperative
for deriving interest rate risk exposures of its
balance sheet. BancWares advanced analytical
models more accurately capture interest rate
risk because they consider optionalities inherent
in mortgages, loans and other balance sheet
items. ABN AMRO worked closely with BancWare
to direct the development of models such as OAV
and the prepayment model.

The Importance of Product Scalability

ABN AMRO installed BancWares Convergence in
1993. BancWare Convergence is an integrated
planning, reporting, and analysis tool that supports
asset/ liability management, forecasting, and
budgeting. As ABN AMROs modeling and business
requirements grew, BancWares advanced analytics
were added. David Ide, first vice president and
deputy director of ABN AMRO North America,
explained, We added to our base functionality as
our needs changed. Our decision to purchase
Convergence pre- payment, term structure, and
valuation modules was driven by the long,
successful relationship we have had with
BancWare. These modules give us the capability to
model the earnings and market value sensitivities
associated with a wide variety of highly complex
financial instruments.

ABN AMRO North America was looking for a total
software solution that had the ability to accurately
model the options embedded in its balance sheet.
After careful evaluation, BancWare was selected.
Some of the reasons ABN AMRO cites for choosing
BancWare include its:
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ABN AMROs Addition of BancWare Advanced Analytics Including
OAV Takes Interest Rate Risk Management at
ABN AMRO North America to New Heights.
1


! Prepayment modeling capabilities which
include the four traditional factors as
well as up to four additional factors
! Overall scalability, flexibility and ease of
use
! Capability to easily customize reports to
current processes and management
requirements
! Ability to integrate measurement of off
balance sheet risks into its ALM process

! Commitment to continual development
of advanced analytics, complex scenario
modeling and risk management











Carl Tannenbaum, senior vice president and
director of treasury research for ABN AMRO North
America, added, We are a huge mortgage bank.
Without OAV for valuing assets with embedded
options we would have a blind spot that would be
25 to 30 percent of total assets our mortgage
loan portfolio alone represents roughly $10
billion in assets we would not be accurately
valuing.

To take an accurate measure of interest rate risk
in todays market, an institution requires the
ability to measure the impact of embedded
options. Tannenbaum noted that mortgage
refinancing, one example of an embedded
option, is beginning to take foot globally in
Europe and also in Australia. Embedded
options, he said, are becoming more
important factors for the risk position of banks
globally.

BancWares combination of prepayment and
term structure modules evaluate the options
embedded in ABN AMROs balance sheet
calibrated to market conditions for statistically
rigorous option valuation.

Because our balance sheet is loaded with
embedded options from mortgage- backed
securities and a large mortgage origination


business, we are very risk sensitive. OAV enables
us to actively manage the risks in our balance
sheet, said Tannenbaum.

BancWare Used to Manage Near- term Business
Positions
ABN AMRO uses the risk numbers derived from
BancWare Convergence to actively manage the
interest rate risk of its balance sheet, said Ide.
ABN AMRO does this by closely examining its risk
positions. This extends to our risk managers,
Ide explained, who tend to think in terms of
duration and market value sensitivity. ABN
AMROs managers can get a better handle on
duration and sensitivity through the risk
numbers Convergence produces.
We are a huge mortgage bank.
Without OAV for valuing assets
with embedded options we would
have a blind spot that would be 25
to 30 percent of total assets
mortgage loan portfolio alone
represents roughly $10 billion in
assets we would not be accurately
valuing.

our

After determining duration, ABN AMRO also uses
BancWare to examine how rate changes affect
duration.

Ide explained, Curves of exposures generated
for market value risks are just derivatives of
market value risk. So, we look at the market
value of the bank under these scenarios and
calculate a localized duration. Essentially, we
look at the change in market value, up and down
10 basis points, and then measure that up and
down the spectrum. Not only did BancWare allow
us to see the market value of the impact to
changes in interest rates, it has allowed us to
communicate these changes, as well the rate of
change, to our managers, noted Ide.
This type of modeling indicates that as interest
rates increase, the duration of equity increases,
and assets extend. At the same time, liabilities
shorten; and duration extends. For instance,
when rates fall, the model shows a dramatic
decline in the duration of equity.

For the first time, our managers could
actually see that and use that to manage their
positions, Ide said.

The risk managers requested modeling that was
outside of the realm of standard policy and
reporting functions. On a daily basis, the
managers think about near- term market
movements and ask, What is my exposure for a
10 or 25 basis point move, - - not 200 points.
They wanted modeling that would help them
manage near- term positions, Ide said. To give
the managers the modeling they desired, ABN
AMRO added BancWares OAV, Intex and Behavior
modules to Convergence in April of 1999.
2


Convergence as a strategic planning tool in
acquisitions

ABN AMRO also employs BancWare as a tool to
evaluate acquisitions. It does not utilize
Convergence in every deal, but more often,
BancWare is called upon to acquisitions where a
balance sheet does not present needed
granularity.

In these cases, ABN AMRO uses BancWare to test:

1. Whether there is risk in the balance sheet
that it might not want to pay for, or that
might be an issue for discussion.

2. Whether there would be costs to fix the
banks position or, conversely, money to
be made by adjusting the position.

Ide says that Convergence has become a real
strategic tool for acquisitions. It is such an
effective simulation tool that it can be used to
either confirm or produce run- rate net interest
income which can be useful for pricing decisions.
Particularly useful [ for this kind of assignment]
is the speed that comes with the Excel interface,
which allows for a quick structuring of a new
balance sheet. For every prospect that we
eventually acquire, the integration is very clean
because we have already done some initial set-
up and analysis on BancWare, Ide said.

Also notable are the acquisitions that ABN AMRO
did not make after an evaluation using
BancWare. Among these was a bank that
presented a weak GAP report and a sizeable
portfolio of purchased funds made up of callable
debt. We used Convergence and the
(BancWare) behavior model to build a model
that predicted the callable behavior of those
advances over different rate environments. We
ran the numbers and saw a horrendous risk
position, Ide said. These results convinced
management not to bid for the bank. Although
Mr. Ide noted that the bank could have come to
this conclusion through a more arduous route,
It was nice to have the ease and reliability of
Convergence for this evaluation.

Modeling Originations and Servicing
Relationships

ABN AMRO also uses BancWare to rigorously
model the natural hedge between its mortgage
origination business and its mortgage servicing
business. ABN AMRO has a huge - - over $100

billion dollar - - mortgage servicing business.
ABN AMRO pays up- front for the right to service
mortgages. These rights have a considerable
adverse option position tied to mortgage
prepayment. In particular, if the mortgages are
refinanced, the value of the servicing rights
evaporates. This business carries a substantial
amount of financial risk. Ide noted. But at the
same time the value of the servicing rights
evaporates, income from the mortgage
origination business begins to pick up steam.
Determining how much mortgage origination
offsets this risk exposure is extremely important
to the bank. Ide continued, We wanted this
relationship to be part of our earnings risk
analysis. We also wanted it to be part of our
market value analysis. Although it does not
have a line on our balance sheet, it has a market
value. We had to determine the extent to which
banks make a mistake if they assume that
originations and servicing are complete natural
offsets to each other. The offset is there in
economic terms but not entirely for reported
earnings. There is a timing problem and
BancWare is critical to our measurement of
these differences, said Ide.

Between the economics and the accounting, ABN
AMRO discovered this difference through
innovative modeling within BancWare,
particularly the behavior and ADCO prepayment
models. Through the BancWare platform and
pre- payment modeling, ABN AMRO modeled an
interest rate exposure for the entire bank and
determined the worth of mortgage originations
when interest rates dropped. The modeling
showed that the bank could make significantly
more income in a falling rate environment than
previously estimated.

To arrive at the mortgage origination
sensitivities ABN AMRO easily built a model into
Convergence. First Mr. Tannenbaums group built
a summarized database in Convergence of the $5
trillion mortgage market in the US and called this
the mortgage universe. Due to the flexibility
and ease of Convergence we can use pre-
payment modeling to project the behavior of the
mortgage universe. The adds in the model
represent the production volume for the entire
industry, said Ide.






3
Market Value of Origination Business
-300 -200 -100 0 100 200 300
Rate movements (bps)
$

m
illio
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Next, working with assumptions on ABN AMROs
market share and profit spreads (which is
related to volume because of fixed costs), the
model projects the fee income the bank expects
to earn. This fee income stream can be
calculated under numerous alternative interest
rate scenarios and incorporated into the banks
earnings- at- risk and market value risk
positions. Because the model is so fast- - it
takes just seconds to run each deterministic
rate scenario- - we could actually go in and run
scenarios in 10 basis point increments, from up
300 basis points, to down 300 basis points, said
Ide. The result was a graph with a lot of detail
and some intuitive results.

The shape of the market value sensitivity, not
coincidentally, closely resembles the typical
shape of a prepayment curve. The slope of the
curve flattens both when the refinance incentive
is significantly out- of- the- money and when it
is significantly in- the- money. When the
refinance incentive is at- the- money or
modestly in- the- money, the slope becomes
very steep, implying a large positive duration for
the origination business.






Streamlined ALM Process

At about the same time that ABN AMRO
implemented BancWares advanced modules the
bank also consolidated the ALCO committees
from its three major US banks. Now it has one
consolidated ALCO and its entire interest- rate
risk modeling is loaded onto one BancWare
platform. This streamlined ALM process yielded
immediate benefits. We saw significant time
savings, To run stochastic scenarios, with 20
starting points and 200 paths, it takes just a few
hours for each of the banks, Ide noted.

Mr. Tannenbaum zeroed in on two factors that
have positively impacted turn- around time:
1. BancWares incorporation of ADCO
prepayment assumptions data,
eliminating the need for the bank to
develop its own set of prepayment
assumptions
2. BancWares ability to run deterministic
valuations for simple assets and the
more complex OAV simulations for assets
with embedded options

We can run one scenario right after another,
without a hitch. The process is streamlined,
commented Mr. Tannenbaum.

Convergence, along with the behavior, term
structure and valuation models, gives us the
capability to model the earnings and market
value sensitivities associated with a wide variety
of highly complex financial instruments.
Convergence is an extremely effective simulation
tool in conjunction with OAV to manage market
rate risk, commented Ide. The flexible
architecture of Convergence loaded with the
advanced analytics of OAV, Intex, ADCO and the
BancWare behavior model, enables ABN AMRO to
analyze market values and income simulations
within an integrated and consistent framework.
This allows ABN AMRO to deliver the market
values that it uses to manage its complex
balance sheet. Ide concluded: We are always
trying to position ourselves based on the risk
numbers we get from the model. Whether that
translates into a hedge or position adjustment,
BancWare modeling impacts the decision. In an
age where markets are volatile, consumers are
savvy, and the demand for up- to- date risk
analytics is never ending, BancWares
Convergence software has played an invaluable
role.
We saw significant time savings.
To run stochastic scenarios, with
20 starting points and 200 paths,
it takes just a few hours for each
of the banks.


SunGard Trading and Risk Systems
Contact: Kim Ferranti, Marketing Director
Phone: 617- 542- 2800 x 337
Fax: 617- 542- 2100
bancware.marketing@risk.sungard.com
http:/ / www.risk.sungard.com


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