Home > About NFS > Blogs

Treasury Blogs

Below are the latest treasury blog posts by NFS consultants and partners. Please check the sources in the right column for a complete view of all posts.

Treasury Leading Group Consolidation

(Wed, 03 Feb 2010, by Magnus Lind)

Generally in cases of group centralizations the treasury is one of the key functions taking a leading role. By getting control of the groups cash processes treasury is a catalyst for the rest of the centralizing initiative. Most of the strategic treasury initiatives are implemented through technology. Treasury process improvements are therefore putting a focus on the TMS and other treasury applications and how well they are integrated in the groups operations. Modern treasury solutions provide huge opportunities for optimizing processes, centralizing cash and control, and for reducing working capital and costs. They therefore become very able tools for leading the consolidation of group operations.

Conclusions of this reasoning are firstly that the ability for technical integration of the treasury applications and the scalability of the IT infrastructure is crucial to achieve results. This is also the reason why the Oracle and SAP treasury and cash management modules are gaining attention and increasing the installed base. Secondly group consolidations is an ample opportunity for the treasury to prove value add for the core business organization. The level of decentralization your company has is part of its DNA and consolidations are therefore usually hard to perform. But getting control of the groups cash is the tool treasury can use. When treasury gains that control the group management has the means of controlling the group. The guy with the wallet decides.

From the treasury blog post Treasury Leading Group Consolidation.

Increase Transparency of Banks Best Regulation

(Fri, 08 Jan 2010, by Magnus Lind)

One can question if the root causes of the crisis were lack of regulation and that the OTC derivatives markets were not properly monitored. Surely the explosion of OTC derivative contracts was an effect of the credit expansion started in the early 80-ties rather than the other way round. The main cause behind the large swings is too much debt. We need to keep that in the back of our mind.

I have studied the work by the EU commission on regulation of OTC derivatives. What strikes me is that regulating separate areas independently seems to be easier than putting the new regulatory framework into context. I am particularly struck by the limited perspective of the discussion. It mainly revolves around banks and other financial institutions when it actually affects the whole society. The corporates are only involved in the periphery of the regulatory discussions.

The key, I believe, for sound financial regulation is to increase the transparency of the banks financial accounts. For many years the accounts have been impossible to decipher because the regulators have been keen on not forcing banks to disclose information to the market with regards to competition. But the fact is that banks do not compete in the general sense of the word.

Competition means having the risk of going bankrupt because your competitors take your market. No bank risks that. The banks go bankrupt when they take too much risk, have insufficient controls and bad management. I feel compelled to question if the regulators and bank supervisors know what competition really is.

Compare the transparency of corporate accounts with that of financial institutions. Why can corporates have transparent accounts when the banks cant? Because the banks are more exposed to competition than corporates?

A more holistic perspective on regulation would be to force the banks to become transparent and enable us to understand what risk their business model and balance sheet entails. Force the banks to become as transparent as the corporates so we all can make our analysis. Now the only parties having sufficient information to evaluate a banks risk position are the supervisors. And what can they do about a bank taking too much risk? What can they do about systemic risk? Basically nothing.

However if everyone would have sufficient information of each banks positions everyone would price the banks shares and choose to transact with the bank based on their own judgment. This is how we usually organize society and free markets. Why shall we not do the same in the financial markets?

From the treasury blog post Increase Transparency of Banks Best Regulation.

Forecasts Does Not Come Easy

(Mon, 14 Dec 2009, by Magnus Lind)

Pre-crisis corporates produced forecasts and ran the business based on relatively stabile conditions. Markets were expected to follow a trend, many times growth rates of the economy. This is no longer true. The trend is not your friend instead you need to be prepared for the unexpected.

The Corporate Plans for 2010 survey, performed by the European Treasurers Peer Group and sponsored by NFS Group, clearly indicated that forecasts do not any longer come easy. This force mitigation through making the cost base and capex programs much more flexible and it raises the question how we shall hedge without reliable forecasts. Anyway hedging of forecasts only postpones the effect of market rate changes. An alternative is to increase the price elasticity transferring the FX effects to the customers and vendors earlier. This would be an effective hedge but require that we adjust our business model. Alternatives are to seize hedging other than for confirmed transactions or hedge unreliable forecasts. But these options raise more questions than answers.

But there is seldom something bad that does not give birth to something good. The crisis has forced corporates being much more agile, fast moving and flexible, not only relying on the trend. This is a very good improvement and it also forces the corporate management to treat financial risks as business risks and adjust the business model to cater for them.

From the treasury blog post Forecasts Does Not Come Easy.

Factoring May Improve Rating

(Mon, 07 Dec 2009, by Magnus Lind)

Factoring might be a way to improve the rating for sub investment grade corporates. Lately there has been a gradual shift by banks to change how they view factoring, or invoice discounting. Previously they regarded the factor to take control over some of the collateral decreasing the security for the other financiers but lately there has been a shift towards regarding the cash generated through factoring as early payments from the customers. This perspective means that the cash flow is improved and therefore the default risk is reduced. Through the grape vine I hear the CRA (Credit Rating Agencies) might even improve the rating dependent on the terms of the factoring program of course. One critical issue is obviously recourse.

Implemented on a broader scale this would mean that factoring companies could substantially increase the amount of available funding for corporates. This does not happen every day and could be a counter action to manage the negative effects of Basel II.

From the treasury blog post Factoring May Improve Rating.

Impact of New (and Old) Regulation

(Mon, 30 Nov 2009, by Magnus Lind)

The European Treasurers Peer Groups discussions with the central banks management assist us in understanding how we must adjust for the future.

Here are some clues:

The window for change has disappeared with the improved economy, which opens up for less drama. Rigorous change basically does not make any political sense any longer and probably the far fetching regulation of the non regulated markets will therefore not happen. And Im not sure that is a bad thing. It might even reduce to only fighting for global taxes on financial transactions and limiting bonus schemes. The former will definitely lead to higher costs of financing for consumers and corporates and I therefore suspect it will not happen. The latter is only populism and has no real impact.

It seems however likely that increased capital requirements will be implemented but slowly and not during present business cycle. We understand that capital requirements will be increased in periods of high economic activity and vice versa. This makes sense and could limit future bubbles.

There is no sign the central banks are paying any attention to the society outside the banking system. This is especially true in Europe where saving the banks means saving society from economic disasters. As us corporates know this is not true. We will unfortunately have to live with a financial regulation with main focus to avoid bank defaults (Basel II). This means that established trends will continue:

Banks continue exiting the market of balance sheet commitments to corporates and focus more on the private market. One of the cornerstones to avoid bank defaults in the Basel framework was making the banks less exposed to corporate risk introducing the credit markets as buffer and high capital requirements on corporate risk. Very little has been learnt from the crisis in this area and therefore the shift to arms-length from relationship banking and increased reliance on automated risk management will continue. The only major lessons learnt by central banks from the crisis is that banks and financial institutions will default despite of Basel II. Therefore they have implemented models to avoid another Lehman. Thats a good but not a sufficient improvement.

One area where the central banks do not take any responsibility is improving the global payment system. This could be an area where modern regulation could have provided substantial value for the non financial sector. The central banks expect the markets to improve payments infrastructure but it is obvious there are few incentives for the financial industry. Instead governments and central banks should assist by prohibiting float by law and breaching institutions would have to pay a severe fine to payer and payee. Then the incentives for change would be there. Actually I would expect that without this legislation payment systems would continue to be dysfunctional for many years to come. This would severely hurt the corporate sector having to continue raising liquidity to provide it to the financial sector, indeed an irrational setup.

From the treasury blog post Impact of New (and Old) Regulation.

Report from Survey on Corporate Plans 2010

(Mon, 23 Nov 2009, by Magnus Lind)

The crisis imposed a paradigm shift on corporate planning and management. The pre-crisis stability of growing markets and following the trend strategies has vanished. The crisis changed the status quo; revenues decreased with 50% in some industries from one month to another; financial markets disappeared over night. The prior relative ease of forecasting was replaced with a sense of prepare for the unexpected. This situation put the limelight on:

counterparty risk management
liquidity and cash management
risk management and hedging strategies

As a consequence corporates have been more adjusted to plan for any eventualities, focus on cash generation and not expect availability of credits at anytime. The rigid strategy of following the trend is being replaced by a more agile and flexible preparedness to adjust with changing conditions. Service levels and relationships with your banks can suddenly change, management information is crucial, economic statistics is not reliable and the trend is not necessarily your friend.

The actions treasuries take as a response:

deleveraging
develop bank relations and new strategies
new hedging strategies
improve technical integration
improve reporting capabilities
be agile and do not take anything for granted
take advantage of the opportunities arising e.g. opportunistic financing

The actions corporate management takes as a response:

improved market and sales focus
flexible cost structures
flexible capital expenditure schemes where projects can be postponed or accelerated depending on conditions
take advantage of the opportunities arising e.g. acquisitions of corporates and markets

Treasury and corporate management monitor the macro economic development more closely; this includes generic parameters (growth rates, inflation etc) and company specific (key currency crosses, commodity prices etc). Cash generation metrics receive increased attention.

This report was sponsored by NFS Group. Please contact johanna.lenner@nfs-group.com if you want to receive the complete survey report.

From the treasury blog post Report from Survey on Corporate Plans 2010.

Companies plans for 2010 and lessons learnt from the past months

(Thu, 19 Nov 2009, by Johanna Lenner)

Irrespective of which industry to ask almost the same answer from all. I.e. the crisis seems to hit all industries almost in the same manner and the preventive and swift measurers taken of the corporate treasury are very similar. Here is a brief list of conclusions.

Liquidity is Paramount

Intensify/strengthened banking relationships and to make an overview to decrease the dependencies on banks, not to be too reliant.
Improve working capital management decreasing AR, collections, disbursements etc.
Improve cash flow forecasting and simplifying the model (migrate way from using spreadsheets instead establishing accurate cash flow forecasting systems and processes).

Counterparty Risk Must be Tightly Managed

Pay closer attention to counterparty exposure and to the ownership structure of counterparties (the obligations of the parent can impact the subsidiaries).
Increase the number of the customers (A/R) who are required to pre-pay before delivery.

Collateral Agreements

Implementing more stringent collateral agreements with counterparties. Introduced and change approach to CSA Thresholds.

Risk Management

Further improved credit & risk processes. Focus on risk management. Need for more feasible risk systems (be able of slice the analysis; country, type of counterparty etc.)

Business Units, Treasury and the Executive Board

Treasury should act as business partner to the Executive Board (provision of scenario analysis, stress tests on liquidity development, etc.). There need to be a greater interaction and integration between treasury and business units to overcome barriers.

The corporate plans for 2010 include closely update all sensitive parameters as the general macro parameters and the variables specific to the own business. The corporate treasuries plan to reduce bank debt, increase public debt and ensure refinance/repay maturities well ahead of maturities and much sooner than they would have done prior to the crisis.

55% of the respondents stated they performed the actions necessary. They feel confident with their staged efforts. Of course we all get hindsight, the lesson learnt is to fought harder to close some of those gaps and approximations which existed before the crisis hit, accurately set Risk management routines, have more bank rating follow-up and monitoring, spread out maturity of hedges and upgraded systems earlier.

Please contact me at johanna.lenner@nfs-group.com if you want to receive the complete survey report.

From the treasury blog post Companies plans for 2010 and lessons learnt from the past months.

How Treasurers Improve Careers

(Mon, 16 Nov 2009, by Magnus Lind)

The crisis has changed the role of the treasurer and we are much more exposed to the board now. This means a new set of rules and expectations. On behalf of the European Treasurers Peer Group I have interviewed CEOs and board members and here is a list what they expect. Fulfilling these expectations is a career improving activity.

Understand the business model and the underlying need from the business areas. Business modeling has not before been on the agenda of the treasury but thats changing. Already many treasurers have understood this by transferring distributor risk on to financial institutions or limiting the financial exposure of vendors as only two examples.

Broaden the scope of markets. It does not only mean financial markets any longer. The expectation is the treasury also understands the markets your corporate is operating in. Follow the business area managers visiting customers and adapt a commercial mindset in the relation. Find ways how treasury can improve the customer experience and how your company adds value.

Act from a group perspective, and be expert in your field. One typical area is working capital management. Do not blame the business units for not understanding and stating that they own the money. Just implement good working capital practices. That is the responsibility of treasury. Blaming others and limiting your area of responsibility is definitely a career limiting activity.

When communicating with the board and C-level give them the solutions not the problems. Do not overwhelm them with details. Do your home work and give them the conclusions and propose what they should decide. Prepare to substantiate with facts and analysis. Be precise. This means taking risks, but the opposite just creates confusion and an unfavorable impression.

Focus on activities leading to top line and bottom line growth earn your right to grow. A treasurer who substantially assists bringing in business or reducing risk in the core business will be a star. Avoiding having Treasurer as a final position requires migrating to the core business and there has been no easier time than now.

Have your eyes on the future, not the past. There are few things CEOs and board members loath as to discuss past quarter figures. Thats already history. The finance/treasury joining the executive management in focusing on the future are the winners.

From the treasury blog post How Treasurers Improve Careers.

Trusting Your Bank

(Mon, 02 Nov 2009, by Magnus Lind)

There are different strategies applied by corporate treasurers in the relationships with their banking partners. Some play with the cards close to the chest and reveal information on a need to know basis. Others are very open and share information in a sense of trust. I tend to prefer the latter strategy. Recently I met with a treasurer from a multinational with investment grade rating. He gave empirical evidence that complete openness is the best strategy. I have heard from treasurers all around the globe saying banks are retreating from credit line commitments particularly at roll-overs but he gave a very different picture. His company has had an open attitude sharing information freely with the banks for decades. They have provided banks C-level access on a regular basis and supplying them with highly confidential information to make them participate in the strategic development and understand the risks and funding needs more precisely. The objective is to avoid unpleasant surprises for the banks. This approach facilitates for the banks to package the offerings based on a full understanding of the business and its risks. His guiding principles for the banking relationships.

He gives the banks what they expect:

Full transparency on strategy, risks and challenges
Open discussions on issues, risks and opportunities
Sharing same information to the whole banking group simultaneously
Fair sharing of wallet between the banks according to credit commitments
No shopping around of original ideas
Access to senior management

He expects from the banks:

Consistent commitment of balance sheet
Creativity
Integrity
Access to senior management

These bank relationship practices have rendered in no bank retreating at roll-overs of facilities and he has a stabile banking group with several banks wanting in. I know some of you say it is easy to do while being investment graded but I would expect it to be true for most companies. The perception of risk is much different if you know the conditions than when you do not know them. If the banks feel secure they understand all the risks and have all information they will be more prone to commit balance sheet. That is only natural. Another reflection I make is that many companies have introduced C-level in the banking relationship only recently being triggered by the crisis. This is appreciated with the banks since it gives them the opportunity to address strategic risk management with those who manages them. Financial risk management is and has always been a C-level and a board issue. For many years even before the crisis. In his company, treasury has been a board and C-level function for ever. This now pays off, he has a stabile banking group and several banks wanting in. Treating your bank as a partner more than a vendor is a clever strategy.

From the treasury blog post Trusting Your Bank.

Perfect Timing for Procuring Cash Management

(Wed, 28 Oct 2009, by Magnus Lind)

Now banks want to return to basic and increase the fee based business the want to do with they corporates. This means that for procuring and setting up new bank account and cash management structures now is the time to do it. Treasurers all over experience this situation. Just remember to share the fee based business (your wallet) to those banks who commit their balance sheet to you.

From the treasury blog post Perfect Timing for Procuring Cash Management.

A Bucket of Junk

(Thu, 15 Oct 2009, by Magnus Lind)

A bucket of junk is always a bucket of junk. In the eyes of the regulatory bodies a bucket with a little junk is still a bucket of junk but if it is filled to the rim with junk it could be rated as almost investment grade. If that's not a folly, what is?

Basel II has created a collateralized attitude to risk management.

From the treasury blog post A Bucket of Junk.

Treasury Risk is Business Risk

(Mon, 28 Sep 2009, by Magnus Lind)

When a decision was made to enter a new market or for a capex the board obviously made a risk reward calculation. Business risks were frequently measured and followed up regularly, but the financial risks were delegated through the treasury policy to the treasury to manage over time. Financial risk management became administration and financial risk was no longer a business risk. The crisis changed all that. Financial risk is now a business risk returning to the boards plate.

The key figures were all earnings related. The crisis changed all that. Now earnings are only accounting, cash generation is the key. Finally the basic rule of positive cash flow generation has replaced the EBITDA focus.

Now the boards have to relearn and embrace financial risk as the business risk it is. Financial risk can not just disappear through a policy, it has to be managed and there is no way to just hedge it away. Hedging is just postponing the effect and facilitating EBITDA budget follow-up. Financial risks should always have been a board level issue. And now many boards have to relearn, many treasurers need to get a better understanding of the way boards operate and their expectations. Our November meeting of the European Treasurers Peer Group will address this issue with treasurers and with a board present. If you are interested to join please contact me to apply for a membership.

From the treasury blog post Treasury Risk is Business Risk.

Negotiating a Facility

(Fri, 18 Sep 2009, by Magnus Lind)

Negotiating a facility is a cumbersome process nowadays. We can not expect that all banks supporting us previously will want to remain. The rating agencies require that we have reasonable planning horizon meaning that we need to start negotiating more than one year prior to maturity. We see a clear trend that companies below investment grade must rely more on the bond market than on bank loans. We have a problem to figure out which banks are global and which banks will be there for the long run. Which banks shall we spend our time and efforts on? Bank relationship management has never been so challenging and time consuming. We should learn to be more opportunistic; take the opportunities to finance to reasonable terms when they pop-up. We should not try to get marginal term improvements. This is not the time to be greedy. Another lesson we have learnt is that we shall conserve our cash and implement stringent cash allocation procedures. Cash will be a scarce resource for the long term.

From the treasury blog post Negotiating a Facility.

Steps of Collateral Management Process

(Thu, 10 Sep 2009, by Johanna Lenner)

The past years market turbulence has lead to increased attention to counterparty risk exposures. The market circumstances led to downgrades of many counterparties. How can your organisation manage it?

One area is setting limits on each counterpart. Yet another area is managing the risk on financial counterparts by entering a CSA (Credit Support Annex) as part of an ISDA (International Swaps and Derivatives Association) agreement.

The process to implement Collateral Management through a CSA is based on a number of variables, as:

Legal contracting e.g. standardize over counterparts so you have the same terms.

Process setup e.g. ensure optimal thresholds, payment frequency.

Netting of exposures.

Decide which assets shall be eligible as collateral.

It simplifies to use a structure similar to this:

The European Treasurers Peer Group performed a survey and saw a great interest in entering CSA agreements, however only 28% of the respondents had actually done it. Read here for more information.

From the treasury blog post Steps of Collateral Management Process.

Why Are We Merrier?

(Wed, 09 Sep 2009, by Magnus Lind)

We have been close to an economic apocalypse so they say. But now we are getting merrier and see more bright on to the future. Is it all stimulus? Or are we just tired of being depressed? Are there actually many or only a few variables that have improved? Or is this a baby bull market that will ride for the long term? We will ask our treasury peers (soon 300) to find out how they plan for the near future. Their input will probably push us closer to the true answer. If you are interested to participate please contact me. Note that only corporate treasury managers are invited.

From the treasury blog post Why Are We Merrier?.

Collateral Arrangements

(Thu, 27 Aug 2009, by Magnus Lind)

Many corporates are contemplating to enter into collateral arrangements with banks. The European Treasurers' Peer Group has performed a survey to inquire about advantages and disadvantages:

Disadvantages

Cash flow may be a problem if the valuations work against you.
Risk of cumbersome administration.
It can be argued that the corporate gets decreased flexibility in managing portfolio when it has to deliver collateral.

Advantages

With a CSA the banks capital requirements are decreased, which should benefit the corporate.
An arrangement decreases the risk for the corporate on the bank.

If you are interested in participating and learning more about the European Treasurers' Peer Group, please contact me.

From the treasury blog post Collateral Arrangements.

Treasurys Focus is Changing

(Thu, 20 Aug 2009, by Magnus Lind)

Since the collapse of Lehman in September 2008 the treasurers focus has passed through several phases. The initial reactions were chock, searching for information, comparing to historical patterns (typically the Great Depression) and analytics. Later we focused on FX risk, emerging markets, liquidity and funding and increased governance in credit risk management.

With time the economic conditions have stabilized, the corporates have improved reporting and analytics so the daily operations including liquidity management is under control. Now it is time to face the new reality with having to adjust to a financial situation with lack of credits. We can not foresee credit will be as easy accessible as pre-Lehman ever again. Therefore we need to be more efficient in how we allocate our cash. How do we improve our models for cash allocation and is WACC et al good enough for this situation?

From the treasury blog post Treasurys Focus is Changing.

How can companies deliver such solid Q2 results and what does it mean for the US and European economic outlook?

(Sat, 01 Aug 2009, by Fredrik Tallsten)
Until now, about 80% of the SP500 companies have delivered results exceeding forecasts made by analysts and the mean deviation for the profit has been about +14%. The same pattern has been obvious for European companies as well. These figures are the largest ever since the figures was started to be tracked back in 1993. To me, a lot of questions have popped up during the last couple of days related to the fact that the Q2 results so far have been extremely solid compared to the broader economic outlook, i.e.:

How can this be possible during such a big economic downturn?
Have analyst, as a group, become too pessimistic about the economic outlook and about companies capacity to deliver good results even in these bad times?
What are the implications for the outlook and business cycle for a longer period?

I will below elaborate on this topic and discuss my view of what has happened and also what I think will be the future related to company results and the US and European economies.

First of all, let me state that companies results are truly impressive! This is the largest downturn since the Great Depression during the 30th. Still companies earn large amounts of money which never before has been the case during certain difficult market conditions. GDP and industrial production decreases by between 4-8% respectively 15-25% in nearly all of the G8 countries! If we take the industrial sector as an example, the main bunch of these has made tremendous results during Q2 2009! How can then companies earn so much money?

The answer to this question is that companies have been very quick in their response to the economic outlook and been really successful in cutting their costs. Companies have also during this downturn been able to cut cost more than during earlier downturns which contributes to their current fairly good results. Today compared to 20 years ago, companies are more built up in blocks where they buy much more from subcontractors. This means that costs in a much larger extent than before are variable and companies can quickly downsize if demand vanish. If we at the same time take a look at Q2 revenues figures for the same companies, these figures are not at all that impressive compared to the results presented. For further details, see the table below describing some companies in the industrial sector in United States and in Europe:

Revenue figures are much more in line with the broader economic outlook and even lower than analysts pessimistic expectations. So my answer to the question if analyst has become too pessimistic about the economic outlook is NO (!) but they have instead underestimated the new era where companies quickly can scale down and cut costs because they are built up in a different way than before. One good example of this is the Swedish company SKF which is the world leader for solutions and products related to rolling bearings. If you go back 20 years in time, SKF would have made large losses during the current market conditions.

But who are really the winners and losers in this new era? Or are there only winners now when companies earn much more money during at least the beginning of a very weak period for the World Economy. I probably surprise many people by using the term beginning because most people and economists right now start talking about a recovery. There will for sure be smaller upturns in the shorter perspective due to some very obvious circumstances:

Very large amount of money are currently spent by governments (fiscal policy) in different countries by implementing different stimulus packages.
Central banks around the world runs a very expansive monetary policy where they support the economy by reducing interest rates and print a lot of money which in the end most probably will cause inflation to increase substantially.
Industrial production and industrial orders cant decrease by 15-25% and 25-40% respectively without popping back up at least temporarily. The reason for this is that at the moment companies in a large scale are reducing their inventories which means that they most probably becomes underinvested for some time with the result that their demand will increase temporarily in the future.

The above circumstances lead to a road more bumpy than smooth. But does it also mean that we are heading for a quick and broad recovery? My answer to this question is NO and I will below explain why this not will be possible.

As mentioned before, the fact that companies at the moment earns a lot of money means that they so far have been very successful cutting costs and cutting staff. But isnt this all good? If you look in a short range of time and only look at the individual company and its shareholders, i.e. not aggregate companies together and let it sum up to the World Economy Then it for sure is good! But for the World Economy, its probably not good and will work in the opposite direction.

The process of downsizing is still an ongoing process and companies at all levels and scales are cutting back making more and more people redundant. The result is that the global spendable income per capita will continue to decrease for a long time and the demand for companies products and services will because of this NOT ramp up in a larger scale. I.e. people cant spend money they dont have! So the fact that the crisis now have been ongoing for a fairly long time will contra dictionary result in that it will keep on going. Neither the US or European consumers nor the companies themselves are able to help the world economy to get the kick start it would need to start ramping up again.

When we have had such a deep economic crisis, a recovery is only possible where it will go gradually and because of this very slowly. What I mean is that the only alternative for a recovery is a gradual recovery where companies will start hiring again and people will start spending money again because their confidence increases. And these two cant take place individually so this in turn means that a recovery automatically will be in very small steps. Neither companies nor the consumers in US/Europe will at the moment take the first step to ramp up in the shorter perspective!

But what is our hope then? How are we going to get out of this economic crisis? During the last 6-8 years, the Asian economies have been the key driver of the world economy. In this difficult situation, the development in this region will be even more important for the US and European economies during the next couple of years. So my conclusion is that we should cross our fingers that China, India and the other Asian countries can help the world economy to start a broader recovery!

From the treasury blog post How can companies deliver such solid Q2 results and what does it mean for the US and European economic outlook?.

New Business Models Required

(Fri, 31 Jul 2009, by Magnus Lind)

What does it mean that the second engine imploded (see my blog from June 5, 2009) for your business model? Do your customers require borrowing money to be able to buy your products? Then you might have to abandon your present model or at least redesign it. That is if you can't wait for the twin-engine model to return to pre-crisis levels. And that will take time.

In our latest European Treasurers' Peer Group we were visited by Robert Bergqvist, Chief Economist at SEB. According to Robert the central banks cannot actually control inflation and we would therefore need a new monetary policy framework. Unclear what but the present opinion is that credit expansion is the key to controlling the economy. This means that credit would not be allowed to grow faster than GDP and this would impose a major change and force us to find new ways to achieve growth without excessive leverage and credit driven consumption.

This would basically also mean that corporates with SME or private customers having to make relatively large investments to buy the products will now have to wait until they have saved up (if you cannot supply credit to them that is). This is a game changer for all industries requiring customers to increase debt. Here is an area where the treasurer can deliver exceptional value in developing a new business model.

From the treasury blog post New Business Models Required.

Software as a Service Faster Than My IT Department

(Fri, 17 Jul 2009, by Magnus Lind)

Treasury is a strange world for the internal IT in large operations. Treasury does not really fit in to all the IT policies, large ERP projects and other bureaucracy surrounding the IT organization. One example is collecting data from the operating companies such as account receivables and payables to calculate risk and cash flow forecasting. Setting up new solutions through the IT governance structure can take a lot of time and be very costly. Therefore SaaS (Software as a Service) many time makes sense for treasury. Buying directly from fast moving suppliers that set-up and run efficient solutions circumventing the inertia of your own IT department.

From the treasury blog post Software as a Service Faster Than My IT Department.

Extreme value statistic approaches for estimating Value at Risk (VaR) Results from a study covering the FX market

(Sat, 11 Jul 2009, by Fredrik Tallsten)

I have in two earlier contributions discussed the current high volatility in the FX market respectively how you can use extreme value statistics to overcome the drawback that the most commonly used VaR method encounter.

In this contribution I will present results from a study that I and my colleague Peter Bergstrm has performed where we compare the three different methods mentioned in the former contribution, i.e. results will be presented comparing:

Assumption about that returns are normally distributed
Block Maxima (Generalized Extreme Value Distribution - BM)
Peak Over Threshold (PoT)

If you would like to review the former contribution about the different methods, press here.

The data used in this study is the same as in the former contribution describing the current high volatility in the FX-market, i.e. we are estimating VaR for the currency pairs USD/SEK and EUR/SEK. For USD/SEK we have used time series from 1982 to 2009. For EUR/SEK we have used time series from 1999 to 2009. Below some tables are presented describing the result from our study.

n is a variable describing how many data points you have in each block, i.e. for BM you divide your dataset in blocks. There is no distinct value which you should use for n In the literature describing the two methods, descriptions are given for how to estimate a proper value for n. When you have found a proper value for n, you can elaborate by changing n around this value to see if the calculated VaR value changes significantly (which not is the case for us). I have left out the more detailed description here for how to estimate n.

As can be seen in the tables, the assumption about normality gives absolutely the lowest estimate of VaR for both USD/SEK and EUR/SEK. Peak Over Threshold is in the middle for both currency pairs and Block Maxima gives the highest estimate of VaR for both currency pairs. This is in line with that the commonly used VaR method do not consider that financial return series have fat tails, i.e. they are NOT normally distributed and that the risk for large losses are larger than anticipated by the normal assumption.

The overall result from the above means that if funds and financial institutions estimate their risk using the normal VaR method - which more or less has become a market standard - this means that they probably underestimate the actual risk in their portfolio!

If you would like to have a more detailed description of our study, please send an email to fredrik.tallsten@nfs-group.com or peter.bergstrom@nfs-group.com.

From the treasury blog post Extreme value statistic approaches for estimating Value at Risk (VaR) Results from a study covering the FX market.

Treasury Wagging the Dog

(Wed, 08 Jul 2009, by Magnus Lind)

Working Capital Management (WCM) is a funny creature that few companies really get their arms around. This is especially true for public companies. From my experience entrepreneur driven companies have a much better control and focus on cash and cash drivers. There it is a necessity to gear the company towards cash generation instead of earning figures forced on to public companies by the analysts.

In public companies where most KPI are built on EPS and EBITDA there is often a hard struggle to implement WCM. Since the organization is not educated on the impact on cash treasury usually is the only function understanding the difference between accounting cash and bank account cash. Therefore giving the treasury the responsibility to implement WCM in an EPS run corporate is like asking treasury to wag the dog.

From the treasury blog post Treasury Wagging the Dog.

Crisis Started in the Regulated Markets

(Thu, 02 Jul 2009, by Magnus Lind)

There are lots of discussions how to regulate hedge funds and other high risk financial companies. Maybe there are actions to take to avoid Ponzi schemes for instance? But we shall never forget that the credit crunch did not start there. It started in the regulated part of the financial industry.

Maybe therefore more regulation is not the full answer. Regulations can be designed in ways to create systemic risks (which I say Basel II has done). Let us hope that we do not just get more regulation. Instead let us hope that we get new regulation based on common sense and the boom and bust nature of the minds of human beings.

From the treasury blog post Crisis Started in the Regulated Markets.

IMF Questions Raise Questions

(Mon, 22 Jun 2009, by Magnus Lind)

The IMF is discussing many questions in the Global Financial Stability Report Responding to the Financial Crisis and Measuring Systemic Risks April 2009 IMF. I here bring up two of them being of significant importance. You find them in the report in pp112-

Question 1: "What were common factors among the financial institutions (FIs) that have required public intervention? Did traditional financial soundness indicators (FSIs) provide meaningful warnings?"

My comment: Putting this question can only an academic or public servant do. Someone who still has the belief that social engineering is an exact science that should be performed only by scholars and the elite. There is nothing replacing experience and common sense. Experience from running businesses and the common sense developed in the process focusing on the survival and growth of the company. Only being exposed to true competition can develop it. The problem with the banking system is that it is not a competitive system forcing survival of the fittest. It is a protected system based on survival of those who conform and those who do will always enjoy government or rather taxpayers' protection. You cannot find a set of indicators to run an enterprise remotely. The conditions change constantly and only flexible minds managing to make investments with relatively low risks will survive over time. And then there is the element of luck that always has to be on your side to win. The aspiration of social engineering and banking supervision and regulation tries to disregard those facts or natural laws if you wish. Risk management cannot be 100% automated, you need to add people with integrity, experience and common sense to have the final word. The IMF is on the wrong path. Social engineering and industry protection leads to moral hazard or plain corruption. The banks have to be exposed to full competition and regulation shall protect society from banks' defaulting, not the other way around.

Question 2: How can one determine which FIs are systemically important? Can one shed light on whether allowing Lehman Brothers to go bankrupt was or was not a policy mistake exante?

My comment: There are probably ways to define which FIs being most important. But why do we have these giant FI? Why not consider a system which does not allow any FI to be systemically important?

The problem with Lehman Brothers was not that it was allowed to go bankcrupt. The problem was instead that the Fed did not have any tools to save it, so Fed had no other option than to let it go. The Fed hadn't prepared for a potential failure of a FI! They have actually admitted that fact (see my blog from May 6 2009 "Fed Lacked Tools"). Read also the Letter to Shareholders by JP Morgans' Chief and get some valuable insight on the chaotic acquisition of Bear Sterns. I'm still amazed that the Central Banking system was so unprepared to handle the crisis.

From the treasury blog post IMF Questions Raise Questions.

Health of European Banking System

(Sun, 14 Jun 2009, by Magnus Lind)

This is an extract from FT dated June 12 2009. Copyright The Financial Times Limited 2009.

"Alistair Darling, UK finance minister, told the Financial Times this week that a failure by other European countries to clean up their banks could hold back economic recovery. They continue:

The euro has been laid low by fears over bad loans, with concerns over the exposure of banks in the region to a potential meltdown in the Baltic states and central and eastern Europe weighing on the single currency. Many commentators expect that trend to intensify. Maurice Pomery at Strategic Alpha says the eurozone banking system is in denial over the extent of toxic assets on its balance sheet. We still dont know the full story, he says. Mr Pomery doubts that German banks have been operating on vastly different business models over the past five years than their peers in the UK, US and Switzerland, which have revealed their high degree of vulnerability to the financial crisis. I think they have significant exposure, he says. Central banks are worried about opening Pandoras box and when they do it will impact on the euro. Analysts say the problems in the eurozones banks are likely to be swept under the carpet ahead of the German general election on September 27. Hans Redeker at BNP Paribas says there is no incentive for the German government to raise the issue ahead of the vote. But whoever wins will want to get the problems out of the way as soon as possible. He regards the German and Austrian bank sectors as the weakest in Europe. But falling real estate prices and rising unemployment will also weaken bank balance sheets in Spain.

The low transparency of the banks accounts is a great worry for corporates and other investors. Probably there is more to it than meets the eye. If the FT is correct than the European governments are hiding very crucial information from us. That would not be ok! How can we know which banks to trust with our cash?

From the treasury blog post Health of European Banking System.

Bonus programs for sure fulfils their purpose!

(Thu, 11 Jun 2009, by Fredrik Tallsten)
The last couple of month there has been an ongoing debate about bonus programs in US as well as in many European countries. It all started when about 400 top executives at the American insurance company AIG where qualified for getting bonuses of around $165 million for 2008 despite that the company had received more than $170 billion in taxpayer bailout money from the Treasury and Federal Reserve during 2008/2009.

My personal view is that the bonus debate has turned in the wrong direction and that it unfortunately has become very political. In for example Sweden, the government has proclaimed that no bonus programs should be allowed in companies controlled by the Swedish state and that Swedish pension funds should work against bonus programs in private companies where they own stocks.

I truly agree with the criticism about the enormous excess bonuses that from time to time have been paid out to top executives but my opinion is at the same time that it should be possible to become rich by working and not only on Sports! No one argues when a sports star earns $100 million! I am convinced that bonus programs for sure can fulfil their purpose depending on how they are set up. My view is that the individual economical compensation needs to be much more closely connected to the individuals performance. This will benefit both the company as well as the individuals!

In my mind, the debate should instead be focusing on other important questions related to bonus systems and economical compensation for individuals like:

How to set up an adequate bonus programme that is very closely related to the individuals performance and at the same time also benefits the employer? This is not an easy task but to get people striving, this is very important!
How to set up a bonus programme that actually reflects the individuals performance and not only to a large extent reflects the current business cycle? Most bonus programmes tend to be very much correlated with the business cycle where top executives get large bonuses during good times and small or no bonus at bad times. But most probably, peoples performance is distributed evenly over good and bad times which means that it should be likely easy to get a high bonus during bad as well as good times! So my opinion is that a good bonus programme needs to as much as possible scale back the influence of the business cycle.
Where in a companys organisation and hierarchy is bonus programmes most effective? If a top executive earns $50 million/year in base salary, he/she is probably fairly indifferent if he/she gets another $50 million in bonus. You cant spend that money anyway! At the same time you know for sure that people that works on the assembly line works more effectively if their salary is based on incentives. My point is twofold here; First, bonus programmes to top executives probably are of little value if the person already has a very high base salary. Second, bonus programmes many times probably works better in the lower part of an organization than for the top executives because for these people it really matters if you can influence your own salary by doing a god job! To answer the question where in the organisation a bonus program is most effective, the important thing is that it is possible to very closely relate it to the individuals performance, see point no 1 above.
Bonus programmes seldom reflects both opportunities and risks. What I mean is that if a stock trader at a trading desk as an example earns very much money one year, he/she will get a very high bonus but the downside is limited where he/she will get only the base salary if not successful. This drives people in certain job roles like in the financial sector to take large risks because risk and return is very closely related to each other.

So my opinion is that the bonus debate has turned in the wrong direction and that bonus programs for sure fulfil their purpose. But, -they should be directed to the right people and the conditions for the programs needs to be set up so they really get people to strive to do an excellent job!

Another aspect of the ongoing debate which is closely related to the discussion about bonus programmes is a more general discussion about the need of flexible salary payments. In these bad times when many companies order intake and production decreases by as much as 40-50% it is obvious that companies either need to make people redundant or decrease salaries and the total working time! There has been a very tough debate about this but to me it seems obvious that companies need to be able to link revenue and salaries to a larger extent, at least in these certain market conditions!

From the treasury blog post Bonus programs for sure fulfils their purpose!.

Second Engine Implosion

(Fri, 05 Jun 2009, by Magnus Lind)

I hear from treasury peers that the credit market is returning gradually. That is comforting but we are still far from the credit expansion bonanza that ended 2007/08. JP Morgan has a very well written paper on the reasons behind the crisis from where I have borrowed (and revised) this picture.

Prior to the Basel Accord the banks did basically all lending to corporates and individuals. Boosted by Reaganomics and the Basel Accord the second engine (in the picture "bond market" and "securitization") took over the lion share of the lending. The purpose of the second engine was to support credit expansion and create a protective shield for the banks.

Now the second engine is working at reduced capacity and regardless if the banks increase lending there remains a huge credit gap. This picture made me understand how vast the financial collapse actually is and that it will take a long time to return to status quo. I believe this picture also shows that high leverage will probably not be the strategy for the imminent future.

From the treasury blog post Second Engine Implosion.

Refining Credit Risk Metrics

(Sat, 30 May 2009, by Magnus Lind)

Rating is not and will not be sufficient. The fact that the issuer pays puts a doubt on where the loyalty of the agencies lie. Ratings are seldom good early warning indicators either but they will probably continue to serve as a standard component for any credit risk model.
Early warning indicators.
We cannot 100% automate risk management which requires we have to include subjective measures or gut feel if you wish.
Black Swan[1] expect the unexpected and develop mitigation plans.
Good local knowledge will remain key and increase in importance.

[1] A large impact and hard to predict, and rare event. "Black Swan" theory refers only to events of large consequence and their dominant role in history. The theory was described by Nassim Nicholas Taleb in his 2007 book The Black Swan.

From the treasury blog post Refining Credit Risk Metrics.

Banks Balance Sheets Lacks Transparency

(Fri, 22 May 2009, by Magnus Lind)

Counterparty risk is a major concern for corporates today especially if the counterpart is a bank. It is virtually impossible to understand the true risk that lies in its balance sheet making it very hard to manage the excess liquidity.

The banks must improve the accounting standards and make the accounts as transparent and open as the corporates. We need a paradigm shift in evaluating and regulating the financial sector.

From the treasury blog post Banks Balance Sheets Lacks Transparency.

HBR - 6 Mistakes in Risk and Working Capital Management

(Tue, 12 May 2009, by Magnus Lind)

Treasury is getting on the agenda of the board as I have discussed earlier. This is proved by Harvard Business Review starting to discuss treasury topics. In the March edition of HBR they list 6 ways companies mismanage risk and in the May edition they list 6 mistakes or "don'ts" of working capital management. The articles are well worth reading. They describe the changing role of treasury when managing the cash flow has become more important than managing earnings short term. The first "don't" HBR lists in working capital management is "don't manage to the income statement". I agree - cash KPIs are here to stay.

From the treasury blog post HBR - 6 Mistakes in Risk and Working Capital Management.

Read the Blog Sources

The NFS blog posts to the left are the latest from the below sources: