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The latest assignment for CFOs? Managing risk in a war zone.
Tim Reason and Ronald Fink, CFO Magazine
November 1, 2001
Days after a truck bomb sent workers fleeing from the World Trade Center in 1993, executives at The New York Board of Trade began hunting for an emergency backup site. They wanted a place to house not just computers, but also replicas of the open outcry pits where NYBOT members trade such things as sugar, cotton, coffee, and orange juice, as well as some financial products. By the spring of 1995, two spare trading pits had been built in an industrial section of Queens. They sat there, empty and unused, for the next six years. Until September 11.
"We thought we'd use it for four or five days," says CFO Walter Hines of the backup site that is now keeping his business alive. "We never envisioned a situation where our building would be destroyed." Four World Trade Center, the 9-story building that housed NYBOT's offices and a 13-pit trading floor, was crushed by 2 World Trade Center, the south tower, when it collapsed at 10:05 a.m. on September 11.
Hines, with four others, had stayed behind after the first plane hit the north tower to make sure everyone had been evacuated. He left when the second plane hit. "As I was walking off the trading floor, I heard another boom," he recalls. "We made the decision, instantaneously and as one, to leave."
He then endured an eerie sprint through the nearly deserted World Trade Center concourse and across Church Street, which was littered with debris from both impacts. Unable to reach NYBOT's designated congregation points, he says, "I began a long day of walking." It was not until much later that day, viewing lower Manhattan from a packed but silent ferry to New Jersey, that he realized both towers were gone. Although all 263 NYBOT employees were safe, he later learned that an options trader who was having breakfast at Windows on the World, and a former board member, were both killed in the collapse.
Before September 11, the expense of the unused Queens site--$300,000 in rent and utilities annually--had come in for frequent questioning. Fortunately, it was never cut. Economic uncertainty breeds volatility--and volume. When NYBOT, like the New York Stock Exchange, reopened for trading the Monday after the attacks, volume soared. "We had two of our biggest days of the year that week," says Hines. Without the spare site, NYBOT would have been out of business, rendering traditional business- interruption policies meaningless.
It is now axiomatic to say the world changed on September 11. But businesses, like individuals and governments, are struggling to understand just what that means. Some effects will prove to be temporary; others will endure. Certainly the events of September 11 have exacerbated problems that had already emerged, especially the slowing of the economy and the hardening of the insurance markets. And some corporate policy debates--the risks of just-in-time sourcing, for example, or the merits of centralized versus decentralized workplaces--have intensified in the wake of the bombings.
One fundamental difference for business, and in particular for finance executives, is the recalibration of risk. Until now, domestic political risk played a fairly minor role in most U.S. business calculations. But going forward, U.S. companies will need to think more along the lines of a Walter Hines. On issues ranging from treasury operations to travel policy, CFOs in companies of every size must weigh the likelihood and possible impact of a terrorist act on their people and operations.
Clearly, a top priority--and possibly a top expense--will be to adjust to a drastically altered definition of disaster recovery, one that goes far beyond insurance and the IT backup plans honed during Y2K preparations. "Most people focused on resumption of their technology operations; those were restored pretty quickly," says Donald Christian, a partner with PricewaterhouseCoopers LLP's risk management practice.
But neither the Y2K preparations nor the 1993 truck bombing of the World Trade Center prepared companies for the loss of life or the possibility that office space would be permanently demolished. "The risk assumptions have changed," says Christian, who suggests that companies must reassess everything from basic transportation to long-accepted practices such as just-in-time manufacturing. "Plans made during 25 years of peace and prosperity must be reconsidered in an environment of war and terrorist threats."
He notes that Ford closed five assembly plants when parts delivery was disrupted. "Would the automotive industry have foreseen that a disaster in lower Manhattan would cause Ford to shut down plants?" he asks.
"Most companies channel their communications services to one vendor to get better pricing," he adds. Now, as they did for Y2K, companies must assess whether the business benefits of such dependence on vendors outweigh the potential risks. "There is a big emphasis on communications, power infrastructure, and the extended supply chain," says Christian.
San Francisco-based PG&E Corp. has long maintained alternative sites and alternative service providers as a disaster hedge. "Given the threat of earthquake, we recognized the need for disaster recovery centers away from our headquarters building," says CFO Peter Darbee. That includes a dedicated site for executives, equipped with all the information and systems needed to keep the company--and its finances--running. "If San Francisco banks are dislocated in an earthquake, we have to reach banks in Chicago or New York," says Darbee. "We have to know how to get in touch with financial resources." That's a drill more CFOs may start practicing, he says.
In The Trenches
Crunching numbers, of course, is not one's first instinct in an emergency. "I wish I could have been down there digging ditches and laying cable, frankly," says Joan Freilich, CFO of New York utility Con Edison. "In the first 48 hours, the goal is to make the system safe and prevent further damage," she says. "In an emergency like this, we don't count dollars."
But, as Darbee notes, finance plays a key role during a disaster. Freilich's finance team proved essential to the enormous procurement effort during Con Edison's 10-day corporate emergency, buying everything from safety clothing to diesel generators, and tracking what was being spent. Freilich will not comment on the financial impact of the terrorist attacks, but the utility released a preliminary estimate that emergency response, temporary service restoration, and long-term repair will cost $400 million.
Longer term, however extraordinary these events may be, returning to business as usual will require that finance departments absorb them into the framework of ordinary accounting practices. That is the message behind the Financial Accounting Standards Board's controversial decision to prohibit the use of extraordinary line item reporting for losses relating to September 11. The attacks "probably contributed to the speed and depth of the economic slowdown," FASB explained, "but determining the portion of the slowdown directly attributable to the September 11 events would be extremely subjective and difficult, if not impossible."
Several CFOs consider themselves lucky that they were already retrenching when New York and Washington were attacked. "Fortunately, we were already in cost-cutting mode," says Unisys CFO Janet Brutschea Haugen.
Indeed, the fact that U.S. corporations were already reacting to the weakening economy may help soften the economic blow of the attacks. Chief financial and planning officer Adrian Dillon of Cleveland-based Eaton Corp. notes that over the past eight months, industrial manufacturers like Eaton have gone through record levels of inventory reduction. "Normally, taking all those excess inventories out of the system accounts for 75 percent of the pain of a recession," says Dillon. "The good news is the shelves are almost bare already."
Of course, unpredictable multiplier effects still pose a forecasting challenge. Unisys's Haugen notes that her company operates in financial services, government, and transportation--precisely the industries that were attacked on September 11. "We know we are going to have to reassess the demand outlook for the rest of 2001 and 2002," she says. But how? Unisys also provides outsourcing, information security, and disaster recovery services, all of which are now likely to be in huge demand. "Some areas of our business will be hurt, others helped," she notes. "But we don't have a crystal ball."
A Capital Question
A more extended source of uncertainty for financial executives is the fact that the financial institutions they rely on daily were attacked as ferociously as military and political targets.
For the most part, the markets have recovered from the physical destruction of the World Trade Center, but the disaster not only deepened investor fear of recession, it also underscored the fact that U.S. financial institutions are under threat. This both creates a much tougher climate in which to raise and manage funds and argues against overly heavy reliance on any one part of the capital markets.
Today, financial leverage is even riskier than it was before. An extreme example is provided by NYBOT, which had already borrowed to renovate its trading floor when it was destroyed. Now Hines must find the money to rebuild without violating existing financial covenants. "Our capital requirements are going to be a lot higher, and we are going to have to rethink our situation," he says.
Even companies not affected directly by the attacks may find themselves hamstrung by debt. Consider the heavily leveraged cable and telecom companies. Cablevision Systems, for instance, canceled an offering of $1 billion in convertible preferred shares on October 5, though analysts say it needed every penny after beginning to roll out its new digital TV services in the New York City area days earlier. AT&T, with heavy capital-spending requirements of its own, decided to go ahead and sell its 30 percent stake after the cancellation. Cablevision is expected to sell its non-New York wireless licenses instead, but analysts, and apparently AT&T as well, worry that it won't get much for them under current conditions.
"Are you going to get fair value?" asks Jeffrey Wlodarczak of CIBC World Markets. With Cablevision's stock extremely volatile since the Trade Center attack, Wlodarczak, for one, is skeptical. "Heavily leveraged companies have had more trouble because of their perceived need to raise capital," he says.
Companies with strong balance sheets and little or no need of further capital have fewer problems. For instance, Bristol-Myers Squibb Co., which gets Standard & Poor's and Moody's Investors Service's highest credit ratings, found it easy to raise $5 billion in the wake of the attack. It will use the proceeds to help finance its $7.8 billion purchase of DuPont's Pharmaceuticals Co. and its $2 billion investment in biotech firm ImClone Systems.
Still, Bristol-Myers CFO Fred Schiff warns that even top-rated companies may have to spend more time these days making sure that underwriters and credit agencies understand exactly how debt proceeds will be used. "We spent a very, very busy summer in preparation for this debt issuance," says Schiff.
Another lesson that companies of all stripes can learn from the disaster is the value of backup credit lines. To be sure, the Federal Reserve flooded the market with billions in temporary reserves in the days immediately following the attacks. And despite some technical problems, most companies had little trouble accessing short- term capital as a result. One dealer, Williams Capital Group, reports that 70 to 80 percent of its 21 commercial-paper customers were able to get what they needed in the three days following the attacks. The others, explains David Coard, head of fixed-income sales and trading for Williams, didn't need to issue commercial paper, in part because the grounding of the airlines meant checks payable to vendors were delayed. "Companies got a few extra days of float on their payments," he adds.
But elsewhere, some companies had to go to greater lengths to get what they needed. Rolling over commercial paper in the three days following the attack, says Dillon, "was really dicey for some--but we were able to do it."
Others had to find alternatives. Because Con Edison, for one, could not roll over its commercial paper during the week of the attacks, it had to use its revolver support. This was especially frustrating, since it had $500 million in cash from the recent sale of a nuclear power plant. Until Citibank and the other banks reopened, the money might as well have been on Mars.
Con Ed wasn't alone, according to Glenn Eckert of Moody's. "We spent a lot of time talking to issuers about liquidity after September 11," he says. In particular, Moody's wanted to know whether companies that were trying to roll over paper had backup credit lines available. Two did not, he says, and were thus left solely dependent on investment bankers that were out of commission. "The general consensus was that the backups worked," he notes. Eckert also points out that before the disaster, many companies had complained when Moody's insisted that they maintain such credit lines. Now, he says, they should have a better understanding of "the importance of redundancy in risk management."
At least some CFOs agree, albeit reluctantly. "If we didn't have the good relationships we have with our banks, and if my revolver were coming due anytime soon, I would be one concerned cowboy," says Dillon. "Because the cost of that credit has got to be going up."
There's another reason that banking relationships may become more important in the wake of the disaster: The alternative represented by venture capitalists and leveraged buyouts has become distinctly less attractive.
The Value Of Liquidity
One continuing pocket of trouble in the capital markets is overnight loans of Treasuries. Corporate treasurers often pick up a few extra basis points of interest in return for lending cash for so-called repurchase agreements (repos, for short). These overnight arrangements are made on the assumption that the borrower, typically an investment bank, has the Treasuries in inventory.
Some analysts speculate that the abnormally high incidence of incomplete trades reported in the repo market suggests that the securities backing the transactions are missing. If so, lenders are making unsecured loans when engaging in repurchase agreements. Any corporate lenders that do so are probably violating their investment policy, says Jeff Wallace of Greenwich Treasury Advisors. Wallace says most of the 25 largest U.S. companies participate in the repo market.
How big a risk do unsecured repos pose? Most of the failed transactions are taking no more than another day to complete. But, says Wallace, "if I were the treasurer of IBM and one of my repo agreements failed, Lou Gerstner wouldn't be very happy with me, nor would the shareholders." So until the repo market returns to normal, treasurers might want to think twice about going this extra mile on cash balances. Immediately following the attack, it was impossible to tell when recovery of the repo market would take place. Cantor Fitzgerald, the biggest Treasury dealer in the market, was all but wiped out in the destruction of the World Trade Center. So was a major custodian, Fiduciary Trust Co.
Return To Normal
The question of where operations should resume is being reopened, and not just by companies displaced by the attacks. The events of September 11 have renewed the old debate about whether centralized or decentralized operations are best, and there is even some talk of companies fleeing New York. "We will see the decentralization of operations," predicts attorney Elliott Feldman, co-chair of the crisis management practice at the Philadelphia office of law firm Cozen O'Connor. "If there is one impossibly overpopulated area of space, it is lower Manhattan."
But many New York companies are choosing to stay put. For example, with hundreds of employees working in both towers of the World Trade Center, Fuji Bank might easily have been among the most devastated of businesses. But like the New York Board of Trade, its experience with the 1993 bombing prompted the bank to open a new data center, in Jersey City, New Jersey, staffed by 22 people and capable of accommodating 240 should operations ever have to be relocated. As a result, less than an hour after the first jet struck Tower One, the bank had shifted operations to New Jersey, suffering almost no interruption in operations.
Fuji Bank continues to hunt for new office space. "And we aren't ruling out Manhattan," says Keizo Kono, the bank's general manager of U.S. operations and administration. "Not at all."
Even PG&E's Darbee, whose company does not have offices in New York, demonstrated his faith in the country's financial center by deciding to announce the reorganization plan for PG&E's bankrupt utility subsidiary as scheduled on September 20, then flying to New York to start selling it. Facing opposition from California's public utilities commission, PG&E's plan needs the full support of creditors as well as investors willing to fund a $13 billion recapitalization that includes $10 billion in debt.
"A key element was the advocacy effort," says Darbee. "The question was, could we get their attention and was it appropriate, or would it appear unseemly?" Ultimately, his decision to go ahead "was based on my view of the strength and vibrancy of the people of New York." Despite everything they had been through, "I thought people would be up for business," he says. "And they were."
Sidebar: Friends in Deed
Outside the United States, all too many companies have had experience with restoring business in the wake of terrorist attacks. "Your biggest problem is getting your communications up; otherwise, you are going to go bust fast," notes Barbara Stephenson, head of corporate finance at the law firm of Norton Rose.
She should know. In 1992, the office complex housing Norton Rose's London headquarters was bombed by the Irish Republican Army. Less than 12 months later, in April 1993, the IRA struck Norton Rose's offices again. The firm is now widely considered to be a source of expert counsel for companies trying to recover quickly from terrorist attacks.
"Most of the companies in the City of London--and in the World Trade Center--are service industries," she adds. "They don't have a stockpile of product that they can keep selling." Although customers are sympathetic in the wake of such horrific attacks, "at some point that ends," she says. "It is very tough, but we are all in business to make money." Norton Rose and its IT systems were back up and running six hours after the second bombing, although the firm was unable to return to its offices for 20 months.
During the 1990s, explains Norton Rose attorney Cheryl Ronaldson, an informal network developed in London to help get companies back on their feet in the immediate aftermath of an attack. "You will find across the City [of London] generally that a lot of different firms have a sort of 'best-friend firm' so that if somebody is hit, they know they can use somebody else's offices," she says. Many of these "best friends," she adds, are fierce business competitors.
No doubt that will become a standard practice in the United States, too. Witness the refugee traders from the American Stock Exchange who were taken in by their rivals at the New York Stock Exchange and the Philadelphia Stock Exchange.