Risk Management

Getting Stiffed by Deadbeats?

It's time to more actively manage credit risk and the deterioration of fixed assets.
David KatzApril 5, 2001

Far from the roller coaster reports of earnings and economic indicators, risks are buried in back offices, moldering in old ledgers.

But CFOs who want to make the best of a worsening economy may soon turn to digging up the facts on less sensational risks and actively managing them.

Like the risk that clients won’t pay for the work you’ve done or the product you’ve provided.

Like the possibility of permitting the ghosts of fixed assets that companies no longer own to haunt their books.

Speakers at the CFO Best Practices conference in Dallas last week tried to rally CFOs to seek risk management opportunities in back-burner areas. And the senior financial executives seemed to respond.

One tub thumper was Jeffrey P. Kinneman, vice president and head of Enron Credit’s North American operations in Houston.

Even though the risk that debtors will go bankrupt or default is a matter affecting balance sheets, credit risk management is “sometimes a back-office process, sometimes an afterthought,” he said.

Kinneman urged CFOs to “transform your credit department into a portfolio-management shop.”

That means giving internal credit managers the freedom to focus on the rewards as well as the risks of extending credit. There are at least two benefits to such freedom, Kinneman says: smoothing out a company’s exposures to non-payment and enabling it to assume more credit risks.

But for a company to manage credit aggressively via a derivative or a swap, for instance, it must be able to quantify the relative abilities of debtors to pay money back.

In a word, that means the risk must be priced. Just as “you wouldn’t buy a stock without knowing the price,” he said, a credit department couldn’t become a “portfolio manager” without knowing the potential cost of lending.

To be sure, Kinneman stands to benefit from aggressive credit management. Enron Credit, which acts as a counterparty on corporate credit risks, is creating a market for “digital bankruptcy swaps.” In such a swap, the buyer pays Enron a premium for an agreed-upon level of protection from the bankruptcy of a designated company. If conditions change, the buyer can sell the derivative back to Enron.

Kinneman, however, has also worn the shoes of a buyer. From 1993 to 1995 he was the credit manager of Enron Corp.’s global credit group and before that, a credit manager at Phibro Energy.

When Kinneman was credit manager at Enron, it managed credit risks in a somewhat aggressive way, reserving a “bucket” of money to protect itself against non-payment by a debtor. It served as “self-insurance, almost, on losses.”

Still, it was “very difficult” to get “good pricing” on credit risks. To truly change that, credit managers must gain access to “transparent,” comparative information on debtors’ risks of bankruptcy and default.

Trying to offer such transparency, Enron provides a free online list of over 10,000 companies that includes its calculations of the cost of providing credit to each company. Click here for the list.

Kinneman says credit risks are ripe for active management in a falling economy. Partly out of his own self-interest and partly out of his experience as an internal credit manager, he urges CFOs to ask themselves: “What’s the unprotected loss if the sector you’re heavily into goes into a downturn?”

Awakening Dormant Assets

Awakening interest in a slumbering area and creating transparency by means of the Web were also the main themes of a session on fixed-asset management.

The subject—dealing with and accounting for such things as machinery, computers, and vehicles— has long glazed CFO eyes. That’s because current, or working, assets, typically “represent areas of more immediate risk than fixed assets,” explained Constantine Konstans, a professor of accounting and information at the University of Texas at Dallas.

Current assets also hit cash flow in a more immediate way, the professor noted. But focusing on fixed assets “results in increasing their productivity and reducing excess investment” in them, he added. That means, for example, that you won’t buy machines you already have.

Walter Wilson, the retired CFO of EOG Resources, the energy giant, threw some jabs at his former peers. “So often we view fixed assets as sunk costs,” he said, and are “tracking those costs and not managing those costs.”

“I think the CFOs often need to take the reins of responsibility with respect to managing fixed assets,” he added.

While one barrier to more active management of fixed assets has been the lack of a way to determine the market value of used equipment, the Web holds out “a unique opportunity,” he said.

“You’ve got a lot of used-equipment companies marketing in Internet space. If you can link [to them], you can find out the value” of your own company’s equipment by comparing it to what’s on the Web, Wilson said.

Vic Mahadevan, chief executive officer and chairman of iVita Corp., a firm that helps companies manage their fixed assets, claims that “hundreds of millions of dollars” are locked away in “ghost assets”—fixed assets still on company books although companies no longer own them. Part of the savings could come from eliminating property taxes by taking such assets off corporate books.

Mahadevan said the failure to manage fixed assets effectively has created a tremendous drain on the economy, even leading to a cruel mismanagement of resources. Good financial management means doing the tough job of eliminating asset redundancies, he asserted. “It doesn’t mean laying off thousands of people because that’s the easy thing to do,” he added.

Following Mahadevan’s logic, you could say that useless fixed assets could be turned into productive human ones. It’s a project worth looking at.

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