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Meeting Summary

Key Takeaways from NeuGroup’s 2019 H1 Treasurers’ Group of Thirty Meeting

November 29, 2019
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T30 members discussed how to organize metrics, captive insurance and optimal cap structure at their first-half meeting. 

T30 2019How to Bring Method to Metrics Madness

The benefits of an Excel workbook and giving treasury ownership of it. 

Treasurers face a major challenge in collecting myriad metrics used to measure treasury’s own performance and provide decision-makers with insights used to make the company more efficient and profitable. Participants at NeuGroup’s T30 2019 H1 meeting in New York discussed the difficulty of satisfying constituents ranging from the C-suite and the board to bondholders, bankers and global business heads—all of whom want different metrics, sometimes to describe the same thing.

The complexity. Led by one of the group’s members, the discussion first addressed the range of metrics used to track just leverage and liquidity. Does the requester want gross or net debt, and if the latter, should all cash or just liquid cash be included? Should interest include bank-fee amortization or not, and should it be accrued interest or interest paid out? And the list goes on. The session leader listed his technology services company’s main treasury metrics, comprising a long list of items under the headings debt compliance, company and accounting.

A solution best left to treasury. It’s not a “magic wand and/or a sophisticated system-based solution,” but rather an easily updated Excel-based tracking and forecasting workbook the session leader’s staff developed to centralize control of all treasury-centric metrics. Of almost equal importance: Those metrics, once contributed by treasury, FP&A, external reporting and investor relations, are now pulled together by treasury into this workbook that consolidates everything in one place.

What’s in the workbook: It provides metrics vital to the C-suite, such as free cash flow and liquid cash, as well as bank net leverage, interest coverage and other numbers requested by the board. It also attempts to replicate rating-agency models to warn about potential changes, and provide treasury with “what if” capability for accelerated debt paydown vs. other capital allocation outcomes. The workbook provides enough granularity to fine-tune quarterly leverage for optimal debt pricing, and the model’s procedures have been documented to avoid a “knowledge trap” should its developers leave the company.

Keep it (relatively) simple. The session leader provided a five-page example of the metrics workbook, highlighting the numbers reported to the board and those to the C-Suite. “We don’t use the whole thing with them, or their eyes would glaze over,” he said.

How to add more value. Several other members said they, too, were seeking ways to gather and use metrics more efficiently, or at least planned to. One meeting participant said his tech services company has pulled together strategic metrics similar to the session leader’s in a workbook but supplements them by looking at operational process efficiencies and how to improve them. The session leader said his team aims to head in a similar direction.

Trumpeting treasury’s story. A metrics workbook quickly provides treasury’s constituencies with the numbers they want, while telling the story of its accomplishments. Ed Scott, NeuGroup’s senior executive advisor who guided the meeting, noted that optimizing metrics helps tell the strategic impact of treasury’s accomplishments as well as treasury’s money-saving but less recognized “plumbing” exercises, such as connecting with banks via straight-through processing. “The combination of the two is a powerful story, and unless treasury tells it, it won’t get told,” he said.

Squeezing More Benefits from a Captive Insurer

A company with an insurance problem turned to a captive and now seeks ways to optimize it.

A tech company suffered a major recall a few years ago and risked being unable to buy product recall insurance—a contractual obligation with customers—if it had a second, similar event. So it turned to a solution that more than 6,500 companies have used to transfer risk beyond traditional insurers: a captive insurance company. The treasurer, meeting recently in New York with other members of NeuGroup’s Treasurers’ Group of Thirty, described the captive and sought suggestions about how to get more benefit from it—perhaps by earning more on the cash it holds or fattening it up with other risks.

Facts and figures: Under the arrangement with the captive, the company retains $10 million and self-insures the first $15 million, farming out the rest of its coverage to other insurers. But that $25 million total doesn’t look so bad when the company considers that prior to the captive, it had a $10 million retention and only recovered about $8 million from the recall, about 50% of the claimed amount. “They covered the cost to ship, the cost to make the units, but not the overhead costs or the cost of actually installing the units,” the treasurer said.

The benefits: Eliminating the previous annual premium of $1 million for external insurance, and taking into account the captive’s rating and other annual expenses, has saved $700,000 a year. The $15 million in cash the company puts in the captive can be replaced by a letter of credit and quickly withdrawn if the need arises, and it contributes to the upwards of $100 million of liquid cash that the board agreed must be available. The treasurer said that hiring outside managers to invest the cash could add further value. And the captive structure retains the tax deductibility of the premium cost, with potentially $2 million in additional tax benefits over 10 years.

How to optimize? The company aims to insure high-severity, low-frequency risks that include product recall, errors and omissions (E&O) and earthquake. To optimize the captive, the treasurer is considering adding certain cyber and medical risks, and asked for more ideas. Peers at the meeting said other risks held by their captives include financial and workers compensation. One member noted that medical does not appear to meet the high-severity/low-frequency criteria. The presenter said it would only kick in when those expenses exceed a certain level—for example, if five corporate executives were hospitalized for life following an accident.

Mitigating deductibles risk: The company farms out the E&O and earthquake deductibles, as well as 7% of the product-recall deductible, to a pool joined by 60 or so corporate captives to share risk. “The risk is capped—a worst-case loss is $670,000, and that would be an outlier; normally it’s around $30,000 or $40,000 annually,” the treasurer said.

The essential Chinese wall: To reap the benefits of a captive, you’ve got to stay at arm’s length from it. “We put $15 million of cash in the captive, and its investment policy and the parent company’s are separate,” the session leader said, adding, “We have to be very careful; it needs to be [a separate] insurance company, or we’ll lose all the tax advantages.” One member asked what would happen if a dispute arose between the company and the captive. Should losses rise above the $15 million in self-insurance, putting the next insurer on the hook, then brokerage Marsh & McLennan, which sits on the captive’s board, would step in to arbitrate.

Calibrating Capital Structure as a Downturn Looms

Balancing ratings, liquidity needs and shareholder returns as the economy slows.

The challenge for treasury of getting capital structure right rises as companies engage in strategic M&A, adjust to changes in tax law and confront current or anticipated shifts in the global economy. And don’t forget about keeping rating agencies and shareholders happy and activists away. With all those factors in play, members of NeuGroup’s Treasurers’ Group of Thirty (T30) recently compared notes with the treasurer of a technology company who presented the results from a capital structure checkup.

The big picture. This company’s treasury wants to err on the conservative side from both a capital and liquidity perspective in response to its leadership’s concerns about a recession as the company delevers and normalizes its balance sheet following an acquisition. At the same time, it’s important to communicate this conservative capital structure carefully to avoid riling up shareholder activists (more on that below). This backdrop has both strategic and tactical implications.

Focus on ratings. The session leader said that ratings, not leverage, determine access to capital, a key strategic consideration in the company’s capital structure. A low investment-grade rating provides the optimal balance of access to capital and its cost, as well as downside protection against a macro or firm-specific shock. He said his company’s BBB- rating and leverage of 2X debt-to-EBITDA, in line with peers, provide what it considers a near ideal cost of capital of about 9%.

Bond refi congestion in 2021? The session leader said that his company has more than $1 billion in bonds coming due in 2021, and that Standard & Poor’s had asked about its plans to refinance the debt. Worrying about refinancing now may seem premature, he said, but the rating agency is concerned about the volume of corporate debt coming due that year.

Focus on liquidity. “Liquidity shocks are what start the tumbleweed rolling for bankruptcies, and not necessarily leverage ratios,” the session leader said, underscoring that liquidity is another key element of the company’s capital strategy. He said its $2 billion to $2.5 billion in liquidity should enable the business to weather a recession, although treasury has recommended an additional $500 million to support growth and mitigate potential supply-chain-finance shocks. He noted that available liquidity is augmented with cash flow generation boosted by reduced working capital needs.

Tactical considerations. The company relies on a significant portion of lower cost, floating-rate debt, including accounts-receivable factoring and supply chain financing. In addition, foreign-currency debt acts as a natural hedge to volatility in foreign operations and cash flow. Another tactic, communicating the company’s low leverage to investors, conveys capital-structure conservatism and low risk, but it can also prompt activists to knock at the door.

Keeping investors at bay. Questioned whether shareholders complain about his company’s cash level and want more share repurchases, the session leader acknowledged such demands. But he said that announcing small buyback programs of $100 million or $200 million—that it commits internally to executing in 12 to 18 months—reduces investor noise. It buys big chunks when the share price falls below the company’s intrinsic value, while half the authorization is through automatic dollar-cost-average purchases.

Share repurchase messages. The session leader’s company splits free cash flow evenly between M&A and share repurchases. He said the business doesn’t want to be locked into a dividend, and few shareholders have asked for one. Another member said investors in his technology company, despite its non-investment-grade rating, demand a dividend and are making noise about resuming stock buybacks, a move he opposes: “We’re highly acquisitive, so it sends a message that there are no more opportunities out there because we’re giving back cash.”

Avoiding Missteps on the Road to Treasury Automation

A key risk is automating processes that are flawed or already outdated.

Treasurers, like the rest of the business world, are racing to implement robotic process automation (RPA) and other technologies that take repetitive, manual tasks out of the hands of humans. “It’s a huge focus area for us, and we’re allocating a lot of capital to it,” said the treasurer of a communications technology company at a recent meeting of NeuGroup’s Treasurers’ Group of Thirty. The trick is knowing what to automate and what mistakes to avoid.

Think through the process. Before using RPA to automate treasury functions, processes must be analyzed to ensure they are optimal and up to date, to avoid perpetuating and perhaps accentuating faults. Anne Friberg, senior director of Peer Knowledge Exchange at NeuGroup, mentioned a warning that emerged from a recent NeuGroup meeting in Europe: Automating a process “just because it’s a pain in the neck” may result in upgrade issues down the road, not to mention potential governance issues (more on that below).

“That’s exactly what we’re finding; folks are trying to automate an existing process that’s really not the correct process to begin with,” one member said. One real-life example: A company already making payments via SWIFT from its SAP enterprise resource planning (ERP) system is confronting an operations initiative to automate cash application and bank reconciliation through a bank portal using tokens—which seems like a big step backward.

“Exactly, don’t automate a process the way a human would do it,” Ms. Friberg said, adding that companies should “make sure that as much as possible can be automated in existing systems or with a macro, and to put in a bot to perform the connecting steps between systems only if there isn’t complete machine-to-machine communication.”

Governance risk. As one process after another gets automated, noted the treasurer of a major packaged food company, a problem with one of the lower building blocks could have broad ramifications. “Operations are going nuts with RPAs, but I don’t know whether at this point we have a robust enough governance process over this, and I fear something could blow up the next time we do an SAP upgrade or whatever,” another member chimed in.

Maintaining treasury intelligence. What happens when the employee who applied RPA or otherwise automated a treasury process moves on to a different part of the company or a different company altogether? When new folks come in and they’re just using the automated function, and something goes awry, they may have no idea how to fix it. “I think that’s a huge risk,” said Ed Scott, senior executive advisor at NeuGroup and retired treasurer of Caterpillar. He recalled questioning a derivative-accounting number that appeared off, and the new employee in accounting said he thought it was correct, given he had plugged the necessary information into an existing spreadsheet designed to automate the process. “But the number was clearly wrong,” Mr. Scott said, adding that a solution may involve requiring employees to perform the processes manually for a time to understand where the numbers come from.

Automation applications. Treasury may not be on the company’s automation front burner, but NeuGroup members are considering or implementing a variety of applications. One mentioned simpler functions, such as investigations into travel and expense costs, enabling more proactive, upfront monitoring rather than relying on back-end audits. A goal of another member is to use RPA to automate confirming whether customers have in fact made recent changes to payment or address information, much like what Amazon and banks do today. Another uses RPA to sum up deductions on pay- ments and match them to invoices, an otherwise “cruel and unusual punishment” to impose on treasury staff that’s much better handed off to a robot. A couple of members noted using Bectran technology to automate their credit systems.

Tier-3 CP Market Remains Small but Offers Liquidity—For Now

Stable economic and financial conditions could increase opportunities for low investment-grade issuers.

The relatively small market for commercial paper (CP) issued by companies with the lowest investment-grade ratings (BBB-minus/Baa3) appears stable in the foreseeable future and might even grow, according to MUFG. That’s good news for some of the participants discussing capital structure at a recent meeting of NeuGroup’s Treasurers’ Group of Thirty.

Half a billion. The so-called tier-3 CP market—for issuers at the low end of the investment-grade spectrum with short-term credit ratings of A3, P3 or F3—will support CP programs of about half a billion dollars. That’s according to bankers consulted by one of the members. “They tell us that right now, in the current market, we could run $500 million,” the treasurer said in response to a question from a member considering what will happen if his company is downgraded a notch.

That number sounds right to Stephany Bushweller, head of short-term credit products at MUFG, who said the bank generally suggests to clients that they can expect $500 million or so in liquidity in the tier-3 market.

“Having said that, a company’s actual market access will depend upon a number of factors: Is the CP issuer a household name? How volatile is the industry in which the issuer operates? Has the issuer assured investors of their commitment to keeping an investment-grade rating?” Ms. Bushweller said.

She added that clients have achieved programs greater than $500 million in the tier-3 market, and one MUFG client has more than $1 billion in CP outstanding.

Small size, short maturity. Another T30 member noted that the tier-3 market is small—only about $8 billion. Indeed, Ms. Bushweller said that historically the market has been too small to track, and MUFG currently estimates its current size at $10 billion to $15 billion. She added the bank has been discussing the “efficacy of the [CP] market with a number of clients whose CP would be rated A3/P3/F3, so we expect the market size to grow.”

Ms. Bushweller noted CP’s ‘in-full and on-time” investors, whose primary goal is principal preservation, with many having charters that do not permit investing in CP rated below investment-grade. To mitigate the risk of a downgrade forcing them to sell below-investment-grade positions, investors tend to keep tier-3 CP maturities quite short.

“A majority of the liquidity is overnight to one month, with a typical weighted average maturity of less than two weeks,” she said. “So tier-3 CP programs have higher rollover risk than tier-2 or tier-1, and can require more staff time to manage, given that issuers tend to be in the market every day.”

The outlook. Ms. Bushweller said more downgrades of companies now in the tier-2 market as well as new entrants could increase the size of the tier-3 market, adding that MUFG believes positive economic conditions and sanguine credit market conditions will continue to encourage buyers of tier-3 CP.

“Alternatively, strain in the overall credit markets, such as widening spreads, would negatively impact appetite for tier-3 CP,” she said. “And certainly, a cliff default of a tier-3 CP issuer would cause investors to reevaluate their appetite. MUFG believes the risk of either scenario occurring in the near term is de minimis.”

Tales from the Cybercrypt

Firsthand accounts from treasury departments coping with cyberthreats.

Nearly every treasury department in the NeuGroup Network has a story to share about the ongoing battle to prevent, detect and react to cyberattacks. We’re going to compile and share those stories from time to time to help spread the word about the various threats and risks out there, as well as best practices to keep treasury as secure as possible. Here’s some of what we heard at T30’s spring meeting:

New house. One treasurer whose data analytics and technology company had experienced a major cyber-related data breach said that after such an attack companies can’t just “fix the plumbing but instead must tear down the house and start from scratch” in terms of rebuilding a new infrastructure.

Treasury is ground zero. Given its role moving corporate cash around, treasury is the cyberattacker’s potential mother lode, so members concluded that educating staff consistently and frequently on the types of cyberattacks being reported is key. “So they’re aware of the latest phishing emails and other mechanisms—make sure your own team is plugged in,” said one participant. Another noted using a third party to test staff, “and we got a 30% fail rate—that was scary,” he said.

Close calls. In one case, a member received an email stating that he had not yet applied for company health insurance and to click a link if the message was in error—“I was very close to clicking,” he said. In another, a fraudster calling in to accounts payable claimed to be from the company’s accounting firm and requested a change to remittance instructions, but the company’s treasury policy now requires calling back the source of the request, thwarting the scam.

Thank you, IRS. Even scarier, a fraudster submitted a request to the IRS to receive a refund of the company’s estimated tax overpay, with the CFO’s forged signature. “The only way it got caught was that the IRS agent saw the payment was to be made to a Russian bank account, and asked us if it was real,” the member said.