Economy & Credit Chest

Once the organization has decided to conduct an internal assessment, leadership must decide what it wants the assessment to focus on.Most organizations look at only one area of the organization: tasks. Some organizations assess employee morale through the use of an employee survey—an example of scanning the organization. But in forming a partnership, both of these areas need attention. I call them the material and ethereal realms of the organization. I use the term realm to describe the degree to which these spheres interact while still maintaining separate energies and characteristics. Let me use an analogy to show how these realms relate to partnerships. On planet Earth, there are two primary realms of existence: the marine environment and the terrestrial environment. While each realm operates independently of the other, the two interact in significant ways. For example, together they affect the atmosphere, which influences all life in both realms. Weather systems are created as the marine environment heats or cools more slowly than the surrounding landmasses and provides the moisture that evaporates into the air.

These systems are then circulated around the globe in a series of geoclimatic patterns that support the life forms that have developed in these environments. It is a system. The different realms of an organization affect the overall atmosphere, too, and thereby affect all other aspects of the organization in the process.

One of our recent clients was interested in establishing a “best-inclass” partnering culture. Having an organization with the competency to partner is becoming more critical as we slowly migrate to a true knowledge- and information-based economy. For the internal assessment we conducted one-on-one interviews with a cross section of the organization.We also arranged for approximately two hundred randomly selected employees to take the PQ Assessment online.

This article shows how employees scored in the assessment. You’ll notice that the results show a bell-shaped curve of normalcy, validating that this population would be typical of any other random population taking this assessment. It also shows that this population falls in the average-to-below-average category of Partnering Intelligence. If we graded them on a curve, they would be C–/D+ students.When the organization’s leadership reviewed this data, they understood that if they were to be world-class leaders in partnering, they needed to dramatically improve the skills of their employees.

Of course in some situations it may not be practical or wise to involve everyone in the internal assessment from the start. One strategy I use is to involve different groups at different stages. You may start with key leadership and then, once you have their commitment, begin to move down the organization. As you assess various areas of the organization, you begin to involve those people in the assessment. As you do, be sure to communicate clearly the purpose and scope of the assessment to alleviate fears.

While you may not be able to involve everyone, it’s essential to communicate information about the assessment to people inside the organization. Tell them what you know, what you are doing, and why. Be as honest and open as you can. It’s a great first step in moving along the Partnership Continuum and increasing your Partnering Intelligence.

When I was working as an internal consultant on the organizational effectiveness team with the telephone company, the company’s leaders didn’t like the information we reported. In fact, the president contracted with an outside consulting group to come in and assess our internal consulting group. This outside firm found conducting the assessment a frustrating experience—so frustrating that they cited the company as one of the most difficult clients they’d ever encountered.

They went so far as to report that their efforts were “sabotaged” and the reliability of their assessment was compromised due to lack of cooperation. Ultimately they advised against basing any future decisions on their internal assessment. They felt it was a waste of their time and the company’s money. Leadership’s mistake was pitting one group against another instead of having the two teams work together. Had the president encouraged the latter strategy, the internal consultants could have advised the outside consultants about the company culture and the political landscape. At the same time, the outside consultants could have contributed a fresh and objective perspective.

The break-even in the IRR profile of the AAAtranche is a multiple of the annualized historical average loss for BBB-rated corporates (10x in this case). The BBB-class hits the IRR of the portfolio at around 0.9 percent which is 4.5 times the historical average loss. Static synthetic mezzanines normally exhibit a lower rating stability than mezzanine notes of managed synthetic CDOs, depending on the skill of the manager.

Assumption: The 5-year cumulative default rate for BBB is around 1.60 percent, assuming a 40 percent recovery rate. This equals an annualized 0.2 percent expected loss rate. The size of the mezzanine tranches affects the expected loss (probability of loss unaffected). As the size of the mezzanine class decreases the expected loss tends to increase hyperbolically as seen (binomial expansion technique with a diversity score of 55 was used). The ratio of the expected tranche losses to the expected CDS portfolio losses would define the risk leverage. When the ratio is above 1 the mezzanine note has a greater expected percentage loss than the underlying portfolio. The percentage of the first loss class has a major impact on the leverage of the mezzanine class (assuming the same underlying exposure in size.

The senior and mezzanine return profile has an option-like feature, like short puts out-of-the-money (BBB) and far-out-of-the money (AAA) in return terms. When investment grade default rates rise significantly above their long-term historical average, mezzanine notes become impaired. On the other hand, CDS portfolio deterioration causes in general mark-to-market losses and might result in rating downgrades with respect to the notes.

Assumption: The annualized 5-year cumulative BBB credit loss rate is 0.20 percent, assuming a recovery rate of 40 percent. The size of the first loss tranche equals 4 percent, the size of the BBB-note 2.5 percent and the AAA note 3 percent in the example with a portfolio of BBB rated CDS.

To compare both asset classes and tranches one needs to construct a corporatebond fund invested in 100 equally weighted BBB corporate bonds (assuming that the bond fund pays a Libor _ 100 bp and runs a maturity of 5 years). The risk/return tradeoff between a corporate bond fund and a BBB–CDO note looks as shown previously.

The BBB note sustains a higher cumulative default rate before suffering any losses, as the equity absorbs the initial losses. But the corporate bond fund may outperform in severe default scenarios. This is largely because of the leverage in the CDO note. At one stage the mezzanine notes become the equity of the structure. The huge difference in IRR is explained by the extra risk between the cash bonds and the BBB-tranche as a total.

In a basic static transaction a sponsor selects a portfolio of about 100 or more investment grade names. Once a static synthetic CDO begins, the reference portfolio remains fixed until maturity. In a static pool delivered obligations usually must be liquidated within a preset timeframe. Some typical trading activities in managed synthetic deals include:

• Terminating credit-improved CDS to generate cash into the CDO
• Terminating credit-deteriorated CDS to avoid/limit future losses
• Buying protection for a smaller amount
• Conducting limited discretionary trading, that is, 10–20 percent annual portfolio turnover.

Normally, managed pool risk offers lower expected loss and lower probability of large loss.

The success or failure of a decision frequently depends on the delegation process. Empowerment, which is discussed below, goes beyond the delegation of specific tasks. It involves granting a defined level of authority and responsibility within which someone makes their own decisions and implements them.

There are several stages in the delegation process.

Preparing to delegate. Some preparation and planning are always needed, perhaps limited to gaining the approval of others or simply informing people. Priorities may also need to be considered. Most of all, you should be clear about the reasons for delegation and what it is meant to achieve. This requires a focus on results and having clear, precise objectives.

Matching person and task. The person who is required to do the job must understand it and have the personal skills and competence to have a realistic chance of doing it successfully.

Discussing and agreeing objectives. Targets, resources, review times and deadlines should be discussed with the delegatee and agreed. It may be necessary to formalise the process in writing in order to avoid, or at least minimise, any misunderstanding.

Providing resources and the appropriate level of authority. When delegating work, it is imperative to provide the delegatee with the necessary resources as well as the authority to complete the task, and then to provide support when needed.

One way of appraising competing options is to look at the desired outcome and then see which option will achieve it. This simple approach is often complicated by the need to prioritise goals, reduce costs or minimise risk, and in selecting the best option usually involves trade-offs and compromise. Another approach is to establish criteria for the final decision – for example, it needs to work quickly, not be expensive, take a reasonable amount of time to organise and so forth – and then score each option against these components on a scale of 1–10. The highest-scoring option wins. With both approaches, you need to fully understand what each option requires, how it works and what it achieves.