Economy & Credit Chest

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.

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.

Effective decision-making depends on a collection of leadership skills that can be learnt and are often closely linked. These include the following:

• An ability to foster innovation and creativity and to exploit synergies between people, sometimes disparate and distant teams.
• The intelligence and courage to recognise and learn from mistakes.
• The perception and sensitivity to analyse competing options, and the ability to help others to find their solutions.
• Skills of delegation and empowerment so that decision-making can be devolved to others in the organisation with sufficient time or insight.
• The capacity to motivate people so that they are inspired to prevent or solve problems themselves, as well as proactively implementing decisions.
• An ability to focus others on the twin issues of serving customers and managing change.
• Skilled communication.
• The courage and ability to make critical decisions.

• Brand management
• What is the purpose of the brand? What values does it need to emphasise to customers?
• How can the brand be used to greatest effect?
• Is sufficient attention given to building and publicising the brand?
• Is the brand used consistently?
• Is the product in the best part of the market, or is repositioning needed?
• What is the best way to appeal to customers? How should the product be sold?
• Avoiding a head-on confrontation with the market leader is often a wise course. Is this happening, or are you in danger of waking a sleeping giant?
• Is a simple, consistent and compelling message being used to sell the product?
• Do you measure the profitability of customers?
• Are you targeting, attracting and retaining the most profitable customers?
• What plans are in place to keep customers loyal? Are they appealing to customers and difficult for  competitors to copy?