By Joseph Neu
Perhaps the biggest trend making treasury a “more strategic” function is its increasing role in capital structure, rate- and capital planning.
The extent to which capital structure and related capital planning, as well as, increasingly, interest-rate planning, have grown as a strategic priority since the financial crisis cannot be overstated. Similarly under appreciated is how the strategic role of treasurers, thanks to this capital structure management and planning, has grown in kind. This seems particularly the case in the US. As one senior official for a major European treasury association noted recently, many European corporate group treasurers are envious of their US counterparts because they don’t share the same visibility with the C-suite and the board that comes withheading up planning around the balance sheet. Be careful what you wish for, however, because one of the drivers of this new form of strategic importance for treasurers has been shareholder activism (and this is being exported from the US more and more aggressively). And, the even bigger driver for banks—namely, supervisory stress-testing—is also a major US export.
Parallels between bank & corporate treasury
Looking at this trend from both the corporate and bank treasurers’ perspective is also enlightening. While the main drivers are different, some of the end results are the same.
Optimization vs. a fortress mentality. What treasurers can be slow to realize, in the midst of defending their balance sheets against scrutiny from bank regulatory supervisors or activists, is how the defense strategy opens the door to new levels of optimization. In the early stages of scrutiny, capital planning is all about understanding what the external scrutinizers are scrutinizing and then how best to respond. This may lead to a fortress mentality, that is, “We will build a balance sheet so strong that it will not be attacked.” But, later on, the understanding gained from responding to external scrutiny leads to a better internal perspective on how to optimize every major element of the balance sheet. Executing on this understanding is what treasurers should be doing today, and many are. This in turn is raising the bar for external parties to pick out potential vulnerabilities.
Stress-testing’s silver lining. Discussions with US regional bank treasurers at their NeuGroup meeting last May underscored how stress-testing, which is now trickling down more noticeably to sub-$50bn total asset banks, is forcing action to refine interest-rate risk management, capital and liquidity planning, modeling as well as funds transfer pricing that might not have occurred otherwise. If and when the pressure by regulators and their supervisory processes ceases to ramp upward, treasurers will be able to focus on putting these refinements to work. That is in measuring balance-sheet sensitivity to interest-rate changes, deposit betas, and positioning their banks to compete more effectively in certain products and lines of business. This payoff can be realized more fully when the Fed exit finally commences.
The silver lining in activism. As a head of debt capital markets for a major bank recently shared: “We see clearly how the debt capital strategies of our clients, starting with their approach to issuance, has grown increasingly sophisticated as a result of activism.” The NeuGroup sees this as well. Capital structure, rates and capital planning (see chart on page 16) is at or near the top of our treasurer priorities ranking each meeting cycle and the discussion of what treasurers are working on as part of every meeting shows a heavy dose of capital structure-related projects. One of the biggest has been the return of capital to shareholders (via buybacks or dividends) vs. the use of capital for strategic acquisitions or investing in organic capabilities to grow. The knee-jerk decision to just buy back more shares in response to activists can no longer happen. Increasingly, the decision must be based on smart analysis with capital metrics that has been communicated up the chain to the board. Returning capital may still be the right decision, but you need the justification. The same is even truer for a decision to make, invest in more R&D, or spin-off a part of the company. And the analytics and metrics used to justify any aspect of capital planning need to be scrutinized, too. As one treasurer noted, “based on our ROIC measures it is hard to see how some of these acquisitions [happening in his sector] make much sense, so you have to ask if your measures are missing something.” Because of this, we see growing use of data and more sophisticated analytical tools and models as a trend to watch.
Banks face the same pressure, but it is regulators that are scrutinizing their decisions and the models and measurements that are guiding them (with reams of inside information). Bank treasurers thus face the dual challenge of first clearing a compliance hurdle and then optimizing outcomes as the second. Corporate treasurers face the watchful eye of activist shareholders or “suggestors,” as they have come to be known, who may have teams of people analyzing their capital structures and planning decisions to see how they might be optimized. Increasingly, it is the treasurer’s job to use the inside information at their disposal to propose a better plan than what may be suggested. Their “regulator” is much easier to please: rating agencies and debt investors who want to ensure that what is optimal for shareholders is not creating too much credit risk for them.
Governance and Organizational Change
In response to stress-testing and related regulatory requirements, banks have been essentially mandated to create vast new governance structures in parallel to their existing asset-liability management committees and risk management groups in order to be in compliance. These cover everything from model validation to capital plan review. They do also have a practical reason for being: without the added resources banks could not have time to manage both the compliance requirements and the actual risks of running a bank.
Corporates don’t yet face the same compliance demands for governance as banks, but some will trickle down.
In the meantime, certain corporates are seeing the benefit of creating additional governance to guide and assess capital structure and planning to complement their enterprise risk committees and board-level finance or audit committees. In a recent survey of one of our corporate treasurers groups we found that 69 percent had at least an informal asset-liability committee (ALCO)/capital risk framework or had this as a key mandate of the board finance/audit committee. To cite one example of a more formal structure presented recently to one of the NeuGroups, a treasurer explained how his firm expanded its finance company ALCO, along with a repatriation, capital markets and capital structure committee into one “capital committee.” It serves as a key integration point to bring together board oversight, strategy and execution with a capital optimization mandate.
Discussions with treasurers also indicate that corporates experienced in countering activists’ capital structure-related proposals may put together a committee like this to guide their response. At some point, it just makes good sense to make the committee permanent. Another member with experience setting up a “business ALCO” as an enterprise risk subcommittee, said the key to making them work is to get representation of risk owners on the business side as well as treasury and finance—“this should not just be a treasury thing.” He also recommended keeping the rating and liquidity constraints in focus. Examples of participants on such a committee might include the head of corporate strategy, the general counsel, the CFO, treasurer, and head of credit for the business(es). Thus, committees like this make talk about the treasurer’s seat at the strategic table real.