Tag Archives: financial risk

Debt as a Source of Risk in the Supply Chain

What debt conditions, putting pressure on our global economy , should procurement pros make themselves familiar with? And how can we mitigate supplier risk? 

This blog was written by William B. Danner

Two leading authorities on corporate financial health, Dr. Edward Altman, Professor of Finance, Emeritus, at New York University’s Stern School of Business and creator of the Altman Score, and CreditRiskMonitor Founder and CEO Jerry Flum, recently presented a webinar to hundreds of supply chain and credit professionals about today’s mammoth corporate debt problem.

As the primary point of contact between their company and suppliers – not to mention a first line of defense against third party risk – procurement and supply chain professionals should be concerned with the degree to which public companies are leveraged today.

Dr. Altman and Jerry Flum identified three unprecedented debt-related conditions, putting pressure on the global economy today that procurement should be aware of from a risk mitigation perspective:

1. Compare debt to GDP

One of the best ways to put debt levels into perspective is to compare debt to GDP. In the U.S., total debt is currently at a historically huge 3.5 times GDP. Of this total, corporate debt is large and growing. Overall debt levels are so large we must be concerned about the investors who own this debt, not just the borrowers. A 10% decline in value would destroy wealth equivalent to 35% of GDP, with a major effect on spending. Junk debt (high-yield bonds and leveraged loans) has soared to $2.5 – 3.0 trillion world-wide.

2. Benign credit cycle

Now in the 8th year of what is usually a 4-7 “benign credit cycle”, many executive teams have let their guard down, forgetting the lessons of the past. As Dr. Altman explained in the webinar, a ‘benign credit cycle’ has four characteristics:

  • Low default rates
  • High recovery rates when bonds default
  • Low interest rates, yields, and spreads
  • High liquidity

In other words, credit is cheap and easily available to publicly traded companies, which leads many companies to take on more debt. A great deal of debt has been issued to pay dividends and buy back stock, making corporations riskier.

3. Corporate valuations

Corporate valuations are inflated, with market values far higher than historical norms. Private equity firms are paying as much as 10 to 11 times cash flow for acquisitions. High stock prices make corporations less risky, but stock prices can fall.

Whether companies give in to the mania or make a disciplined choice to break free from the pack, procurement and supply chain professionals can take action to mitigate supplier risk and prepare their companies to handle the downturn when the next recession inevitably comes.

Suggested Steps for Supply Chain Professionals to Mitigate Supplier Risk :

1. Build in a monitoring process

Don’t stop with an initial vendor screening. Companies’ financial health can change and even a periodic review simply isn’t good enough. Avoid surprises and react quickly to change.

2. Get to know the vendors you do business with well

Ask questions such as:

  • “Who is the corporation we are paying? Is it under a different name?”
  • “Are they actually manufacturing the product or is someone else?”
  • “Where are their operations?”

Be cautious, especially if you are not getting clear answers.

3. Don’t over-do it

Not all your vendors will present a problem if they enter financial risk. Ask yourself:

  • “Is the commodity/product easy to replace? Is this a one-time contract?”
  • “Or, could this vendor create a major issue with our ability to ship on time, the quality of our product, or with our customer satisfaction?”

Only if you find that it’s a “yes” to the second question do you need extensive review.

4. Incorporate financial analysis in your key vendor review process

Be sure to include multiple periods of financial statements in your review to see trends. If you are finding it difficult to get financial information, be wary. 

5. Compare your vendors with the financial condition of their peers

You may find more secure sources of supply.

6. When appropriate, take a hard look at the financial stability of your vendor’s suppliers

They are part of your supply chain and could be a significant exposure.

7. Have an open and honest communications process

You’ll want to explore with your vendor the performance factors that directly impact you such as shipping reliability, product quality, etc. but also financial stability. Knowledge is power and knowing all the facts gives you the time to identify and prepare alternative source(s) of supply.

8. Look at more radical options if a vendor looks too weak

  • Make vs. buy decision
  • Engineer a stronger vendor into the supply chain
  • Buy the troubled vendor, or
  • Help arrange for a preferred vendor to purchase the troubled vendor.

The fact of the matter is that today’s debt situation is historically unprecedented. We can’t be certain of the timing of a change in the financial markets, or what will serve as the trigger, but a shift is coming – so now is the time to prepare and put your processes and procedures in place.

The full webinar can be viewed here.


William B. Danner has been president of CreditRiskMonitor since May 2007. Bill has more than 35 years of financial and information services experience. 

Prior to CreditRiskMonitor he worked in brand strategy and business development consulting for financial services clients at his own firm, Danner Marketing. Previously he was at Citigate Albert Frank, a marketing communications company in New York City, where he worked on a variety of leading financial services accounts including Reuters Instinet and the CFA Institute. From 1997 to 2001, Bill was Vice President of Market Development at MetLife’s employee-benefits business. Before joining MetLife, he was at Dun & Bradstreet, most recently as VP Strategic Planning. He spent the first decade of his career at GE Information Services and GE Capital.

Bill earned a BA in economics from Harvard College and an MBA from Harvard Business School.

How To Play The Hand You’re Dealt In The Age Of Uncertainty

Poker: It’s a game filled with excitement and risk. But just how far does it correlate with the uncertainty of our everyday lives?

Last month, Procurious attended eWorld Procurement and Supply where we were  lucky enough to experience a thought provoking talk from Caspar Berry on risk-taking and decision-making in the age of uncertainty.

Whatever our political leanings, we can all agree that unpredictable occurrences are happening everywhere in today’s world.  2016 saw Brexit and the election of president Trump; two events many  had thought impossible. There’s the refugee crisis in the Middle East, the continued prevalence of ISIS and upcoming elections in France and Germany; the results of which could determine the future of the EU.

Caspar Berry, professional poker player and poker advisor on Casino Royale, knows exactly what it means to take risks and admits that it can be dangerous, scary or disruptive. But, we need  risk, whether it’s in our personal or professional lives.

Have you ever considered what it is that makes sport so compelling? We’re gripped by the uncertainty. We have no idea what’s going to happen or who’s going to score and that adds a level of excitement and interest. But of course in professional sport, as is the case with poker, we’re not the ones who have to take the leap. We can leave all of that reckless risk-taking to the professionals… or can we?

Everyday Risk

Caspar pointed out that the average person would love to believe their everyday life has a level of  risk-free stability and  consistency. Whilst we might marvel at the bravery of prevalent risk takers in the casino or on the sports pitch, we’d much prefer to avoid a life of uncertainty.

In actual fact, there a number of parallels to  draw between poker and real life. The future is far more uncertain than we would choose to acknowledge.

In poker, the cards are randomly shuffled making it utterly impossible to predict what’s coming.  Our everyday lives are much the same. We can’t be sure when something will change the course of the future, whether it be a large scale political event, an encounter with a new person or a medical diagnosis.

The Butterfly Affect

The phenomenon whereby a minute localised change in a complex system can have large effects elsewhere. Originating from the notion in chaos theory that a butterfly fluttering in Rio de Janeiro could change the weather in Chicago.

Every single moment of every single day people are doing things somewhere in the world which could change your life.  If any one of your ancestors hadn’t been around, you wouldn’t be either.  If one tiny interaction hadn’t happened hundreds of years ago, history  might look very different indeed. These examples are just two of the billions of butterflies that are interacting with each-other; impacting events across the globe.

When so much is out of our control, it’s natural that we would try to limit uncertainty. We set laws and implement criminal justice systems so we have a vague knowledge of how people are going to behave. We buy branded clothing and eat in chain restaurants because it’s reassuring to know exactly what we’re going to get for our money. We’ll happily pay a premium for these things because it lowers the associated risks.

When we come across people or institutions that seem to know what’s going on, whether it’s a religious group, a futurist or a bank, we want to believe them. And so we do.

Philip Tetlock and The Good Judgment Project

Philip Tetlock, Canadian-American political science writer, began an extensive 20-year study in 1984 on future judgements.

He questioned 284 world experts on their future predictions and requested that each prediction be awarded a likelihood of occurrence. The study is widely considered one of the most robust in the history of social sciences with approximately 2800 answers obtained. And what did those answers show?

As Caspar put it, you  would have gotten the exact same results by asking an eight-year-old to randomly throw darts at predictions. In fact, the strongest correlation in the survey results was between successful predictions and the confidence of the person predicting, but a negative correlation!

Why  were the least confident participants correct? As Caspar explained, these are the people who are both humble and intelligent enough to embrace the concept of uncertainty.

How to manage risk and face uncertainty head on

In our organisations we know, for the most part, that taking risks won’t result in someone getting hurt. But it could mean something going very wrong for the business. So, how do you know when its worth taking a risk and how can we become more confident to do so?

  1. Be competent at assessing risk

We’ll never be able to predict exactly what’s coming our way. But  we can get better at deciding when to take a chance. In business, evaluate what the chance of success is, what’s the return on a gamble. If you’re faced with a 25 per cent chance of success and an amazing ROI, it’s worth taking that risk. Sometimes it will pay off.

2. Immunise yourself to loss

When it comes to risk-taking you will fail and you will lose out, perhaps more often that not. Caspar cited Abraham Lincoln as an icon who endured multiple short term failures, moments of rejection and losses. But he went on to great success.  We can all do better at immunising ourselves to loss,  let downs and failure.

3. Embrace risk taking

Casper asserted that if someone is cocky at poker, they’re possibly a bit insane. It takes a level of caution and the acceptance that there is always risk involved. But risky people have something to teach us, we can learn from them and embrace the uncertainty ahead.

Australia’s Love of Credit Set to Continue

Australia’s love of credit isn’t likely to fade anytime soon, a conference in Sydney was told last week. But that’s no bad thing.

The Banking and Financial Stability Conference, hosted by the University of Sydney Business School, brought together senior representatives of the US Federal Reserve Bank, the Reserve Bank of Australia, the Australian Prudential Regulation Authority, the Bank for International Settlements, and The Bank of Finland.

The one-day conference also discussed:

  • The current global obsession with monetary policy;
  • The constant pressure banks face from new fintech players; and
  • The Brexit vote and what its broader impact could be.
“Over-exuberant Lending”

The Reserve Bank of Australia’s Head of Financial Stability Department, Luci Ellis, spoke on the topic of ‘Financial Stability and the Banking Sector’.

Ellis told the conference that Australia’s ongoing need for credit can mean that the value of a well-functioning creditor sector is sometimes under-appreciated.

“Especially since the (global financial) crisis, the dangers of too much credit have become all too apparent. Over-exuberant lending and borrowing can mean that some people are getting loans that they have little prospect of being able to repay, even in good times.”

Importance of Credit

Less well appreciated are the costs of having too little credit available, Ellis added.

“The point here is simply that in recognising that too much credit can be dangerous, we should not instead fall into the trap of thinking of all borrowing as illegitimate, or somehow immoral. Less credit isn’t always better,” she said.

“The low credit levels available in regulated past decades are not the benchmark we should be evaluating ourselves against now, when trying to assess risk in the system. Some activities can and should be financed with at least some debt, even in bad times. And even thought there are plenty of others that should not.”

While Australia doesn’t have this problem, some recent examples overseas show the damage that can be done when there isn’t enough credit available, Ellis told the audience.

“Australia is one of the more bank-orientated financial systems when it comes to providing credit, but it is hardly alone. Some of the countries at the lower end of the range, such as the United States and Canada, are there partly because their governments support the securitisation market in various ways.

“These interventions allow banks to take some exposures, particularly mortgage exposures, off their balance sheets. In some cases they also allow some non-bank loan originators to operate at larger scale than might otherwise be possible,” Ellis says.

Broader Brexit Impact

Conference Co-Chair and Associate Professor in Finance at Sydney Business School, Eliza Wu, says pull-back in bank lending to Asia-Pacific by global, and in particular European, banks can be expected as a result of the Brexit. This is a major concern for the region’s investment and growth.

“This trend started with the GFC, continued into the European debt crisis, and now with Brexit,” Wu says.

Wu told the conference that, “enhancing financial stability in the face of unprecedented monetary policy regimes, and new risks that have developed, will remain a major challenge for policy makers and conference attendees alike.”

Associate Professor within the Discipline of Finance, Professor Suk-Joong Kim, added: “The most immediate concern is the increased level of uncertainty and volatility expected, and experienced, in the international financial markets due to the Brexit vote. Brexit has cast doubt over London as the world’s most important financial centre, and the future of the international banks that operate there.”

Regulation & Supervision

Luci Ellis also spoke on the role that major banks will play in the future. In a world where banks are central to financial stability, they will always need to be regulated and supervised.

“The Australian financial system has managed to weather the external shocks of the past two decades reasonably well. Strong prudential supervision has helped achieve that positive outcome.”

However, supervision goes far beyond ensuing that banks have enough capital, she added. History shows that banks can have much higher shares of capital in their liabilities than we see nowadays.

“We should remember that the policy measures that safeguard the liquidity of bank deposit liabilities, such as deposit insurance and liquidity provision by the central bank, can create incentives for banks to take those risks,” Ellis said.

“If the ultimate goal of financial stability policy is the real economy, it isn’t enough to require banks to hold enough capital to absorb losses, while disregarding the scale of those losses. The losses themselves can represent distress in the economy. The holders of capital are often part of the same economy, so absorbing the losses does not make them go away,” she says.

“Absorbing the losses, and thus avoiding a collapse of the banking system, prevents knock-on effects to other parts of the economy, which is better than nothing. But it would be irresponsible to disregard the risk profile of the banking system’s assets, as long as banks have enough capital to cover those risks,” Ellis says.