VUCA, value and managing risk

4/17/2018
ABN AMRO Managing Volatility

It’s ten years since the financial crisis. And it seems complacency is creeping into both banking and business, flying in the face of rising uncertainty. But there are ways to manage volatility without missing out on opportunities, says Managing Director Richard de Keijzer.

We’re never afraid to face the facts: one of the big changes for Asset Based Finance is high levels of liquidity in the market. There’s too much money around. Banks are chasing business borrowers with low rates, fuelled by quantitative easing (QE – printing money via government debt). 

Borrowers have the upper hand right now – especially compared to the years after the crash of 2008, when active lenders could perhaps afford to take a firmer lead. But that’s not always going to be the case.

Certainly if QE slows, throttling back liquidity and raising interest margins, we’ll see banks soften their search for yield, driving up the price of financing. But cheap money and a degree of complacency among many banks and businesses ought to have us all wondering: what’s next? And are we ready for change?

The big picture

The issue is that there’s been clear uptick in VUCA – volatility, uncertainty, complexity and ambiguity – over the past couple of years. Brexit, Trump, Russia, the prospect of trade wars (and even real ones), rate-rises and technological change has made identifying and managing risks much tougher.

It’s been a major factor in finance, too, especially longer-term facilities. We’ve seen a spike in the risk premium of financing on a five year plus horizon as a result of a VUCA context. 

Of course there have always been economic cycles that play out. But when we start to see more bankruptcies – of the likes of Carillion, Maplin and Toys R Us – you know that the VUCA risks are starting to bite in real businesses, too.

Risk and capital

There are two aspects businesses need to consider. The first is how long excess liquidity is going to define their financing options. And the second is the way that different forms of financing allow them to manage risk – both on the upside and on the downside.

We’ve seen with Carillion that there are cracks even in some of the biggest companies. Yet some banks are perhaps not making the level of provision for bad debt that they might – especially as new capital adequacy rules bite. The collective memory seems a little fuzzy when it comes to increased leverage to companies, and the re-emergence of covenant-lite financing structures suggests some imbalance in the calculations around risk and return.

Businesses are also looking to their own balance sheets for finance, however collateralizing their assets to raise cash for investment and/or working capital purposes.

Then, for us, understanding how to make provisions for secured lending is an advantage. The probability of default (PD) is never zero. And we know from the write-offs of 2007/08 that when banks and other lenders underestimate defaults, the consequences can be dire. Given the fact that PD is never zero we, as ABF, have the expertise in Loss Given Default (LGD) what is the (residual) value of the asset that was financed having the ability to better predict PD and LGD, we can optimise the financing against the assets for customers. 

Which leaves the question of what businesses can do to better control their fate in a VUCA world.

Planning to act on instinct

Ideally, a business would know exactly what it planned to spend for the foreseeable future – then we could design exactly the right finance approach around their balance sheet.

Real-world capex doesn’t work like that, of course. Those VUCA considerations are all changing more rapidly than ever. 

It’s not just about downside risk. Yes, Brexit might potentially affect trade, as well as sourcing and staffing. But if there are new trade deals around the world, for example, we might find lots of UK businesses with an urgent need to invest or remodel their working capital to exploit them.

As a specialist lender – not just around invoice discounting, but also vehicles, stock and plant and machinery – we can help businesses secure a little certainty in amongst the chaos accessing finance quickly and reliably based on the assets already owned or providing finance to secure those assets. When opportunities arise, we know businesses need to act fast to invest in line with their commercial activities.

(Our expertise in Bad Debt Protection and Leasing – offering protection against the ill-effects of VUCA, then putting smarter structures around the capex/opex mix – is a big plus for our clients, of course.)

It’s a reminder that the best hedges against VUCA are agility and flexibility. And that should be informing every business’s approach to finance and balance sheet efficiency. There’s value in VUCA – and the right approach to finance can certainly help you manage risk.

 

Asset Based Lending (ABL)

ABL creates finance against your existing assets – allowing you to raise funds secured on the tangibles you already own.

Bad Debt Protection (BDP)

BDP safeguards your business against the risk of late and non payment - protecting your ability to grow with complete confidence.

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