Financial assets that are worth either less than was originally paid for them, or less than the value they were expected to attain, are an unfortunate fact of life. Often it’s not a case of one asset, but a portfolio of positions to be dealt with.
They can be referred to in polite company as legacy assets. For internal meetings we can be a little more direct and use a term like toxic positions. At home they are “that stinking mess that landed on my desk because nobody else wants to touch it”.
They come from a variety of sources; some are generated for good reasons, such as planned long-term investments or hedging that was reasonably expected to be needed, or bundled in with an acquisition. Others come from not-so-good reasons like unauthorised, speculative (rogue) trading or even just errors.
The cause, however, is just a historic detail and playing ‘could have, should have, would have’ will not make the situation go away.
Sorting out this kind of problem often falls to treasury, either because that’s where the situation was created in the first place, or because treasury is deemed to have greater expertise in dealing with financial asset positions.
There are four broad strategies that can be taken: sit and wait, clear-cut, controlled disposal or trade out.
But that’s jumping ahead. Like a doctor with a patient, you have two principal tasks to perform: diagnosis and treatment selection. And they have to occur in that order.
With a full assessment of the situation we can begin to see clearly what is actually there. Using timelines for when the fixed cash flows will occur for the different business units involved, we can draw a ‘pain map’ to identify what challenges lie ahead.
Remember to include a bubble on the end of the timeline for cash flows that don’t have a fixed date, such as selling shares you want to clear out, but don’t have to. This would be the ‘evil twin’ of the business’s normal cash-flow plan; combining the two would give early warnings of any liquidity shortfalls. As the medical profession puts it so well: ‘first do no harm’.
Listing the various items to deal with, if it’s a portfolio of problems, gives better granularity when it comes to selecting an appropriate treatment for each issue – they won’t all necessarily be best handled in the same way.
Like a doctor with a patient, you have two principle tasks to perform: diagnosis and treatment selection
A final couple of things to consider before beginning the actual clear-up.
Firstly, are there similar problem positions out there that would be best dealt with at the same time? An amnesty period to get other issues on the table and sorted out before they become bigger problems might be a good idea, depending on the original cause of issue.
Secondly, how the matter is being discussed internally might need to be addressed, especially if you need support for some of the required actions when people are worried about reputational damage from being associated with a train wreck, even if they’re not responsible. Clearly labelling a clean-up and recovery situation as such might be embarrassing, but means it can be honestly treated as the necessary housekeeping operation that it is.
The treatment strategies each have strengths and weaknesses. The best one depends on the type of problem in relation to the business situation. And more than one can be used. As detailed in the box above, sometimes there is a silver lining.
The treatment strategies are as follows:
Doing nothing is always a possibility, and might be better than rushing into action simply for the sake of doing so. This approach is especially appropriate if a cool and calm assessment indicates that the current situation can’t really deteriorate any further.
A bought option position that is no longer needed and out of the money might not even be worth the effort of selling. Wait and let it time out and just book the premium.
However, in other cases inaction could be a really bad idea, for example, where somebody has written an option that should be covered at noticeable cost, rather than “gambling on survival” that it doesn’t become a catastrophic loss.
Simply shutting down all the problem positions immediately and walking away. The upfront financial pain is potentially highest, but if it’s affordable, this approach allows a rapid return to concentrating on the real activity of the business.
When there are multiple small hits to take, this might be the best option, rather than tying up a lot of time and effort for marginal savings.
Clearing positions on a preplanned timetable allows some more control as to when losses are realised, though that might mean the value impacts are less predictable.
If it is to be effective, it requires accurate cash-flow estimates of both the problem assets and business. Otherwise it amounts to merely hoping the rest of the business can generate enough to cover the loss from closing out positions.
Treating the assets as an active trading portfolio, regardless of original intent, and releasing parts of them as and when the market moves to predetermined target levels.
This gives more control over the value of impacts depending on the close-out levels selected, to limit loss or even generate a profit, but does so by giving up control of timing. When cash is limited, and the asset’s nature doesn’t dictate imminent cash flows, this method of clearing out the problems as and when they can be afforded might effectively be the only choice.
In summary: an accurate objective assessment of the situation and clear plan of how to deal with the challenges of toxic positions should help nurse your firm’s finances back to health. Of course, if everyone had taken that approach in the first place there might not have been an issue to begin with. Time for some preventative medicine?
Sometimes there are opportunities in adversity. Here are a few tips for how to find them:
Scott Raeburn is a treasury professional in the industrial manufacturing sector
