Enterprise-wide epiphany

There was one obvious candidate for the job when Heller Financial needed to appoint a new chief credit officer in 1997. Mike Litwin had spent most of his nearly 30-year career at the Chicago-based financial services giant in Heller’s various credit businesses, and ran many of them himself. He had hired many of Heller’s senior managers and devised large parts of its business strategy. This experience also prepared him for the challenge he took on two years later: revamping the company’s entire risk reporting and management framework using an enterprise-wide risk management (ERM) model, with final accountability for all Heller’s risk flowing up to him in a new position as chief credit and risk officer. 

Heller, with $19 billion in assets, provides middle-market companies with an array of financial services – including equipment financing, factoring, asset-based lending and leasing. It has operations in 16 countries besides the US, through joint ventures with local banks or through wholly-owned subsidiaries. The combination of the product offerings, geographic scope and the characteristics of its client base – middle-market companies that are often private and unrated – make managing its credit, market and operational risks a challenge.

If Heller’s deal originators and traders had regarded Litwin suspiciously and resisted his efforts – a problem many chief risk officers report – the job might have been impossible. But Litwin says the staff see his role as an integral part of the effort to achieve the company’s financial goals. “We view risk management as a value-creation exercise. As a result, it has been easier for me to implement cultural changes,” he says. The company has set a target of 15% annual growth in earnings and 15% return on equity, which, Litwin says, it may not be far from achieving. 

Litwin’s first priority is to ensure the company’s credit risk strategies are up-to-date and functioning. “Our strategies are embarrassingly simple, and based on the lessons we’ve learned over the years,” he says. Heller begins by emphasising quality deal-selection. It also has clearly articulated credit standards for all its products, and uses “credit boxes” – preset standards for deal originators – to ensure new transactions meet them.

Heller also seeks to maintain as liquid a portfolio as possible. To do so, it over-originates products and distributes them through securitisations or syndications. It also ensures that its portfolio is diversified geographically, by business line and by instrument type. Heller’s distribution capability allows it to tailor its portfolio to maintain adequate diversification, Litwin says. Heller also keeps a lid on deal size: “If you have a large deal that goes south you have a heart attack,” he jokes. “We like to say we’re in the heartburn – not heart attack – business.”

Even with these policies in place, dealing with middle-market clients raises a number of sticky credit risk issues. “Our market is much more inefficient in terms of understanding macro default and loss frequencies,” Litwin says. To improve its analytical toolbox, Heller is revising its risk rating system to be more granular, and creating databases of default and loss, he says.

As Litwin progressed in the chief credit officer job, he became aware of the severity of operational risk issues. “I had an epiphany in July 1999,” Litwin says. “We were taking credit write-offs that did not feel right – some were clearly not credit, they were due to errors.” Heller had no system to deal with these types of operational risks – in the past, when it had a business line that incurred many operational losses, it would simply sell or close the division.

Litwin determined that slightly less than one-third of the write-offs reported as credit had nothing to do with credit – they were primarily operational. These included losses due to a variety of one-off mistakes, such as improperly documented loans or failure to charge an agreed fee. Heller estimates that it sustained 25 basis points in operational loss-related write-offs in 1999. 

To get these losses under control, the firm set out to establish an ERM framework in September 1999, and hired New York consulting firm Oliver, Wyman & Company to assist it. “We had a typical organisational structure where the chief financial officer is responsible for the market risk of the company, the credit committee is responsible for credit risk and the chief operating officer is responsible for the operational risk,” Litwin notes. Heller reorganised these reporting lines, changing Litwin’s title to chief credit and risk officer, and charging him with responsibility for all risk. It also created staff and line managers called operational risk managers to monitor, manage and report exposures in each of the business units. The system provided better information and accountability. “If you can create accountability for risks and measure and report them, they are almost always mitigated,” Litwin says. 

His operational risk managers now meet once a month to compare notes on the experiences of the various business units. They gather reports both on actual problems and on episodes where a problem was narrowly avoided – what Litwin calls “misses and near misses”. “Before this, no-one would have talked about situations where they almost had a loss, they would breathe a sigh of relief and move on,” he notes. “Now they are willing to talk, so we can learn from them.” 

Litwin also regularly asks Heller’s managers, “What keeps you up at night?”, yielding useful information about what may be systematic problems that can be addressed. His team also gathers firm-wide reports on new initiatives, the implementation of which is often laden with operational risk. “There is a tremendous number of new initiatives occurring at any one time in an organisation like ours,” he says. 

These initiatives have not yet produced a dramatic lowering of operational risk-related write-offs, mainly because Heller’s portfolio turns over about every three or four years. Many of the risks (say, faulty documentation) already reside in the transactions in the portfolio. But he predicts that, over the next few years, current efforts will begin bearing fruit.

The risk information system Heller is putting in place to support the ERM approach will help it reach another of its goals: the ability to analyse its various businesses on a risk-adjusted return basis. “We would like to do scenario testing and profitability testing; we’re about a year away from really being able to do that,” he says. “We’re now in an account management mode rather than a portfolio management mode. We want to manage our portfolio in a way that really allows us to optimise risk/reward.”