Toyota Financial decided to turn the traditional tension between headquarters and field operations on its head to achieve nothing short of a financial breakthrough. It rescued its risk-adjusted return on capital (RAROC), which was tanking, by decentralizing. It took control over credit pricing decisions–and thus control over RAROC–away from a corporate committee and gave it to its 30 dispersed dealer sales and service offices.

TFS made its RAROC model accessible to hundreds of field managers and taught them how to use it to achieve their monthly RAROC targets. The result: In roughly 12 months, RAROC had rebounded from a precious few basis points to a significantly higher number, which TFS will not reveal for competitive reasons. "[It's] back to a normal, healthy level," according to Gruebler.

To get there, it meant that the central committee had to relinquish power and, perhaps more difficult, their database and sophisticated modeling involving the cost of funds, macro demand forecasts and projected credit losses. The alternative was for the committee to learn what field units already knew about dealer needs and local competitor offers, and "pricing committee members could not imagine themselves becoming experts on local conditions in each of the pricing regions," Gruebler says.

TFS gave authority to those who could be locally responsive and armed them with online access to the corporate RAROC model they would need to mimic the macro sophistication of the TFS treasury. Since Toyota field offices are measured by volume–and regularly complained that headquarters demanded inflated returns on loans–the unconventional and certainly out-of-vogue move to decentralize could be seen as asking the foxes to guard the hen house. Neverthe- less, TFS's senior treasury, sales and risk executives decided to err on the side of those with the most up-to-date information.

Toyota Financial brought a Wall Street-like tool into the corporate world and invited field leaders to test the simple client/server technology. After a successful unveiling, the rest of the field staff was trained in how to use the RAROC model and given new, RAROC-based goals. The selling point: They were getting the local input into pricing decisions they had always wanted.

Much of the gain, Gruebler explains, comes from slicing the TFS portfolio into about 200 segments based on geography, credit quality, loan-to-value ratio, loan term, etc. Toyota field offices can now meet local competition and hit RAROC targets by matching competitive pricing in the most sensitive segments and making up the margin in less sensitive segments.

The project managers knew that aligning the interests of the field staff with the interests of headquarters would be costly until the volume interest of the field offices was aligned with the profitability interests of headquarters. The solution required putting a healthy dose of profitability into the metrics by which field staff would be compensated. That alignment is still a work in progress, Gruebler admits, but the bottom line is that RAROC has turned up and continues to climb, albeit with some month-to-month volatility.

SILVER AWARD WINNER

General Electric Co.

As $150 billion General Electric Co. grew its business and expanded its book of derivatives used for hedging foreign currency and interest-rate exposures, the number of highly rated counterparties with which it could do business remained static. That meant that GE, by 2004, was approaching credit thresholds, and expected future growth could pose problems. If GE reached the limit on the credit exposure it could have with a given derivatives dealer, it might have to cut back on trading with that counterparty to stay within its exposure cap. If the bank with which it was trading derivatives contracts reached its limit on credit exposure to GE, the bank would have to allocate more capital to back up additonal exposure–a cost it would pass on to GE. "Our existing structure could have limited GE treasury's ability to hedge efficiently," notes Dennis Sweeney, deputy treasurer.

To open up room to grow, GE organized a new legal entity called GE Financial Markets. GEFM now serves as GE's primary face to the financial markets for FX and interest-rate derivatives. Every dealer has most of its exposure to GEFM. GEFM executes derivatives trades with GE affiliates and then, to the extent that there is a consolidated exposure, GEFM enters into offsetting positions in the external market. "With collateral agreements in place, the exposure each party has to the other is capped by the threshold on the collateral agreement," explains Rob Ceske, chief risk manager in GE's corporate treasury. Overall, the new subsidiary and strategy could reduce banks' potential exposure to GE by as much as $10 billion and free up capital for other purposes. For GE, the change means net savings of about $25 million annually in fewer credit charges and better prices from counterparties. "It gives us the scale to implement better systems, stronger controls and improved performance metrics," Sweeney concludes.

BRONZE AWARD WINNER

Paychex Inc.

Paychex Inc. was cruising in 2002when it hit a bad-debt pothole. When write-offs more than doubled that year, it was a culture-changing shock. In theory, it was paying the employees of its clients with money it had already collected through the ACH, but the companies could still take money out of their accounts and stick Paychex with the ACH equivalent of a bounced check. And in 2002, when the dot.com bubble burst, that was happening all too often, reports Frank Fiorille, director of enterprise risk management.

That's when management launched the ERM project and hired Fiorille, who had a bank credit background. His assignment: set up a leading-edge program with an emphasis on front-end credit review, drawing largely from the current staff, which included no credit experts. The first line of defense would be a sophisticated effort to screen out companies on the verge of bankruptcy and deliberate fraudsters, but it had to be automated. Paychex, based in Rochester, N.Y., has 540,000 clients for its payroll and human resource services; 99% of its transactions are for less than $100,000, but they account for 75% of its credit exposure. Using an array of credit bureau reports and analysis tools from Experian, Equifax, D&B, Lexis Nexis and law enforcement agencies, the ERM staff automated the way more than 100 field offices could screen those large numbers of transactions and highlight the ones that look suspicious. In extreme cases, clients would be asked to fund their payroll by wire.

It worked. In the first year under ERM, the bad-debt provision was reduced by 72%. And it stayed low, declining slightly over the next two years while overall business and exposure continued to climb. "We created a bank-like credit function with front-end credit review, back-end collections and support from legal and audit," Fiorille says. "In 2002, we were behind, but now we're a leader."