The VA's Financial Stress Test

Based on an unscientific survey of headlines from Federal News Radio, when it comes to higher interest rates, folks in the government contracting community are primarily concerned with whether their TSPs balances have gone up.

Rising interest rates have had a pretty profound on the US economy, though. Bond returns are at historic lows. We've seen major bankruptcies and corporate layoffs. And even though it seems like ages ago, just a bit over six months ago, we experienced a systemic banking crisis caused by insolvency of some major banks.

Still, for the most part, I would argue that the impact of higher interest rates on the economy has not really been felt in the context of #govcon or affected acquisition strategies. At least, I would have argued that.

As it turns out, though, contracting officers at the Department of Veterans Affairs (VA) are worried about corporate debt? At least, that's what I learned through a recent GAO protest filed by IBM related to a VA effort to "procure supply chain modernization services."

According to the GAO, in late June, the VA put out a solicitation for a 10-year contract to implement "an easy-to-use cloud-based platform to manage the flow of goods, services, and information internally between agency personnel, and externally between agency personnel and customers." And the VA proposed a three-step evaluation process, with a first-step evaluation of corporate expertise.

At this first step, vendor debt came into the discussion. Specifically, the VA allocated 17% of its evaluation for corporate expertise to two specific debt-coverage ratios. According to the VA, its focus on corporate debt was based on its "need to evaluate offerors’ financial health because [the modernization effort] is deeply complex, has agency-wide implications, and will be performed over a 10‑year period."[1]

To evaluate the financial health of the vendors, the VA chose two financial stress tests: (1) a "current ratio" greater than 1.0; and (2) a "solvency ratio" greater than 0.2. And IBM argued that the VA's use of these ratios would effectively eliminate it from competition.

Now, an earlier draft of this post went into great detail about why I am intellectually sympathetic with IBM about its argument that the VA's choices of financial ratios were probably not the best choices. I will spare you that analysis, though, and instead simply posit that the VA's choices were not the best choices.

But I can't let one thing go. Whether or not the specific tests were the best choices or reasonable choices, I keep reading and re-reading this paragraph in awe (note that I am keeping in the citations for a reason):

For instance, the agency shows that financial sources refer to the selected liquidity test as a commonly understood ratio that measures a company’s ability to pay short-term obligations or those due within one year and indicates how a company can maximize the current assets on its balance sheet to satisfy its current debt and other payables. MOL at 9 (citing Jason Fernando, “Current Ratio Explained with Formula and Examples,”, and CFI Team, “Lending Ratios,”…). For solvency, the agency shows that financial sources refer to the selected test as a commonly understood metric that examines whether a company can meet its financial obligations in the long-term. MOL at 10 (citing CFI Team, “Solvency Ratio,”…).

I kept in the citations above because, if you click through the links, you'll find that the actual amounts for the stress tests (1.0 for current ratio and 0.2 for solvency ratio) appear to be taken directly from the Corporate Finance Institute's write-ups.[2]

Have I googled financial things and stumbled across CFI's website before? Yes. Definitely. Did the VA really just pick these numbers because a highly Search Engine Optimized website gave some benchmarks? I kinda think yes maybe?

In the end, though, the GAO found that the VA "demonstrated that the financial liquidity and solvency tests are reasonably related to its needs and withstand logical scrutiny." The VA felt that it needed a financial stress test for its vendors and GAO deferred to the VA. IBM lost and them's the breaks.

It's a weird case and I sort of hope its an anomaly. After all, contractor officers are not exactly financial analysts and the last thing we need in #govcon is training folks to be savvy in financial engineering.

But, its an anomaly that I guess makes some sense in the upside-down world we live that is the year of our lord 2023. After all, the VA issued the solicitation only a few weeks after Congress narrowly avoided a default on our nation's debt. We're a few weeks from another potential government shutdown and the House still doesn't have a Speaker. So, at the rate we're going, perhaps expecting your vendors to have a bunch of cash on hand is a defensible hedge? The GAO seems to have thought so.

I just hope that the Treasury Department isn't primarily relying on the Corporate Finance Institute to evaluate the nation's balance sheet.

[1] I have to admit that the VA's approach and the GAO's opinion confuse me a bit. My instincts are that debt-coverage ratios should be a factor in making a responsibility determination under FAR 9.104-1, but shouldn't be a factor in "corporate expertise." But what do I know?

[2] Here are the quotes from CFI: (a) "In many cases, a company with a current ratio of less than 1.00 does not have the capital on hand to meet its short-term obligations if they were all due at once, while a current ratio greater than 1.00 indicates that the company has the financial resources to remain solvent in the short term."; (b) "Important to note is that a company is considered financially strong if it achieves a solvency ratio exceeding 20%."

IBM clearly thinks these ratios are inappropriate for its business. And a cursory review of IBM's latest annual report suggests why! It's current ratio is below 1.0, which the CFI's analysis would claim that IBM is at risk of failing this year (not financial advice!). But a major reason why IBM's current ratio is below 1.0 is that IBM provides financing to its customers and, practically speaking, that means IBM is acting more like a bank than a software company from a balance-sheet perspective. If that's a correct read, the use of the current ratio is pretty unfortunate for IBM. After all, Bank of America and JP Morgan Chase's current ratios are also below 1.0. God help us if BoA, JPMC, and IBM all fail in the next year.

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