The current crisis in financial markets and its credit and liquidity constraints is different from the credit and liquidity crises of the past 60 years. The present crisis started from within the banking system and has rippled out to the mainstream economy. Corporate treasuries have been obliged to respond to the credit and liquidity problems that banking institutions and financial markets – the traditional sources of funding, investment and liquidity – have themselves inflicted on the global economy.
Overall indications are that corporate treasuries quickly realised the scale of credit and liquidity crisis. They are making realistic assessments about the duration of the crises and the impact on their banking relationships.
How has the financial market turbulence over the last 12 months affected corporate and treasury investment and funding?
Market turbulence has had a pernicious effect on corporate and treasury investment and funding over the past 12 months. Initially, certainly until the end of 2007, the extent of the US sub-prime mortgage crisis was underestimated. The crisis was viewed as an awkward intermission and normal service was expected to resume shortly. Events have proved otherwise. ‘The worst financial crisis since the 1930s’ is becoming the general consensus. Corporate liquidity is under increasing pressure as credit becomes scarcer and markedly more expensive. The costs of bank borrowing, lending facilities and revolving credit facilities have risen. The financial markets are imposing higher rates on companies’ commercial paper issuance programmes.
Corporations have determined that the credit crisis and liquidity crisis have crystallised into a prolonged crisis of confidence in financial institutions and financial markets. Accordingly, they have taken action to ensure as far as they are able that their funding requirements, both short-term and longer-term, are secured against the uncertainty about banking institutions’ ability to continue performing lending services and capital raising functions for their clients at the same level as before the credit crisis.
How have corporate treasuries responded to the market turmoil?
In general, corporate treasuries are trying to avoid new funding programmes by taking a more active approach to managing cash flows. Corporate treasuries have had even greater demand for a real-time view of cash balances to make the most of company funds, which is one of the benefits of having a direct connectivity to entities such as SWIFT. Deploying a more active approach to managing cash flow prompts corporate treasuries to review their banking relationships and the number and disposition of those accounts across the countries in which they and their corporate subsidiaries operate.
Ironically, corporations with strong balance sheets and cash flows are now able to review their banking relationship in light of the strength of the banks’ balance sheets and their ability to offer investment and funding services. They are likely to rationalise their banking and account relationships in consequence.
Corporations or sectors that are more exposed to the financial impact of the credit and liquidity crises have an overriding requirement to preserve their access to financing requirements for what they perceive as the duration of the credit and liquidity crisis. In the UK, for example, corporate earnings in 2008 will grow more slowly than the average 5% rate, according to City analysts. While the credit squeeze may be imposed by the banks, expansionary demand for credit is likely to be limited.
What trends are emerging from corporate treasuries’ responses?
The squeeze on liquidity is increasingly transmitting itself to the corporate sector through a reduced supply of credit and rising cost of credit. Actions such as lengthening payments terms to suppliers of goods and services and tightening terms of payment for customers are relatively cosmetic in the current environment, essentially good housekeeping. Corporates operating in weak sectors, such as residential and commercial property retail and leisure, have limited scope to tighten their financial terms of business.
Stress in the banking system has led to a decline in chief financial officers’ (CFOs) apparent appetite for bank borrowing. This represents a significant shift from surveys in 2007, when CFOs rated bank borrowing far more attractive than either corporate debt or equity.
Tighter credit conditions have revealed a major change in corporates’ attitude to debt. Enthusiasm for raising funds through borrowing, or gearing, has fallen sharply since Q3 2007. Some corporates are reducing borrowing where they are able and not committing to new borrowing. There is almost universal avoidance of issuance of long-term corporate debt in the current environment. The issue would have to be premium priced, of top rating quality. Any corporate issuer faces the reputational risk danger that external market events could limit the ability of underwriters to place the issue with financial institutions.
The equities markets, outside of the property, retail, and leisure and, of course, financial services sector, have maintained their market values to the date of this writing despite the credit crunch.
Opportunities exist for raising equity funding for longer-term investment and for repaying debt funding. Private equity continues to remain available for long-term investment propositions in areas such as technology and even very specific financial services lines of business.
What are the main challenges and risks encountered by corporate treasuries?
The key challenge for corporate treasuries is predicting the duration of the credit and liquidity crisis. Estimating the duration of the credit and liquidity crunch is critical for corporate treasuries to advise their boards of management whether to delay or proceed with investment plans. Equally, they have to advise when to reassess them where they have been delayed. The credit crunch and liquidity crises are now impacting banks’ earnings from the corporate sector. The banking results for Q2 2008 issued in Q3 2008 continue to reflect a poor outlook for the sector and demonstrate the capital constraints under which the banking sector is operating.
Corporates have to pay increased fees for access to banking facilities whether they are using them or not. In the current environment, banks have a tendency to cancel unused corporate banking funding lines to free their available facilities for corporates or even as a means of contracting their business. To maintain these facilities, corporates have to pay increased fees. Alternatively, they can explore the opportunities to open facilities at other banks – banks whose balance sheet strength and capital ratios appear to be weathering the credit crunch and liquidity crisis. While some European and US banks stand out exceptionally, they are able discriminate in favour of quality corporates as they establish new banking relationships.
A number of well-capitalised banks from the Middle East and Asia-Pacific region have established themselves in Europe and America. To date, they have not demonstrated aggressive acquisition of the corporate business that the US and European banks with capital constraints are currently unable to service. Perhaps they sense the risks of a longer economic downturn in the US and western Europe and wish to avoid association with the banking problems of those regions.
What plans are corporate treasuries developing for their companies to maintain access to working capital, investment and funding?
With the notable exceptions of resources companies and those with substantial revenues from the Middle East, Russia and the Asia-Pacific region, corporates are battening down the hatches. They are reducing borrowing, where possible, but have to ensure they maintain lines for financial contingencies and other unexpected events, certainly until the middle of 2009, the earliest date at which a revival of the world economy is anticipated. For the vast majority of corporates, the credit and liquidity shortage has resulted in increased bank fees and interest costs.
The economic outlook remains bleak, uncertain at best, in western Europe and the US. Corporate treasurers are acutely aware of the economic outlook. In contrast to the banking institutions, the credit crunch and liquidity crisis have not taken them by surprise. They are making adequate preparations to survive the liquidity crisis.