The latest edition of the AFP Liquidity Survey
finds that both the size and management of corporate short-term cash holdings stayed relatively steady over the past year. The reasons are two-fold. First, the business and regulatory climate remains one of middling economic growth and uncertainty. At the same time, the historic ultra-low interest rate environment has greatly reduced the opportunity to generate yield.
Low interest rates have not dissuaded companies from building their cash reserves. This is cash that could be used for capital investments, hiring, merger and acquisition activity, and stock repurchases, but instead remains in company coffers. According to the Federal Reserve, total liquid assets of non-financial corporate businesses grew more than 40 percent from late 2007 to the late 2013. But what many companies have been doing with the $1.944 trillion is characterized, by some, as similar as stuffing it in a mattress.Three vehicles
Sure enough, this year’s survey reveals that organizations kept an average of 75 percent of their cash and short-term investment holdings in three safe and liquid investment vehicles: bank deposits, MMFs and Treasury securities. That number is up sharply from 2006, when only 56 percent of corporate cash holdings were maintained in bank deposits, MMFs and Treasury securities.
But even that shift does not fully demonstrate the conservative investment strategies held by most companies. The typical organi¬zation in the 2014 survey maintains 52 percent of its short-term invest-ment portfolio in bank deposits. This is up from the 50 percent reported in 2013, and the highest share reported in the nine-year history of the AFP Liquidity Survey. By contrast, in 2006 the percentage of funds held at banks was 23 percent.
Banks are attractive repositories for corporate cash holdings for a number of reasons. First, the lack of strong investment alternatives that generate yield, combined with the belief that banks are safe places to invest, make them particularly compelling places to hold cash. Another reason is the ability to generate earned credit rates (ECRs) offered by many financial institutions that help defray cash management and other banks fees.
But the business environment is changing. Most analysts and policymakers see the huge economic contraction during the first quarter of 2014 as an aberration, caused by a number of one-time events, including the harsh winter weather. Instead, they point to a labor market that continues to regain its footing, and inflation that is moving back towards long-term trends, as signs that the U.S. economy will build strength during the remainder of 2014 and beyond.
It is likely that at some time in 2015 the Fed will begin to push up short-term interest rates by raising the fed funds target rate above the near-zero percent level, where it has been since December 2008. The median forecast of Federal Reserve Board Members and Federal Reserve Bank Presidents has the fed funds target rate at 1.0 percent by the end of 2015, and at 2.5 percent by the end of 2016.
The reality is, banks will likely remain an important repository for corporate cash and short-term investment holdings for many of the reasons why organizations hold their cash there now: a dearth of opportunities to earn significant yield from other investments, the ability to generate earnings credit rates from bank deposits, and safety being the primary investment goal of two-thirds of organizations. MMFs not the answer
New money market fund rules could make MMFs ineligible for inclusion in many organizations’ investment portfolios. The mere anticipation that changes to MMFs were in the offing, along with the relative lack of yield MMFs generate, has led to an orderly liquidation by a number of organizations. In 2007, 31 percent of corporate cash and short-term investment holdings were maintained in MMFs. That percentage has dropped to 16 percent in 2014, with much of this cash rolling into banks.
The question is: Now that the SEC has finally acted, will organizations pull even more of their funds out of MMFs, or have the already adjusted to what they perceived to be the new normal?A longer version of this article appears in the July/August edition of AFP Exchange.