With the coronavirus pandemic creating a ripple effect in the U.S. economy, more companies are looking to enhance their liquidity positions and secure access to credit as they prepare for some tough months ahead.
A new whitepaper from The Hackett Group recommends that companies tap into excess cash within current working capital management practices to support the supply chain. U.S. companies had $1.3 trillion tied up in excess working capital last year, so treasury teams may find that this is an area to explore.
Among Hackett’s recommendations are tightening up accounts receivable processes by strengthening collections; introducing liquidity mechanisms, such as payment terms and financing solutions, for smaller customers and suppliers; and monitoring daily demand fluctuations and supply limitations closely to make sure cash isn’t invested in the wrong inventory.
Many companies are also drawing down their credit facilities to strengthen their cash positions. General Motors said Tuesday that would draw down $16 billion from its revolving facilities as a “protective measure.”
Simultaneously, companies have been taking cash out of derivatives like FX forwards and cross-currency swaps that had suddenly become significant assets due to rapid strengthening of the dollar.
“They essentially terminated the trades, and put on new ones at current market rates,” said Amol Dhargalkar, Managing Director for Chatham Financial. “They got cash out and bolstered their balance sheets. The new trades they put in place were at worse rates than the old trades, but they also got cash to offset them for that.”
Chatham has observed many of its clients taking this approach as the coronavirus outlook has worsened in the U.S., though this activity has slowed down in the past week as both the Federal Reserve and Congress have taken actions to support the economy. “Generally, the big theme was, ‘Let's look for cash and draw down on facilities. Where else can we get cash just in case?’ The answer was derivatives,” Dhargalkar said.
There are some challenges to this strategy, however. Since banks tend not to be comfortable writing big checks to settle trades in times of stress, many companies have looked to advisory firms like Chatham to help them work through the process. “Because we represent so many companies, we were able to have a little bit more of a broader discussion with the bank rather than in isolation for one particular trade,” Dhargalkar said.
Another key issue was that credit has been impacted negatively in the last few weeks, not only for high-yield companies but also for investment grade companies. Because banks are taking on risk in a derivative transaction, they are requiring some type of return on that risk. That’s where credit charges come in. “Those credit charges are much, much higher today than they had been even just months ago at this time,” Dhargalkar said. “When companies were either booking or re-booking the trades, or when they unwound the old trades to cash out and entered into new trades, the costs to entering into those new trades were higher as well.”
The current market environment also has many companies focusing on pre-issuance hedging. With Treasury yields and swap rates falling and credit spreads increasing, treasury teams have been locking in underlying yields for issuances as far forward as two or three years out. “It’s farther out than we've seen in years across the investment grade spectrum, almost farther than I've ever seen,” Dhargalkar said.
This has resulted in a lot of derivative structuring conversations at treasury departments; companies are looking at whether they should use a Treasury or swap-based hedge. There have also been a lot of hedge accounting considerations, because if rates stay low, these hedges will become liabilities. Hedge accounting allows them to spread that liability. “If you had a $10 million liability on your hedge, good hedge accounting treatment allows you amortize roughly $1 million every year on a 10-year issuance, rather than a $10 million immediate hit to earnings,” Dhargalkar said. “So getting hedge accounting treatment is really helpful because it reduces the volatility that you're going to experience.”
EXPANDING CREDIT ACCESS
Last week, the Fed further expanded its efforts to support the economy, unveiling three new facilities that will give corporates greater access to credit.
- The Primary Market Corporate Credit Facility (PMCCF) provides companies with access to credit to help them keep business operations running during the pandemic. Open to investment grade companies only, this facility allows borrowers to defer payments for the first six months so that they have more cash to pay employees and suppliers.
- The Secondary Market Corporate Credit Facility (SMCCF) is a special purpose vehicle (SPV) that supports the corporate bond market through the purchase of investment grade corporate bonds and eligible corporate bond portfolios in the secondary market.
- The Term Asset-Backed Securities Loan Facility (TALF), a rebooted version of the 2008 program of the same name, is intended to support the flow of credit to consumers and businesses by enabling the issuance of asset-backed securities (ABS). The 2008 TALF was highly successful, jumpstarting lending at a time when it had grinded to a halt.
AFP spoke with the Treasury department about the PMCFF and SMCFF, in an effort to shore up the difference in the programs from a credit quality standpoint. The Money Market Mutual Fund Liquidity Facility (MMLF) and the Commercial Paper Funding Facility (CPFF), which were announced the week before, only allow Tier 1 commercial paper. “Yet on an equivalent basis, the PMCFF and SMCFF allow long-term credit ratings of equivalent Tier 2 issuers, but exclude them on the short end with the MMLF and CP facilities,” said Tom Hunt, AFP’s director of treasury services. “This further complicates the liquidity shortfall that Tier 2 issuers are experiencing because they need funding now.”
The Fed certainly has its work cut out for it. Michael Bright, CEO of the Structured Finance Association, noted that the central bank “needs to get the new TALF program and five other facility programs up and running, provide needed liquidity to the markets, all while not running afoul of the legal limitations outlined in Section 13(3) of the Federal Reserve Act, which guides the central bank’s emergency lending authorities.”
Dhargalkar believes that the Fed’s efforts will ultimately have positive results, and has already seen the beginnings of a turnaround. “The intention is absolutely to help in all these markets, and I think we're starting to see the early signs of that,” he said. “It’s hard to say exactly whether equity markets are responding favorably to stimulus, but the fact is that they are responding favorably.”
For more insights during this difficult time, visit AFP’s Coronavirus Resource Center.