Published: January 01, 2012
Companies all around the world are awash with cash. According to the US Federal Reserve, American corporations held a record $2.05tr in cash as of mid-2011 [1]. At the end of last year Bloomberg reported that European companies held almost $700bn in cash [2], which is 16% higher than at the end of 2007 when the financial crisis first emerged. At the same time, a report from UBS said that some European companies have cash on their books roughly equal to 5% or more of their total assets [3]. Regardless of industry or region, corporations cannot be sanguine about these cash mountains; cash is an asset that needs to be rigorously tracked and risk-managed.
Although the current amounts of cash present numerous opportunities for corporations, there are also significant issues to consider. While it may seem counterintuitive that a company can suffer from being flush with cash, the risks that such excess poses are often overlooked. Excess cash can actually increase risk, offsetting the ostensible benefits of accumulating cash in the first place.
For companies with large cash balances the main issues that need to be addressed include:
Visibility and hedging. Generating and maintaining large international cash balances raises the importance of cash visibility and FX hedging. Large international banks have made enhancements to offer high-visibility, notional and physical cash management pooling programmes that centralise and optimise overseas subsidiary cash at the end of each day and hedge the net amount. World-class companies place a premium on managing their FX risk and invest in technology that keeps close tabs on the banks managing these pooling programmes.
Banks’ dwindling options. Basel III is forcing banks to collateralise their cash holdings. This is driving banks to limit cash and fund investment options. Limiting options will ultimately drive down yields or even push corporations toward non-stable investment options.
Tax considerations. Despite ongoing lobbying in the US for a ‘Homeland Investment Act 2.0’, American multinationals should not make their plans contingent on a tax holiday. While many developed countries, such as Japan and the UK, have territorial tax systems, which leave overseas profits to be taxed in the jurisdictions in which they are generated, the US has not followed suit. This means cash held overseas by US multinationals remains subject to a 35% tax rate, if repatriated to the US. Companies have issued debt to avoid this—even to fund dividends and buybacks—making it slightly less attractive to keep the cash abroad. But as long as rates stay low, there will be little impetus to bring the cash home.[[[PAGE]]]
Counterparty risk. The bankruptcy of Lehman Brothers, the US Federal Reserve Fund’s subsequent breaking of the buck, and the run on money funds in the wake of those events demonstrated the importance of managing the counterparty risk of the institutions where corporate cash is deposited or invested. Today’s volatile economy, coupled with the web of counterparties and geographies that institutions deal with, demands new-world technology that can generate counterparty risk assessments that are both comprehensive and timely.
Banking costs. Banks may begin to charge fees on cash holdings above certain levels. Bank of New York Mellon (BONY) last summer became the first to announce such a move, saying it would charge 13 basis points on balances of $50m or more. This fee is driven by banks’ increased collateral necessities and FDIC requirements mandated by legislation, as well as the simple difficulty faced by bank treasurers looking to put the deposits to work in positive-return short-term investments. Other banks may not follow BONY’s lead, since bankers traditionally see deposits as a cheap source of stable funding, and one that will help them meet Basel III liquidity requirements. This may offset the cost of managing the funds, especially when the value of client relationships is added to the mix. Nonetheless, BONY’s move has been a major source of uncertainty.
For companies that hold significant amounts of cash there are typically four options in how to deploy it:
1. M&A. Cash-rich companies do not have to rely on the capital markets to fund acquisitions.
2. Stock buy-backs. Cash enables publicly listed companies to regain value by buying potentially undervalued shares.
3. Reinvestment. Cash can be deployed back into the business through capital expenditure.
4. Holding onto the cash.
Although there are many benefits to holding onto cash, it is crucial that the decision to do so is made following a full analysis of the risks and costs involved. Whether the associated risks are with banks, regulation, or FX, cash can easily turn from asset to headache: cash is neither a static nor risk-free asset.
Assessing the opportunities and risks of deploying or holding cash requires a high degree of visibility. Without the ability to see clearly where cash sits across an enterprise, CFOs and treasurers cannot maximise the effectiveness and value of cash as an asset.
Notes
[1] http://www.federalreserve.gov/apps/fof/DisplayTable.aspx?t=l.102
[2] http://www.bloomberg.com/news/2010-11-30/european-companies-with-700-billion-set-to-ease-deal-deadlock.html
[3] http://online.barrons.com/article/SB50001424052970203408504575588620858561714.html#articleTabs%3Darticle
How Thought Leadership Can Reduce the Cost of Sales by Patrik Havander, Havander & Partners A focused attention on the costs incurred by the global sales and marketing processes is becoming increasingly important for corporate banks and their transaction banking departments. While the client/bank relationship remains vital, research has shown that in fact relationship selling […]
