Corporate finance departments have taken significant steps to ensure they have access to their cash, but they still face significant challenges in terms of aggregating, analyzing and monitoring their exposures to banks and other counterparties.
Those were two important findings of the fourth annual Liquidity Risk Survey from consultancy Strategic Treasurer and investment advisor Capital Advisors Group, which collected the responses of 112 corporate treasury and finance executives and detailed the findings in early June.
Summarizing the other major takeaways, Craig Jeffery, managing partner of Strategic Treasurer, said in a webinar that the survey indicates companies are increasing the pace at which they negotiate and renegotiate credit facilities, often structuring them with multiple maturity dates to diversify when payments are due. More companies also appear to have updated their investment policies within the last six months.
On the downside, he noted, more companies see their short-term forecasts as less reliable, and many do not appear to have formal counterparty risk exposure policies or frameworks in place, resulting in difficulties aggregating, normalizing and monitoring the risk.
In terms of investment policies, 42 percent of firms changed them in the last year, a similar percentage to 2013’s survey. However, 21 percent reported changing their policies in the last six months compared to 13 percent in last year’s survey.
“The change in the backdrop of both the economy and modifications to investment classes has potentially spurred more active adjustments,” said Ben Campbell, president and CEO of Capital Advisors, in the webinar.
Bank deposits, including DDAs, sweeps and MMDAs, were the most common investment channel, with 69 percent of corporates parking their cash there in 2014 compared to 78 percent last year. Direct money market funds were unchanged, with 38 percent of corporates investing in them both years, and money market funds sold through bank portals saw a slight inflow. Money market funds sold through independent portals and government securities each saw sizable drop in corporates investing in them.
Mr. Campbell noted that some of the funds leaving bank deposits appear to have remained within the banking system, by flowing into money market funds sold through bank portals. And some funds likely went into repurchase agreements, which have become more popular among corporates because they’re fully collateralized.
Corporates’ use of offshore deposits fell even more, to 36 percent in 2014 from 54 percent last year. Mr. Campbell said one catalyst prompting coporates to shy away from deposits, onshore and offshore, was the FDIC’s move to reduce unlimited bank deposit insurance, instituted in the wake of the financial crisis, to $250,000.
Another catalyst has been banks’ credit ratings, which have dropped sharply since the 2008, when 60 percent of the 20 largest banks were still rated Aa2 or better, compared to only 5 percent today. Mr. Campbell noted that Moody’s recently put Deutsche Bank’s Aa2 rating on review for a downgrade due to a 34 percent decline in first quarter net income.
In reaction, companies appear to be changing their investment policy to reduce the maximum dollar values they invest in uninsured bank deposits. In 2013, the survey found, 51 percent of banks had no policy limitations and this year only 36 percent had no limitations; on the other hand, 26 percent of banks had balances of $1 million or less in 2014, up from only 13 percent last year.
Meanwhile, according to the survey, companies are changing their policies to require higher minimum credit ratings from their banks, with 38 percent requiring a rating of AA- or better, up 9 percentage points from last year, and significantly fewer permitting ratings of A or A-.
“We’ve seen a number of companies take action in their policy adjustments for controlling uninsured bank deposits,” Mr. Campbell said, noting, however that the percentage of companies that do not specific minimum counterparty credit ratings increased by the same amount year over year, to 35 percent in 2014, a trend that bears monitoring in later surveys.
Despite progress, the survey found, managing and mitigating counterparty risk remains a significant challenge for corporates, with 19 percent citing aggregating risk exposures across the company as the most urgent need. Knowledge, transparency and visibility were each listed by 6 percent of respondents.
One hurdle may be gaps in companies’ processes for formally monitoring counterparty risk. Only 36 percent of companies surveyed said they formally monitor credit counterparties with respect to debt, and only 14 percent view counterparty risk as an important factor in their debt decisions.
Another problem appears to be the limited set of variables companies use to calculate risk. The major rating agencies are a tool that77 percent of companies use to calibrate counterparty risk, with much smaller percentages using industry ratings and market data such as credit-default-swap levels.
“Given the conflict of interest that arises because issuers pay the ratings agencies, using ratings data alone may be insufficient for gauging risk,” notes an analysis of the survey published by its sponsors. “It’s important to pull together data from multiple sources and internally generate credit risk ratings.”