By Ted Howard and John Hintze
Companies are taking no chances when it comes to the uncertainties of where taxes and rates are headed.
Rising interest rates and the uncertainty around whether tax reform will proceed and what shape it may take has companies thinking even more about where to put their operating and medium-term cash.
And where they’re keeping it is in short-duration vehicles. Where they’re not going, except for in very small amounts, is back into prime money market funds.
At a recent meeting of the NeuGroup’s Treasurers’ Group of Thirty Large Cap group (T30LC), one treasurer of a global consumer goods company said tax reform was foremost on the company’s mind. He explained that the excess cash generated by a handful of his companies’ global affiliates is typically centralized every four months then handed over to managers of separately managed accounts. The third-party managers are given guidelines and restrictions, and off they go. But not anymore. “We stopped doing that this year because we want the option of keeping the money shorter term, and closer, so depending on how tax reform works out, we’d actually be able to take it back” to the US, the executive said.
Another treasurer, this one from a technology company, noted his firm was investing in average durations of two to three years. That operation was suspended and resulted in a cash build-up in Ireland, where the cash to manage Bermuda’s day-to-day operations had come from.
“Rather than invest that cash for two to three years, we’ve invested it to only a nine-month duration; waiting to see what happens with tax reform,” he said. “We didn’t want to have it tied up investments, so if we want to bring [cash] home in a year or two from now we would have to liquidate them.”
But interest rates are also a factor for remaining in short duration products. Jerry Klein, director and partner at Treasury Partners in New York says that although the Fed talks about tightening, the market isn’t quite on board yet. Thus there is safety in staying short. “You’re seeing a Fed that has begun to raise rates and told us they intend to raise rates further this year,” Mr. Klein said. “But the market doesn’t appear to believe it when you see the 1-year Treasury at 1% and the 2-year at around 1.25%.”
So the market is not pricing in as much Fed tightening as could occur over the next two years, he explained, pointing out that the yield curve is relatively flat between 6-month and 2-year Treasuries. Therefore companies “in general are running shorter durations than we have historically because of this interest-rate environment.”
The danger in putting cash in longer-dated paper is that the market’s view of the Fed could change by June and rates could pop, Mr. Klein said. “If you go and buy a 2-year Treasury at 1.25% and then the Fed does tighten in June and signals they’re going to continue to tighten and the market finally starts believing them, and all of a sudden the 2-year goes to 1.75, you’ve missed that yield increase.”
Prime Pick-up
Meanwhile there have been reports of money trickling back to prime money market funds, as companies dip their toes into the once vaunted market. Many larger companies might be going back to see how they do and to see how the accounting will now work. After the SEC rules forcing prime funds to use a floating net asset value regime, the Treasury Department and the IRS said floating-NAV MMFs could measure net gain or net loss without transaction-by-transaction calculations, which would simplify tax compliance.
Those flows were confirmed by feedback from a recent NeuGroup Treasury Investment Managers’ Peer Group meeting, where some members said they have begun moving back into prime money market funds; that trend is expected to continue in 2017. Liquidity has been good, and funds have been kept deliberately short, members said.
One treasurer of a manufacturer attending the T30LC meeting said his company exited prime funds for about a week last October when the new MMF rules became effective but then quickly jumped back in. He noted that some of the fund companies have started managing offshore prime funds that yield more than the onshore version. Others in the T30LC have taken a more cautious approach, with one member reconsidering MMFs. “We exited onshore prime funds. Now we’re looking at the spreads and we’re considering working our way back into prime,” he said.
Whatever the curiosity, it’s still a very small amount going back. Brandon Semilof, managing director at StoneCastle Partners, agreed prime is still being used, but mainly by companies that can afford to tinker with their portfolio. “If you have billions on your balance sheet, what’s going into prime funds is de minimus,” he said. “It doesn’t matter and it’s probably for diversification purposes.”
Aside from bank deposits, SMAs and other vehicles that offer short-duration products, companies are looking at alternatives. StoneCastle’s structured deposit, the Federally Insured Cash Account (FICA) program, is one product growing in popularity. It offers next-day liquidity with no transaction fees or redemption gates.