By Ted Howard

Despite minimal impact, treasurers should still prepare for more uncertainty after the S&P downgrade. 

On the face of it, most experts and practitioners agree that corporations won’t feel a direct impact from S&P’s recent downgrade of US long-term debt. Nonetheless, the markets have and will continue to feel the effects. And with the European sovereign debt crisis looming in the background, the current negative market sentiment could end up complicating many corporate projects from issuing debt to M&A to stock buybacks. The impacts could be long-term and not immediately apparent.

Take for example S&P’s concurrent notch downgrade of 73 funds, including bond funds, ETFs and hedge funds. S&P said in a release that these funds generally had exposures of 50 percent or more, directly or indirectly, to US Treasuries and agency securities. Included on that list are firms that many companies utilize, from BlackRock to State Street to Goldman Sachs to Federated Advisors. Will these changes change bank/advisor/manager behaviors? In the long term, possibly.

Then there’s the dollar. “Obviously, the downgrade is not a dollar-positive,” wrote Marc Chandler of Brown Brothers Harriman in a note to clients. “But we do not expect it to be a driver of the dollar for anything but the shortest of terms.“ But it could influence markets at some point. “The USD is a wild card,” according to Kasper Christoffersen, head of US Government Bond Trading at Goldman Sachs. The question is what foreign holders will do with dollar allocations, he said in a conference call with clients.

Then there is the possibility of another downgrade in November. Bank of America’s North American Economist Ethan Harris told clients on a call that BofA expects “further downgrades” as early as November due to a lack of confidence that the newly appointed congressional deficit committee will come up with a credible long-term deficit reduction plan.

However, some of the immediate worries that treasurers were nervous about during the debt ceiling debate haven’t come to fruition.

Already prepped

“Overall, the S&P downgrade has had limited impact on our cash/investments since we positioned our portfolio in advance of the debt ceiling vote,” wrote one tech treasurer in an email. “We considered the debt ceiling vote a key market event.” As such, the treasurer scaled back the company’s exposure to MMFs by moving into cash and also limited its treasury holdings, commercial paper, and agency holdings.”

The treasurer also said they were concerned with a downgrade creating collateral/margin calls, hence, short-term liquidity event. But that didn’t happen either and the Depository Trust & Clearing Corp said that it will not change any valuations of securities required as collateral for the activities of Fixed Income Clearing Corp. In fact, according to Barron’s, most major US clearing firms will not adjust current margin valuations on Treasuries.

Check and affirm

Nonetheless, in the long-term, treasurers should take stock of their situations. For example, here are 10 items to prepare for the post downgrade rollercoaster.

1) Stress-test liquidity scenarios. Cash-rich corporates are more likely to want to simulate indirect liquidity risk impacts on financial and commercial counterparties as well as money funds in what has become an all-too-familiar drill. Scenario-planning may also help with avoiding market seize-ups during hedge rollovers and the like. Don’t forget that supplier and customer vulnerabilities may be where your exposure lies.

2) Check your cash blind spots. If 100 percent, 24/7 global cash visibility is not a reality for you, know where your cash blind spots are and identify what cash is likely to be passing through them, especially in high-risk periods.

3) Get out the cash vault blueprints. Treasurers jokingly talk about wishing they had cash vaults of their own to park cash safely during recurring crisis periods. If you are going to build them, you might as well see if there is room for gold along with your six months or more of operating cash.

4) Capture opportunistic financing. High-end IG credits will have additional safe-haven glow to issue at the short-end and out the curve. Given increasing Fed signaling that short-term rates will not start their upward hike until 2013-2014, the long-end may get more interesting.

5) Prepare for opportunistic investments. If your policy is to hoard cash, one way to offset the drag of safe-asset returns and exposure to diminishing risk-free assets is to be prepared to take some calculated risk to earn returns when the market calls for buyer liquidity. Treasuries with a tested, well-thought-out risk-based investment policy are in a better position to do this successfully. But you’ll never be prepared if you don’t get this policy started and find the time to practice.

6) Purge rating references. S&P has set up rating agencies for an even more intense round of scrutiny, increasing the likelihood of subjective decisions. Reduce your firm’s vulnerability and rewrite any remaining policies and procedures that still rely on ratings (see related story – “SEC Wash of Credit Ratings a Light Rinse”). Ask counterparties to do the same. Remember that diminished importance also means you don’t need to pay more for a rating opinion.

7) Redo your counterparty risk matrices. The S&P downgrade has made real the knock-on effects for government-supported institutions. These knock-on effects also must be factored into probabilities that government support will be provided to institutions that seek it in the future. Monitor interbank lending and repo indicators for signs that counterparties may have been put on “safe settle” status by their peers.

8) ISDA Review. As part of any counterparty and rating reference review it makes sense to pull out ISDA documentation and especially CSAs associated with this. Hopefully, efforts over the past several years to put new ISDAs in place and standardize them with equal protection clauses will make these reviews short, but recent developments may not have been fully anticipated.

9) Get a jump on the board deck. Treasury presentations to the board have ticked down over a bit since the Lehman collapse, but a few treasury-centric slides have become staples of most board decks. In response to the US downgrade, plus ongoing risk to the eurozone, a few more slides may be called for in
advance of the next board meeting.

10) Re-sync with the lines of business. For the next little while at least, the market will be rewarding businesses that throw off reliable and sizeable cash flow. This is a time to ensure that capital allocation (known as funds-transfer pricing in the banking world) and risk management efforts are in sync with supporting these businesses appropriately. Given these incentives, cash-flow forecasting accuracy across the lines of business should be also more intensely monitored and accurate performance encouraged.