In a world where the unprecedented happens, treasurers must build in contingencies they know can work.
The kick-off meeting of The Treasurers’ Group of Thirty Large-Cap Edition, sponsored by Société Générale, brought to mind the Boy Scout motto: “Be prepared.” Members need to be able to respond to unexpected financing issues leading into a large strategic transaction, changing dynamics in counterparty risk that leverage banks’ improving credit risk management capabilities and cash investment trends that favor added duration. Accordingly, three key takeaways stand out:
Contingency financing is needed to close a large strategic financing. Treasurers need to ensure that their contingency plans are both well understood and operational (i.e., by making use of them before needed) in order to expect them to succeed.
Leverage bank partners increasing credit-risk acumen. Every bank has its own risk model that is being refined by regulation as well as stress-testing, and it’s increasingly tied to collateral. Corporates might consider doing the same and asking their bank partners to assist in the development.
Use MMF reform to revisit cash investment strategy. Money-market fund reform is driving new investment strategies and long-term thinking.
Financing the Interim to a Large Strategic Transaction
Acquisition financing often sheds light on broader funding trends. Two members shared their experiences with funding issues related to closing large strategic transactions.
Key Takeaways
1) Make sure your contingency plans are real. The big and broadly applicable takeaway from the discussion on interim financing for strategic transactions was how treasurers need to ensure that their contingency plans are both well understood and operational (i.e., by making use of them before needed) in order to expect them to succeed. Additionally, build in contingencies for the use of financing proceeds to avoid having to turn to capital markets both to take out a bridge and raise subsequent capital for a recap. (See the sidebar “Testing Financing Contingencies.”)
2) Think twice about mandatory redemption features. When one of the members’ organization went to redeem bonds after a failed bid, it found some bondholders were willing to keep them since they were trading at a premium to the call. You could also negotiate a draw provision in a bridge loan, so that it can be drawn on (say, for a period of 20 days) without triggering the takeout.
3) More banks is better — but not too many more. When needing to move quickly in response to opportunities or avoid negative contingencies, it can be helpful to have more than one lead bank. One of the presenting members noted having two lead banks and bringing in two additional leads, which resulted in the best of both worlds by having two leads on the transaction and two on the financing. A couple more banks is okay, but no more.
4) Don’t be afraid of term loans. In a merger-spin type of transaction, it can be more difficult to sell bonds because you are, in effect, selling bonds in a company that won’t exist later or that does not have any financials because it does not exist yet. Delayed draw triggers and other features can help mitigate the cost/add flexibility. Both presenters urged members to shop banks from different jurisdictions, since term loans tend to be more capital unfriendly to European banks than US banks, for instance.
5) Sell receivables. Receivables sales and financing backed by receivables can add to your spectrum of contingency funding, which can prove useful in working toward a strategic transaction.
6) Identify all your change of control provisions. One area not to forget is compensation plans that often can have change of control provisions — Talk to HR.
7) Funding in place is not a deal guarantee. In-hand financing doesn’t close the deal. You may be better off having one wave of financing when the deal looks highly probably and a second when it is essentially a done deal, or avoid permanent financing altogether until the deal risk is zero.
Outlook
These member case studies underscored the need for contingencies in financing. The current rate environment makes this easier, since the cost of diversifying funding is much lower, even before accounting for the risk-adjusted cost.
Testing Financing Contingencies
Member presentations underscored the need for contingencies in financing, and that plays into the broader trend of corporates seeking to diversify their sources of funding. This means ticking all the boxes on accessing capital markets, bank and non-bank credit markets to ensure access to financing when they don’t really know what is going to happen next in financial markets.
One treasurer recommended actually tapping alternative funding options, including tier 2 CP to ensure that they will be there when needed. Also, if a merger involves a spin-off post-acquisition, treasury needs to have a contingency plan to go to market on an accelerated timetable when required, such as to fund the SpinCo when the pro forma financials are still valid and the parent is not in blackout.
Another member highlighted the need to build flexibility into your use of proceeds to avoid having to turn to capital markets both to take out a bridge and raise subsequent capital for a recap. Similarly, you can negotiate a draw provision in a bridge loan, so that it can be drawn on without triggering the takeout.
Managing Growing Risk, Especially Your Risk to Others at Risk
Members are reviewing their approach to counterparty risk management now that sufficient time has passed since the financial crisis. According to Société Générale, the way banks are managing counterparty risk is changing, and their enormous investment in risk resources in response to ever more stringent bank regulation and supervision might be put to use for corporate clients as well.
Key Takeaways
1) Every bank has its own risk model, and it’s increasingly tied to collateral. In the discussion on counterparty risk, Guido van Hauwermeiren, head of coverage for Société Générale, noted that every bank tends to have its own “secret sauce” in how it applies its risk model to each customer from a risk and capital allocation perspective. Corporates might consider doing the same and can ask their banks to help in the development. Liquidity is an additional concern, as is collateral. Some members in the group believe that collateral management is well worth it considering the price adjustments received, especially on longer-dated swaps. Others are focused on the cash: “I’d rather be charged a higher price than have to put out cash as collateral,” one noted. As banks’ risk models continue to evolve due to regulatory edicts, avoiding collateral may prove to be increasingly unwise.
2) The cadence of counterparty monitoring should be more frequent. The pre-meeting survey showed that the credit-worthiness of counterparties is typically evaluated on a quarterly basis for bank/FI counterparties (36%), annually for insurance counterparties (36%), and ad hoc as requested by the business for commercial counterparties (50%). As a legacy of the banking crisis, more frequent monitoring is prevalent with bank/FIs, with 29% monitoring them monthly and 21% daily. Better systems/automated reporting would help more members increase the frequency across all risk types. Just 21% say it is very good and none say it is excellent.
Outlook
So much about treasury is a lack-of-adequate-resources issue, so the idea that banks that are investing heavily in risk management resources might help their clients here is one worth exploring further. Meanwhile the reliance on ratings is interesting, as trust in them is diminishing and treasurers’ increasing reluctance to pay more to be rated raises questions about how rating agencies are going to fund their own resources to improve rating processes.
Where Now With Your Capital? Solving the Rating Agency Puzzle
While most members would like to see better alternatives to the current rating agencies emerge that did not overcharge for the value they offer, no real alternatives are on the horizon. According to Karl Pettersen, Head of Ratings Advisory for the Americas at Société Générale, however, treasurers do have more of an opportunity to steer the rating narrative toward a better rating outcome.
As more and more corporates drift into the BBB range of investment grade, financial policies become more critical. Rating agencies are more nervous because growing cash balances are often offshore and activist investors are pressuring corporates to become more aggressive with their balance sheets and subject to event risk — in a world where event risks are prevalent.
In response, treasurers need to evaluate their financial policies around four factors: leverage, liquidity, shareholder distributions and capex/M&A. They should evaluate these four factors against all scenarios and articulate how financial policies and strategy will respond with them to rating analysts. “Give them the impression that you are running the business for them,” noted Karl. The rating story should be told in the rating agencies’ language of key stated ratios and fully adjusted metrics.
Where to Put Your Cash Hoard
One of the members led a discussion on cash investment policy, using some of the changes to policy and approach his company is considering. He did this under the guiding principle for most treasurers: “If I reach for an extra 10bps and miss, I get fired, but if I stay the way things are and underperform by 20bps no one cares.”
Key Takeaways
1) Use MMF reform to revisit cash investment strategy. As one member familiar with the more sophisticated cash investment approaches of cash-rich tech companies noted, you can lose sight of how many corporates have been content to use money-market funds as their primary cash investment vehicle. The prospect of gates and availability of government paper for government funds has more firms looking to emulate cash-rich tech firms with separately managed accounts that have optimized mandates and established longer-term cash buckets to expand the range of asset classes and instrument types available to invest in.
2) Growing offshore cash forces thinking on longer-duration strategies. The member’s company has seen its offshore cash portfolio grow in the last few years to 50% of the total. In line with this, treasury has embraced longer-term strategies targeting one year and relying on external managers.
3) Benchmarking external managers with the same mandate? Another consideration for the member’s company is how to benchmark external managers to its policy mandate. Should the managers be given the same mandate to make it easy to measure?
4) Do you have the staffing to pursue your desired approach? The member also noted that evaluating current staffing to see if it would allow him to pursue the changes he would like to implement. To do what he wants to do, he will probably need to eventually hire a cash investment manager.
Outlook
As the cash portfolio grows offshore and regulatory pressure increases on holding less in cash and money market funds, there is a natural tendency to want to expand the longer-duration bucket or add a strategic cash bucket. Policy restrictions on credit, allocation to other asset classes and concentration limits hinder the decision to execute on this. Plus, to manage the additional mandates and risk requires more staff and other resources. Thus the bias to continue with the status quo or even move to a US Treasuries-only approach (since there is rarely a concentration limit on them) remains strong.
TMS Implementation — A Reality Check
While a new TMS gives treasury a “new car with more features,” you have to take some time to learn and develop the skill to take advantage of the functionality before it can fully measure up to the business case. Thus, a treasurer’s enthusiasm should not get too far out in front of the realities of treasury staff learning what their new TMS is capable of.
One of the key takeaways from a member presentation of key impacts of his TMS implementation was that it enables his people to anticipate and get in front of problems — instead of chasing them. In this way, the TMS project was not about headcount reduction but repurposing people away from clerical jobs and getting them more excited about their work.
In this rollout, a third-party advisor was critical to the success of the implementation. The member used the TMS vendor as its principal consultant. The TMS provider has a feature-rich system, and while they know their system, they will be reluctant to tell you how much you really need and how much you don’t. A third-party can help focus you on what is needed and not needed.
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