The Groans of August: CFOs Acclimate
First, the Standard & Poor’s downgrade of its rating on the U.S. sent shivers through the corporate finance — and the rest of the world — late last week, dropping the nation from AAA to AA+. In its report explaining the change, S&P described Washington’s compromise fiscal consolidation plan as falling short “of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.” Then came the global markets’ tumbles, recoveries, and tumbles again, reflecting European concerns as well as American ones.
For CFOs and the people who work with them, now comes trying to deal with it all. And try to explain what it means.
“We’re in unknown waters,” says Anthony Carfang, partner and director with Treasury Strategies Inc., who notes that a primary impact of the change is to boost an already high level of uncertainty in the economy. “CFOs have never had to issue corporate bonds when U.S. debt itself, the benchmark, was not triple-A rated.”
With the downgrade, Treasuries have gone from being viewed as riskless to carrying at least a bit of risk, adds Lance Pan, director of investment research and strategy with Capital Advisors Group in Newton, Mass. “There’s no precedent,” he says. “This is the benchmark from which all securities are priced.”
In practical terms, of course, among corporate and other investors “Treasuries are still considered a safe haven,” according to Pan, participating in a conference call. In fact, the yield on one-year Treasuries, which was at about 20 basis points in late July, dropped to 10 basis points in early August, according the Federal Reserve.
Tough Decisions, Delayed
What’s more, the debt ceiling agreement reached in Washington just days before merely put off tough decisions on spending and taxes to be dealt with later; the congressional committee, formed to address those issues, became the latest “team of rivals” put in charge of finding a solution. And the spending cuts agreed to don’t occur until 2012 and 2013. As a result, “CFOs are taking more and more chips off the table, because they’re losing confidence in Washington,” Carfang says.
In an environment with this level of uncertainty, raising cash is a prudent step that many CFOs already are taking, he observes. “They’re building a bigger cushion, being more cautious.”
On Friday — just before the downgrade — FMC Corp., the $3.2 billion chemical company, executed a five-year, $1.5 billion unsecured credit agreement with a group of lenders; the company can use the funds to grow existing businesses, pursue external growth opportunities and reward shareholders, according to a statement announcing the loan agreement.
“It felt really good to get a five-year renewal of the credit agreement in place before the storm broke,” says Tom Deas, vice president and treasurer of FMC, and also president of the National Association of Corporate Treasurers.
Deas and his colleagues had been monitoring borrowing conditions over the past year or so, and saw them tick steadily upward. By early summer, they concluded that further improvement was unlikely, and that the greater risk was that conditions would deteriorate, due either to political instability or poor news on the economy. That prompted their decision to complete the renewal as quickly as they could.
So, Where to Invest?
The downgrade adds a few wrinkles for companies deciding where to put excess cash — so plentiful in many corporate coffers these days. To be sure, most companies’ investment policies don’t specifically require U.S. Treasuries to meet a certain rating, Pan says. This should reduce companies’ need to sell some investments in order to ensure they remain within their investment policies, he adds. “We don’t foresee forced sales.”
At the same time, companies may want to reevaluate their investment policies, many of which were written for calmer periods, Carfang adds. “They presumed that government securities would not be rated triple-A.”
That’s one step that Craig Creaturo, CFO and treasurer with II-VI, Incorporated, a $500 million producer of crystalline compounds for use in laser optics and other applications, will be taking. The policy, which allows for investments in U.S. government obligations without regard to credit rating “was drafted with the view toward the U.S. always being AAA rated.”
Liquidity and solid asset quality, while always important, now are key considerations when investing, given that that the market itself has gotten riskier, Carfang says. “The proper position two months ago is no longer proper today.”
‘Paying for Safety’
Still, the options for short-term investments appear more limited than before. Pan advises against moving beyond securities of the U.S. government or government-sponsored entities. He notes that other regions of the world, such as Europe, are dealing with their own financial crises.
At the same time, at least one bank, Bank of New York Mellon, has begun charging for deposits. According to this report, it will levy a fee of 13 basis points on deposits of more than $50 million. Should other banks follow suit, short-term yields could turn negative, Pan says. “Companies may have to pay for safety.”
That may prompt investors to move to money market funds, which in the past few months have seen a net exodus. Institutional investments in money market funds dropped from $1.8 trillion to $1.6 trillion between early June and early August, statistics from the Investment Company Institute show. Pan does not see a risk of a ratings drop for money market funds, noting that S&P affirmed its A-1+ short-term rating for the U.S.
Investment guidelines provide that minimum rating usually is required of two of the three rating main agencies, Pan says. And just after S&P announced its downgrade, on Monday, Moody’s reaffirmed its Aaa rating on the U.S. Prior to S&P’s actions, Fitch said it was keeping its AAA rating on the U.S., although it added that may post a negative outlook on the U.S. when it concludes its review at the end of August, according to this article in Reuters. (Perhaps further confusing things, however, is that S&P did place a negative outlook on the U.S., noting that it could drop the country’s long-term rating further if the government’s debt trajectory moves higher than S&P assumed in its base case.)
One CFO’s ‘Positive Note’
So for now, with S&P standing alone in its downgrade, the U.S. still can be considered a AAA-rated sovereign. Only if another agency to lower its rating would the feared rise in long-term borrowing rates be likely to result, Pan says.
Are there any bright spots in all this from the CFO perspective? Well, at least one.
“On a positive note, it appears that the debate has changed in Washington and throughout the nation,” says Bill Carroll, chief financial officer of Homedics, a producer of health and wellness products. “Hopefully we now will make the hard choices to help reestablish the appropriate balance between our obligations and the size of our economy, so that we can meet those obligations while preserving and enhancing the physical and intellectual infrastructure so that we can bequeath a vibrant US economy to our children.”
Like most CFOs, Carroll will quickly expand on his answer when he’s asked about what it means for the nation. “The downgrade is also a blow to America’s image in the financial and non-financial world,” he says. “It is more difficult to provide global leadership on free and open markets, fiscal rectitude, et cetera, if it appears that we don’t have our own house in order. It will also provide an additional argument for the nations that are seeking to propose an alternative to the U.S. dollar as the global ‘reserve currency,’ with all of the benefits that this provides the U.S.”
By Karen M. Kroll