Alternatives to the Mattress: A Review of Sound Cash Investment Options
Amidst the financial rubble brought on by the subprime crisis, might there be havens for cash (aside from under the mattress) for the corporate treasury investor? We think so.
First, let’s review what led to the flurry of recent negative headlines. Since last August, there have been large write-downs by financial firms with credit exposure to complex securities linked to subprime mortgage loans. Fearing more bad news to come, bond investors held back their investments in all but U.S. Treasury securities. The short-duration credit market was the soft belly of this contagion as financial issuers tend to rely more heavily on short-term financing while cash investors tend to be more risk averse.
Surveying the bruised credit landscape, we think the pendulum of “irrational exuberance” has swung from excessive greed to extreme fear. Where there is fear, there lies opportunity. Let’s look at three bond investment areas that may offer just rewards without comprising safety and liquidity.
1. Return to Basics – Diversified Non-financial Issuers:
The defensive corporate credits are those with stable cash flows, revenue diversification, low debt burden, and strong capital positions. Such marquee names as PepsiCo, Proctor & Gamble and Pfizer, which used to be prohibitively expensive, have now cheapened relative to Treasuries along with the entire market. Many of these issuers are not only recession-resilient, but are also internationally diversified which may allow them to benefit from economic growth in the non-US areas and from the weaker dollar.
2. Bedrock of Stability – Super-Regional U.S. Banks:
With multi-billion dollar write-downs by several large banks, this may sound counter-intuitive, but it’s not. Banking corporations, especially the so-called “super-regionals” including Bank of America, Wachovia, and Wells Fargo, are the bedrock of financial system stability in the U.S. Strong and “sticky” core customer deposits put commercial banks in a better funding position than investment banks and finance companies. Mandatory capital ratio requirements for bank holding companies offer strong bondholder protection against excessive capital erosion. Even without the “too-big-to-fail” argument, many of the regional banks are in a much better position compared to the Savings & Loan crisis in the 1980s. They enjoy vastly improved operating efficiency, revenue diversification, risk pricing and management, and credit underwriting standards. Note that most of the subprime mortgage originations came not from regulated banking entities but from third-party mortgage companies.
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