The credit crunch is taking a toll on corporate liquidity, as the soaring cost of debt—for both commercial paper and private placements—pinches the balance sheets of all but the most highly rated non-financial companies.
Cash and short-term investments of non-financial companies dropped by $250 billion in the second half of 2007, the first decline in the nine years that consultancy Treasury Strategies has been tracking the data.
Corporate liquidity had risen steadily, from $3.9 trillion in 1999 to $5.5 trillion in June 2007. But at the end of last year, it had fallen to $5.25 trillion, a 5% drop.
The findings are part of a survey of 135 corporate treasurers conducted by Treasury Strategies between July 1, 2007, and Jan. 1, 2008. Treasury Strategies then adjusted that data with findings from its annual survey of 600 corporate treasurers.
Anthony J. Carfang, a co-founder of Treasury Strategies, attributes much of the drop to a decline in commercial paper issuance. Many companies issue commercial paper not just to finance operations but to bolster the cash on their balance sheet. “As companies have tightened up, they’re shrinking balance sheets just a little bit by borrowing less,” Mr. Carfang said. “A lot of companies had been directly issuing commercial paper because it was easy to do, and keeping a little cash cushion as a result.”
But when the credit crunch began, it became expensive for all but the most highly rated companies to issue paper. As a result, he said, cash balances dropped.
For non-financial issuers of 30-day A2/P2 commercial paper, spreads jumped as high as 150 basis points in the second half of 2007, according to Federal Reserve data. Prior to that, spreads had hovered around 15 basis points for much of the last five years.
Commercial paper has become so expensive for some firms that they can’t issue it at all. Last week, commercial financier CIT Group reported it needed to tap $7.3 billion in unsecured credit lines because it was unable to raise money by selling commercial paper.
The jump in spreads caused a slowdown in issuance of commercial paper by non-financial firms. After increasing in the first half of 2007 by $14.2 billion, to $185.5 billion, the amount of commercial paper outstanding issued by non-financial firms fell by $10.3 billion, to $175.2 billion, during the following six months, according to Fed data.
One Treasury Strategies client, which Mr. Carfang declined to name, had $500 million in commercial paper outstanding prior to the credit crunch. That amount had to be cut to $200 million because the company found it difficult to issue amounts larger than that.
Commercial paper issuance by non-financial firms has bounced back since the end of last year, increasing by $7.8 billion, to $183 billion, through February. But spreads are still higher than normal, at around 80 basis points.
As a result of rising credit costs, said Treasury Strategies partner Dave Robertson, companies have been forced to use excess cash to pay down debt. And the cost increase isn’t limited to commercial paper, he added, noting that issuing debt via the private placement market has also become “significantly more expensive.”
The reason, Mr. Robertson explained, is the investment banks that aid companies with private placements don’t have the same access to the assets of a company—such as their cash balances—that a company’s primary commercial bank would. So, as fears of defaults grow, investment banks are forced to charge more to issue debt.
As part of the same study, Treasury Strategies found that approximately one-fifth of companies had invested in securities that had been affected by the credit crunch, also causing a hit to liquidity. In reporting their earnings for the fourth quarter, some companies have cited year-over-year declines in cash and short-term equivalents due to poor investment decisions made by management.
Teen retailer Hot Topic, for instance, earlier this month announced a 4% year-over-year decline in cash and cash equivalents and short-term investments, to $53 million, in part because it spent $7.2 million on its stock-buyback program. In addition, it reported that $21 million, or nearly half of its cash, was in auction-rate securities, of which the company had only been able to liquidate $8 million.
“We are looking at the long-term future of our business, and we want to be very prudent with our capital resources in terms of how we utilize them,” CFO Jim McGinty said in a conference call with analysts. “At this point in time, in the current environment, we feel like the preservation of cash should be our key concern.”
The beleaguered newspaper publisher Sun-Times Media Group, formerly known as Hollinger International, announced in its third-quarter earnings release that cash and short-term investments had declined to $132 million from $212 million at the end of the second quarter, in part because it held $48 million in Canadian commercial-paper investments that had become frozen when the asset-backed commercial paper market there seized up. By the end of the fourth quarter, cash had increased to $143 million, but that still reflected a 24% year-over-year decline.
Despite these incidents, Mr. Carfang notes that for the most part, balance sheets are in remarkably good shape, especially in a recessionary environment. “Corporate balance sheets are the strongest we’ve ever seen for non-financials heading into an environment such as this one,” he said. But while the higher costs won’t be fatal to most companies, “in some cases it hurts.” FW
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