Corporate Cash Management In Turbulent Times

Treasury Management
January 13, 2009

Corporate Cash Management In Turbulent Times
January 13, 2009

By Brendan Casey
Senior Product Manager, SVB Securities

Introduction

Companies face unprecedented challenges managing their cash reserves due to the recent turmoil in the financial markets. In turbulent times like these, companies should review their investment policies, stay current on market developments and fully understand their options. It may be helpful to focus on developments in some of the most pertinent areas of the corporate cash landscape.

Money Market Fund Support Programs

On September 16, 2008 the Reserve Primary money market fund "broke the buck" or saw its share price dip below $1. This exceptionally rare event (there has been only one other occurrence of this happening), triggered large scale redemptions out of "prime" funds which invest in corporate debt, resulting in huge demand for Treasury funds and insured bank products. In response, the U.S. Treasury Department and Federal Reserve implemented a variety of guarantee and lending programs designed to help stabilize the money fund industry and unfreeze the commercial paper market that is so dependent on these funds for liquidity. These programs include:

• Temporary Guarantee Program for Money Market Funds
• Money Market Investor Funding Facility (MMIF)
• Asset-Backed Commercial Paper MMMF Liquidity Facility (AMLF)
• Commercial Paper Funding Facility (CPFF)

Additionally, the FDIC's Temporary Liquidity Guarantee Program (TLGP) guarantees newly issued, senior unsecured debt with maturities of more than 30 days for participating banks, thrifts and certain holding companies. The guarantee lasts until the earlier of the maturity of the debt or June 30, 2012. Although prime money market funds are eligible to purchase qualified TLGP guaranteed debt, purchases so far have been modest largely because much of the debt has been issued with maturities beyond what is acceptable for money funds. While it seems likely that Treasury and government funds will be eligible to purchase this debt, many fund managers will wait for additional ratings agency and legal guidance before doing so.

These support actions seem to be having a positive effect. Flows into money funds including many prime funds are positive, LIBOR spreads have narrowed and liquidity in the commercial paper market has improved. For the week ended December 31, 2008 total money fund assets stood at a record $3.8 trillion according to the Investment Company Institute. Money fund assets have risen by $628.4 billion, or 20.2 percent year-to-date in 2008, and now represent 40 percent of all mutual fund assets.

Although these statistics seem to indicate that the government support programs have been largely successful, the real test will come once these programs expire. Most of the programs expire in April 2009, although they could be extended if necessary.

Pressure on U.S. Treasury Investments

While government programs have benefited the money fund industry, investor demand for U.S. Treasury-based investments is still exceptionally high. This demand has resulted in the exceedingly low yields these investments are producing, as well as purchase limitations on many Treasury-only money funds. Several Treasury funds have stopped taking in money altogether and many if not all Treasury funds have waived their management fees in order to provide some return to investors. Regardless, with short-term Treasury bills consistently trading in negative yield territory over the past few weeks, investors in Treasury-based instruments have become accustomed to seeing zero percent or .01 percent yields. While many corporate cash investors are willing to accept zero or even negative returns in exchange for the safety of the U.S. Treasury, at some point presumably, the need for yield will resurface.

Direct investments in Government Sponsored Entity (GSE) debt will likely absorb much of the cash allocated to Treasuries. With Fannie Mae and Freddie Mac under government conservatorship, their debt effectively carries the backing of the full faith and credit of the U.S. government. Many government funds offer an attractive yield premium to Treasury funds, while presenting a marginal increase in risk. With interest rates not expected to go up anytime soon, investors may begin to pay more attention to the spread between government and Treasury funds. Whether the higher yields offered by prime funds entice investors back is an open question. Despite the fact that prime fund assets have rebounded since the Reserve fund broke the buck, they are still below their September 2008 highs.

Whether unable to make additional investments into existing Treasury funds, or just seeking more yield, investors relying solely on Treasury investments will likely be looking for other options. Assuming the investment policy permits it, an allocation to GSE debt or funds may be an appropriate first step.

Changes to FDIC Insurance

The financial crisis has resulted in temporary changes to traditional FDIC insurance on bank deposits. At most banks, non-interest bearing transaction accounts like demand deposit accounts (DDA) are now guaranteed to an unlimited amount by the FDIC. Interest bearing deposit accounts (like money market accounts or CDs) are now guaranteed up to $250,000 per depositor. This additional coverage is in effect through December 31, 2009.

For example, a client with a balance of $500,000 in a DDA and a balance of $250,000 in a CD would receive FDIC coverage on the full $750,000. The DDA is FDIC insured up to the full balance in the account (dollar-for-dollar insurance), while the CD is insured up to $250,000.

The prospect of excess or unlimited FDIC insurance is an appealing one for a number of corporate cash investors. Many who are earning next to nothing in a Treasury fund and may not be covered under the Temporary Guarantee Program for Money Market Funds are temporarily holding more of their cash in a DDA to take full advantage of the coverage. Many investment policies do not provide specific guidance regarding bank deposit products. Investment policies typically are geared towards a company's longer-term cash investments as opposed to the short-term operating cash normally housed at a bank. Historically however, most corporate cash investors have avoided placing 100 percent of their cash on to the balance sheet of any bank because the yields offered were unattractive or they applied the fundamental principles of diversification to bank deposits as well as securities.

The question to consider is: In an environment where yields are low across the board and unlimited insurance is temporarily available through the convenience of a checking account, is it better to remain under the FDIC's security blanket for a while longer? Or, does the prospect of an extended period of near zero return compel you to seek alternatives to increase the return on some or all of your cash? It's a question we believe many corporate finance teams are asking themselves and their boards.

In Conclusion

One certainty is that corporate cash investors who have the broadest range of options at their disposal are well positioned to make smart decisions that comply with their current investment policies. These options should include a mix of securities and bank deposit products in order to achieve the right balance between principal protection, liquidity and return.