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Balancing the Liquidity Scales

Treasury Services December 11, 2020
Treasury Services December 11, 2020


For CFOs and corporate treasurers, the events of 2020 have highlighted the need for sound fundamentals. We’ve seen organizations boost their cash holdings, but that creates its own set of challenges in a low-yield environment.

Oscar Johnson, Head of US Commercial Sales for Treasury and Payment Solutions, recently discussed the issue of how CFOs and treasurers can get the most out of their liquidity strategies with three experts: 

  • Christina Boyle, Managing Director and Head, Corporate Banking Business Services, BMO Capital Markets 

  • Jim Santoro, Managing Director, Liquidity Specialist, BMO Capital Markets 

  • Grant Nicholson, Treasurer, IHS Markit, a provider of information, analytics and economic measures 

Following is a summary of the conversation. 

Cash Reserves Increase 

As Boyle pointed out, corporate treasurers reacted immediately to the onset of the COVID-19 pandemic by increasing their cash reserves, though slightly less so than they did in 2009 in response to the credit crisis. For the most part, treasurers boost their cash holdings by:

  • Delaying investments in capital expenditures and discretionary projects  

  • Moderating capital return activities like share repurchases or dividends 

  • Raising cash from draws to bank source liquidity 

But Boyle pointed out that the amount of liquidity available from bank sources fell for non-investment-grade firms, which drew on revolvers to source their cash. For investment-grade companies, on the other hand, the proportion of bank sources held steady, and even increased for those able to raise incremental 364-day facilities.  

“The punchline here is that unless you're an investment-grade firm, the choices you make on bank credit facility size may portend your framing for your overall liquidity profile in the next crisis,” Boyle said. 

Determining Your Liquidity Needs 

Beyond shoring up cash reserves, it's critical to determine the right amount of liquidity for your organization in both typical and uncertain market conditions. There's no single formula that determines the exact amount of liquidity you need—company size, industry sector and other factors all play a role. That’s why determining the right amount of liquidity is as much art as it is science.  

Market conditions also play a role. The Paycheck Protection Program in the U.S. and the Business Development Bank of Canada’s COVID-19 support programs added significant liquidity to the markets, leaving a lot of bank balance sheets well-funded, which in turn means bank deposit products are not offering attractive yields. But as Santoro said, it’s important to make sure that you're optimizing the returns on your cash and cash equivalents to generate revenue and maximize shareholder value.  

Santoro and Nicholson pointed to three best practices to achieving this goal. 

  1. Forecasting. Knowing how much cash you have on hand is crucial, Nicholson said. In his role, Nicholson focuses on two types of forecasting. The direct cash flow model, which tracks balance inflows and outflows. He said this approach works well for forecasting 90 days out. For forecasting beyond 90 days,  Nicholson prefers an indirect method that includes net income and changes to the balance sheet, along with FP&A forecasts and strategic plans. “You have to collaborate across the organization— really tight efforts with accounting, finance teams, tax teams, etc.—to get that information,” he said. 

    Nicholson also noted that different companies will have different needs. Forecasting for a capex-intensive companies like a manufacturer, for example, will look different than it will for a data analytics firm.  

  2. Differentiation. Not all cash is the same, and according to Santoro, this consideration is often overlooked when determining liquidity requirements. Knowing how to handle the three main buckets of cash—your operating, reserve and strategic capital—is a key to maximizing overall liquidity.“What we often see with a lot of companies is an outsized position in working capital cash, meaning the reserve and strategic buckets—where some of the cash should really live—is being shortchanged,” Santoro said. “The inability to best differentiate that type of cash often causes companies to forego opportunities for more higher yield-generating solutions than you may find against reserve and strategic cash.” 

  3. A game plan. Once you have a handle on those three buckets of cash, Santoro said you can be in a position to capitalize on solutions optimized for each category. “Properly differentiating your types of cash can often generate 10, 20, 30 basis points, even in this environment, of additional yield. Making sure that you forecast it properly, have differentiated your buckets properly, and are identifying solutions—either bank deposit solutions or short-term liquidity solutions—that maximize yield will enable you to optimize the return you get on your cash and cash equivalents.”  

Understanding Sticky Cash 

Whereas Santoro outlined the three main buckets of cash reserves, Nicholson added a category he calls “sticky” cash.

“You could have cash that may take three months to get access to through some tax structuring activity or intercompany loan structure if you're a global company,” he said. “You really have to understand the types of cash that are on your balance sheet because during challenging times, it could be really difficult to access it in the near term.”  

Nicholson also said treasurers need to be aware of how your working capital is being deployed. Some of it is often “trapped in the system.”  

"It's liquid,” he said. “You can move it around, but you're constantly collecting or you're constantly paying out of certain receipts and disbursement accounts. You might have a lot of cash showing on your balance sheet, but it could be trapped on top of that amount. Let's say that's $10 million, and you need $30 million around the business. So you really need $40 million of liquidity, not $30 million.” 

Secure Your Liquidity When You Don’t Need It 

If 2020 has demonstrated anything, it’s that conditions can deteriorate quickly, so organizations and treasury departments need to be nimble. That’s why, as Boyle said, “The best time to address the bank liquidity need is when you don't need it.” 

Nicholson agrees with that kind of proactive approach. "Treasurers don't typically get fired for having too much liquidity. If you wait, when you do need it, it may be harder to get because it's either a macro environment challenge, or even maybe a specific corporate challenge. So even if you can get it, it's also going to be extremely expensive at that time, so prepare ahead.” 

Most of our clients and prospects felt the impact resulting from the pandemic. Our discussion was a good reminder that liquidity requires being disciplined around both preserving cash and generating returns.

As Boyle noted: “Change and uncertainty is inevitable, and financial decision makers are best served to maintain a liquidity plan for the next unplanned shock to the market.” 

Read more
Marc-Andre Bergeron Managing Director & Head, Global Corporate Transaction Banking
James Santoro Managing Director, Liquidity Specialist
Christina M. Boyle Managing Director , Team Lead, T&BS and Corporate Banker in the Investment & Corporate Banking group

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