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Optimizing Liquidity During a Recovery

Treasury Services COVID-19 Insights December 13, 2021
Treasury Services COVID-19 Insights December 13, 2021

 

The North American economy has staged a robust recovery since the early days of the pandemic. Nonetheless, supply chain bottlenecks, transitory inflation, stalled vaccination rates and, most recently, the omicron variant are creating an uncertain environment for businesses.

We recently held an event to discuss the current economic backdrop and how businesses can optimize their liquidity in an ever-changing landscape. Our panelists were Michael Gregory, BMO’s Deputy Chief Economist; Megan Kells, BMO’s Head of North American Treasury & Payments Solutions; and Derek Vernon, BMO’s Head of North American Commercial Deposits and Corporate Card.

Following is a summary of the discussion.

Economic outlook: Winter is coming

As Gregory noted, the economic recovery continues on both sides of the border, albeit with different trajectories. Canada’s GDP grew 5.4% in the third quarter on an annualized basis. That’s after a 3% contraction in the second quarter. The U.S. economy was up 2.1% in the third quarter, but that was significantly slower than its 6.7% growth in the second quarter.

Gregory attributed the choppy performance to two key factors: the dramatic rebound after the lifting of pandemic-related restrictions last year, and the shortage of production inputs due to supply chain bottlenecks. “These two factors will continue to cloud the outlook,” Gregory said. “It’s not only the outlook for growth—it’s the outlook for jobs, it’s the outlook for inflation, it’s the outlook for interest rates.”

With the emergence of the omicron variant, more onerous restrictions (and in some cases lockdowns) are being reintroduced in some European countries where vaccine rates are low, which negatively impacts economic growth. While Gregory doesn’t expect lockdowns to return to Canada or the U.S., consumer confidence could suffer amid new variant concerns.

Meanwhile, inflation is the highest it’s been in three decades, driven by factors on both the supply and demand sides. On the supply side, Gregory noted that climate change has been a key culprit.

Droughts in the western regions of Canada and the U.S. have affected crop production, leading to rising food prices and negatively impacting farms and food processors. Elsewhere, the global semiconductor shortage has been exacerbated by the drought in Taiwan, which is responsible for two-thirds of the global microchip supply. As Gregory pointed out, “You need a lot of water to make microchips.”

While supplies are constrained for multiple reasons, consumer demand remains strong, which is putting even more pressure on supply chains. It’s what Gregory described as akin to a game of whack-a-mole.

“Even as we deal with one supply disruption, another one pops up,” Gregory said. “Next in line is a shortage of magnesium, which is used for hardening aluminum—an important ingredient in automobile production.”

Nonetheless, Gregory said the outlook for both economies remains strong thanks to robust business, government and consumer spending. He expects Canada to fully recover its pandemic-related job losses by the end of 2021, while the U.S. should see a full jobs recovery by mid-2022. That’s when the central banks will start to feel comfortable raising interest rates. Expect the Bank of Canada to start raising rates next summer, with the Federal Reserve following suit in the fall.

“Not only is winter coming, but rate hikes are coming too,” Gregory said. “We’re looking at a cadence of roughly a rate hike per quarter. The net risk is that those rate hikes start a little sooner and have a faster cadence. Rates are moving higher, and the risks are that they may move even faster than what the markets are pricing in.”

Managing liquidity amid uncertainty

Against this constantly evolving backdrop, Vernon noted that the pandemic has changed how companies do business with their customers. What hasn’t changed—and has only become more apparent since March 2020—is the importance of maintaining strong cash reserves and working capital.

“Operating with this level of uncertainty has made investment decisions more difficult and has put more emphasis on liquidity management and working capital optimization strategies,” Vernon said. “Given the level of uncertainty, you’re going to have to be nimble.”

Kells noted that for many businesses, digital payments can be a critical tool for ensuring greater cash flow visibility, which can aid businesses in their decision making. The pandemic has accelerated companies’ willingness to adopt digital payments. According to the Association of Financial Professionals, about 60% of organizations said they were either very or somewhat likely to convert the majority of B2B payments to suppliers from checks to electronic payments.

“One of the biggest advantages of moving to digital payments is it enables greater predictability on your overall cash flow, specifically on forecasting,” Kells said.

That predictability becomes crucial for optimizing liquidity in an uncertain environment, particularly during periods when liquidity is squeezed.

“It will enable more predictability on vendor payments and payments they’re making to their clients to smooth out those [liquidity] crunch periods,” Kells said. “Payment optimization helps you understand the cost of the payments, it gives you more options, and it gives you more control because it gives you greater information in terms of your ERP systems, so it should smooth out those crunch periods.”

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Eric Hart:Clients and colleagues, welcome to the latest edition of NextGen Treasury. My name is Eric Hart, I'm the Head of TPS I&CB, Canada, and I'm your host today. Our aim is to deliver great content and ideas on topics that are both meaningful and timely. In October, we brought you the latest in minimizing your exposure to fraud with expert Larry Zelvin, and if he didn't scare you, you weren't listening. Just one year ago, we brought you Balancing the Liquidity Scales with expert Jim Centauro and discussed liquidity in the context of a deteriorating economic backdrop. Does everybody remember last year?

Today, we're actually bringing back the liquidity conversation, but in a much different context. That context is recovery. I hope that everyone is feeling an economic recovery brewing under our feet, or at least feeling optimism returning, and despite challenges with global supply chains, stalled vaccination rates, transitory inflation, and the Omicron variant, there is recovery in our future. That question, the question then, is how do we optimize liquidity during this recovery phase that we are seeing?

I'm pleased to bring you three expert speakers that will provide their thoughts and unique perspectives, followed by a panel where they'll take questions from you. A quick introduction of our experts today, and then right into the core of their current thoughts. First, we have Michael Gregory, BMO's Deputy Chief Economist. Welcome, Michael. We have Derek Vernon, VP and Head of North American products, also responsible for deposits, corporate card, and our enterprise payment modernization. Welcome, Derek. Finally, Megan Kells, VP and Head North American product, cash management, and global trade. Welcome, Megan. Michael, first over to you with your views of the economy.

Michael Gregory:Thank you. You talked about the recovery, Eric, and corporate recovery because we actually began today with new news on the Canadian economy that that recovery continues. We grew at around 5.5% percent annualized rates in the third quarter, and that compares to a slightly more than 3% contraction in the second quarter. Meanwhile, in the US, they grew more than 6.5% in the second quarter, only to slow to around 2% in the third quarter.

Now, this choppy performance that we're seeing on both sides of the border is reflecting the same factors. First, it's the recovery or the rebound in the economy after pandemic-related restrictions are lifted, and secondly, it's the impact of shortages of inputs to production due to supply bottlenecks. Both economies have been affected by these factors, definitely depending on timing and intensity.

The key thing in terms of the outlook going forward is that these two factors will continue to cloud that outlook, and it's not only the outlook for growth, it's the outlook for jobs, it's the outlook for inflation, it's the outlook for interest rates, and that's what I'll be talking about for the next 10 to 15 minutes. I see the first slide is already up here, so let's talk first about the pandemic itself. Now, there's an old saying from that famous show,The Game of Thrones, that winter is coming, and it's very appropriate when you talk about respiratory infections because we all know these things tend to rise during the winter months.

Despite the fact we are still dealing with the Delta variant of the virus, now we discovered, as Eric mentioned, we have the Omicron we have to worry about. Now, it's unclear how Omicron stands up in terms of its transmissibility, its severity, in terms of health outcomes relative to the Delta, so we'll just have to wait and see. Hopefully, the next couple of weeks will give us an initial sense of what that is, but in the meantime, we're still dealing with Delta. As we're seeing in for example, in Europe, their case rates are beginning to rise. We are seeing more onerous restrictions being reintroduced, even lockdowns in some countries. Of course, this is negative for economic growth.

How we're going to do things in North America is uncertain. Will we have some more restrictions? I don't know. I doubt we'll get the full kind of lockdowns we've had before, given that we do have pretty high vaccination rates. Where we're seeing those lockdowns of those European countries are where vaccination rates are relatively low, but one thing is key is that apart from those restrictions themselves, the other key thing we have to worry about is consumer confidence because we saw during the Delta wave in the United States, where there basically were no restrictions, that consumers chose not to fly as much, consumers chose not to eat in restaurants or visit bars as much. Even without restrictions, it impacts the economy. The next slide, please.

Well, those bottlenecks I mentioned before also have a manifestation in terms of helping to push up inflation. On both sides of the border, we're looking at inflation rates right now that are running the highest that we've seen in some 30 years. In fact, we do think that they will continue to rise further before cresting potentially, during the winter months. A lot of that depends on what happens to energy prices.

Now, when you think about these supply bottlenecks, one thing to keep in mind is that it's driven by factors both on the supply side, and also the demand side. Now, on the supply side, that's very much the constraints that if the factory is in the countries that were impacted especially by the pandemic, and affecting their flow of goods or their flow of exports, but it's also climate change, believe it or not, has entered in this a little bit as well. Whether it is the droughts in Western Canada and the Western US, which is affected grains, and therefore feed prices and rippled through the agricultural sector, but also the drought in Taiwan in making microchips. By the way, two-thirds of the global supply of microchips come from Taiwan.

You need a lot of water to make microchips. Guess what? You have a drought, and all of a sudden your ability to produce is somewhat constrained. Now, it's not only quite frankly about supply side. It's the demand side as well remaining strong. I've talked to businesses and they say, "Listen, demand is so strong that it's putting this pressure on the supply chain constantly." Even as we deal with one supply disruption, one shortage, another one pops up. A little game of Whac-A-Mole.

I'll give you a quick example. We're all worried about the global microchip shortage for the auto sector. Next in line here is a shortage of magnesium. Magnesium is used for hardening up aluminum, which we all know is an important ingredient in automobile production these days. It is a big problem. Go to the next slide, please.

Well, it's not just goods we have to worry about shortages. It's also workers. When you look on both sides of the borders, we're seeing record highs in terms of job vacancies, job openings. In fact, we're still running at more than 10 million job openings in the United States, more than a million in Canada. It begs the question, where did all these workers go? Well, firstly, I think a lot of workers are not engaging in the labor market simply because they either still have a child to care or other kinds of caregiving restraints, or they [unintelligible 00:08:20] concerned on both sides of the border that early retirements have gone up since the pandemic. That suggests that a lot of these people may not be coming back in short order.

Another phenomenon, more so in the United States, has been- as we've seen the waves of moving from the urban areas to potentially more affordable areas outside the urban core, we've seen a lot of households move from two-income down to one-income. That may have something to do with caregiving responsibilities. Still, it's another phenomenon trend that second, a spouse is no longer in the workforce. Some also point to very generous unemployment insurance benefits, which is obviously a more pressing issue in the United States. Quite frankly, in both Canada and the United States, these benefit programs are now over. The bottom line here is that it's going to take some time to get back all of these workers that have gone to other jobs, and it does mean we're going to get wage pressures on top of the inflation pressures caused by supply bottlenecks.

If you go to the next slide, please. This is where I think you got to think about, "Well, what about the economy itself? Where are we going to get this momentum to drive growth going forward?" Well, we're [unintelligible 00:09:47] [trying?] to get decent job growth, decent income growth, governments on both sides of the border continue to spend lots of money and that doesn't look like it's going to be stopping anytime soon. That's supportive for the economy, but beyond that, we think one of the key supports for the economy is the fact that during the pandemic households on both sides of the border amass huge amounts of additional savings; savings that they've accumulated above the saving rates that they were were conducting before the pandemic. In Canada, we just get these new numbers out this morning, $292 billion of excess savings, about 11.5% of GDP. It's well over 2 trillion in the United States now.

Some of this money has become permanent savings. It's gone into the housing market. Hence we've seen record home prices on both sides of the border. Some of it has gone into the stock market and we've seen record stock prices on both sides of the border, but most of it still remains. I think that is money that's available to continue to fund spending going forward. It's also a means by which consumers can continue to pay higher prices for a lot longer than they otherwise could. This demand strength we're seeing is also a source of inflation. When you talk about demand-driven inflation in addition to supply-driven inflation, that's when central banks get a little bit more worried. As we've seen, both the Fed and the Bank of Canada are sounding a little more hawkish these days. In the case of the Bank of Canada, a lot more hawkish these days. That is, I think, the key thing driving the outlook are the risks about inflation. Go to the next slide, please.

When you think about the outlook for the economy itself, we actually think that it looks pretty strong. We've got business investment continuing at a rapid pace, government spending, unfortunately, or fortunately, depending on how you perceive things, continue at a pretty rapid pace. We have consumer spending still supported by rising wages, but also all this liquidity that they've unmasked sitting around for the most part in their bank accounts, and that means we're going to see relatively strong growth on both sides of the border.

In fact, we do think Canada, while lagging behind this year, will likely do a little bit better than the US next year. Part of that is because we had more owners' restrictions for the most part. As a result, we get a little bit more lift as those restrictions were lifted, and it turned out to be a little bit more of an impact on Canadian agricultural output. It's a bigger share of the economy. As a result, we get a bit bigger bounce when those crops hopefully come back in better shape next year.

If you go to the next slide, please. Well, this strong growth, and by the way, you talk about growth of 3, 4, and 5, that's well above the sub-2% longer-term speed limits we think about for both the US and Canadian economy. That's going to pull down the unemployment rates quite well. We do think that not only will we be back to the jobless rates we had before the pandemic hit, but also we'll get back all the jobs we lost perhaps by the end of this year in Canada by the middle of next year in the United States. As a result, I do think that central banks will feel very comfortable about starting to raise rates, starting to remove liquidity in the backdrop of these pretty high inflation rates sometime next year. If you go to the next slide.

What do we really think about inflation? Well, I mentioned before that we do think it is going to continue to run a little bit higher in the months ahead as we go through the winter months. We've seen the way in which energy prices have reacted to the news of the Omicron. Maybe that takes some of the inflationary gusto out of energy prices, but we'll just have to see how that unfolds, but come next spring, as this spring's surge in pricing as we reopen, that doesn't get repeated, inflation will come down.

In fact, the Fed is expecting, the Bank of Canada is expecting, everyone's expecting inflation to fall from whatever highs we hit early next year. The question is where does it end up after that fall? We happen to think we will end up with a run rate that's lot closer to 3% than 2%. As a result, that's pushing the tolerance, I think, of the central banks which further reinforces this idea of that be prepared, folks, not only is winter coming, but rate hikes are coming too.

For my last slide, the next one, please, we happen to- at least, our current thinking now is that the Bank of Canada will start raising rates by next summer, the Fed by next autumn. Once we get to see those rates, we're looking at roughly a cadence of around a rate hike per quarter. That's a pretty steady increase as we move back to a more neutral level of interest rates, and we do think that the net risk still, quite frankly, is that those rate hikes start a little bit sooner, and perhaps even have a faster cadence. Recall the times when the Fed used to raise interest rates every meeting, not just once a quarter, and I think that's where the risk lies now.

Omicron, of course, is throwing a massive curveball in terms of the outlook. Fed Chair Powell today even indicated that he's probably on the side of expediting the reduction of the pace of asset purchases, the so-called speeding up the tapering process in order to end it sooner because basically, you have to end QE before you start raising rates. That's a signal that despite the concerns about Omicron, which Fed Chair Powell has already mentioned, it gives upside risk to inflation, but unfortunately, downside risks to growth. Central banks have to juggle those offsetting forces and it seems like they're getting a little bit more worried about inflation.

The last takeaway I'll leave you with is that rates are moving higher, and the risks are that they may move even faster than what the market is currently pricing in. I'll leave it at that [unintelligible 00:16:23] things over to my colleague, Megan.

Megan Kells:Thanks so much, Michael, for really painting the picture so clearly about how to think about all the factors that play in the environment right now. I'm going to spend just a couple of minutes on the theme of uncertainty and talking about where digital payments might fit into your plans. COVID has introduced a lot of change, as Michael spoke about, in the environment, but many of your corporate goals likely have not changed during COVID. They might have shifted their weight of importance as you look at the goals on the bottom of the screen, Their weighting might have shifted between increasing your working capital, creating efficiencies in your infrastructure, maximizing your financial position, and minimizing risk.

[unintelligible 00:17:15]as known as AFP and with thousands of members across North America, the survey provides some really helpful data points as you think about your own challenges and opportunities for your finance and treasury teams. During the last 20 months, you've likely been thinking about where digital payments fit into your overall company, and whether you're just starting your journey, and you're primarily cheque based or whether you're pretty far down the path and you have most of your payments in digital. You'll see that 60% of your peers are either very likely or somewhat likely to be moving the majority of their paper payments to digital payments as well and we can move to the next slide.

One of the biggest advantages of moving digital payments is no surprise, it enables greater predictability on your overall cash flow, specifically on forecasting, and what we've heard from clients like you in many geographies, different industry verticals in the US and Canada is one of the benefits of COVID, dare I say there's any benefits from COVID, is the aspect of both convincing vendors and convincing clients to move to electronic payments. It's never been easier to do this convincing. For vendors, they receive the payments in a more timely fashion, and for companies and customers, there's more flexibility in digital payments, and we can move to the next slide.

Very similar survey choices from AFP members ring true for receiving payments, the ability to have an overall stronger picture on liquidity management, and working capital optimization through moving to electronic options such as Zelle, email money transfer, EFT, ACH, virtual card, et cetera. As the opportunities for introducing more digital payments grow for both outgoing payments and incoming payments, we've heard from clients over the past year and a half about so many benefits, benefits that you would likely expect to hear about which is reflected in the EFP stats here.

Companies saw cost savings, speed of payment, reconciliation, and reporting, improved transaction matching in many cases straight-through processing to your internal ARAP system, your treasury workstation, or your ERP system. There was however another huge benefit that many companies realized in spades, and that's the overall employee benefit to their team. Digital payments means speed, it means efficiency, it means quite frankly less frustrating manual activities and this means individuals spend less time on what can be taxing tedious transactional work, and more time on strategic work.

As Michael talked about, many of us have been reflecting during COVID, and on the call today, I know people have been thinking about what aspects of their work and their team's work brings them joy. Employers have been able to tip the scales on not such a positive piece of the workday. This has been a real game-changer by moving to digital payments, especially during a time when recruiting is super tough. As many firms look at their liquidity management and working capable optimization, especially in the time of COVID as really an important strategic work, this can take over the time they're freeing up from their teams as they move to digital payments. With that backdrop, I'm going to hand it over to Derek to speak on that topic.

Derek Vernon:Thanks, Megan. Clearly, a key message that you've heard from us today is that the pandemic has meaningfully changed how we all managed and do business with our customers. This is especially true for a large financial institution, such as our own. As an industry, we are seeing commercial deposits at unprecedented levels, which is evidenced by the Federal Reserve balance levels, which have moved from approximately 2 trillion pre-COVID to over 4 trillion today, and total industry commercial deposit of balances from just under $14 trillion to about $18 trillion.

As a bank, as the onset of the global pandemic took hold, we had to pivot quickly from enabling almost our entire global workforce to work remotely for a period of time to rethinking in some cases how our customers will form their day-to-day banking activities. This, in fact, accelerated a number of our digital-first strategies, many of which were already underway, and doing all this while always being there with our customers.

We all know you had to do exactly the same, including becoming more digital and evolving how you serve your own customers. The pandemic has and will continue to have an effect on the broader economy, including impacts on the global supply chain that Michael spoke about, and this will continue for some time. With all that backdrop, I'm still optimistic that things are going to improve.

What hasn't changed throughout the past few years is the importance of cash and working capital, which are the lifeblood of every company. In fact, during the global pandemic, this has become even more critical. What is consistent regardless of the size of the company is that we've all had to learn quickly to adapt, to managing complex situations in a time of great uncertainty. Operating with this level of uncertainty has made decisions more difficult and has put more of an emphasis and need for liquidity management and working capital optimization strategies.

What we've been hearing from a number of our corporate customers is that they have not seen such an excess liquidity position in their history. Given we're not out of the woods yet with continued levels of economic uncertainty, especially given the recent Omicron news and the risk of further variants, we expect some of you will want to play it safe and choose to hold liquidity in reserve as a precaution.

I'll remind you that in times like this, it's critically important to stay connected to your centers of influence and advice, to understand what options you have to maximize your returns while efficiently managing your day-to-day working capital needs. All this said and while the pandemic has and will continue to have a profound impact on businesses of all sizes in all industries, we've seen a number of businesses that have actually seen hyper-growth and strong business momentum, which has put added stress on their working capital.

What do you do with all that idle cash? It's a good time to evaluate medium to longer-term strategic roadmaps and the associated working capital needs as you think about how you're managing your liquidity today and going forward as the business environment evolves. We recommend you to continue to keep a close eye, obviously, on the key economic indicators, many of which Michael spoke about, including the likely moves by the Bank of Canada, who will probably lead the charge followed by the Fed. As Michael also said, this will likely start to up earlier than previously expected as early as the spring, in addition, of course, to always staying close to the evolving COVID variant situation.

Based on discussions we've been having with corporate treasurers, a number of them are reviewing their company's investment policies to ensure they're optimizing their cash investments, looking for opportunities to optimize returns while maintaining sufficient levels of liquidity, to deploy more working capital as the economy and operating environment strengthens while always, of course, balancing their company's need and appetite for yield, principal protection, maturity, and risk diversification.

For some businesses, it may be a good time to actually invest back into the company through new product development, expansions, acquisitions, or even stock dividends. Decisions on capital deployment versus investment are always more complicated when plagued with uncertainty. If decisions are made to defer investments, cash should be invested to optimize returns while maintaining some flexibility with sufficient liquidity. A reminder, your bank has experts you can talk to that will enable you to meet this objective and I would encourage you to have those conversations and ensure you understand all the options in front of you, and with that, I think I'll hand things back to Eric.

Eric:Thank you, Michael, Derek, and Megan, for those incredible insights and recommendations. Now we're going to go through the question we took in advance of the event. Audience, if you do have any other questions throughout the webinar, we have a live chat box, so please type them in. We'll try and do our best to get to all of your questions today and I would encourage anybody in French language to type in their questions as well. We have that taken care of as well, and we will do our best to get to all of your questions, even if it's after the fact, and we'll have somebody reach out to you to make sure that the right answers are provided. First of the questions, Megan, I'm going to direct this one towards you. What are the best ways for companies to ameliorate a liquidity crunch? I had to Google that one.

Megan:Thanks, Eric. It's a great question. I'll make the assumption that if you're in a crunch situation, you have some opportunity to smooth out your payment cycle and it goes back to a lot of the themes that I was talking about earlier. I think it makes sense for companies to really evaluate where digital payments fits into their overall ecosystem, in terms of, are they really leveraging all the digital payments available to them where they do business? That will give them predictability of cash flows, both incoming and outgoing. It will give them some sense into terms of flows and timing in terms of the month, and it will enable them to have a little bit more predictability, certainly on vendor payments, payments from partners, and also payments that they're making to their clients to smooth out those crunch periods.

Lots of clients ask, is it really worth the effort to go the last mile, and to get rid of checks, to look at options like virtual card, et cetera, and it really is. Every company's journey is a little bit different, but taking the time to really do a session around payment optimizations, payments coming in and going out, really helps you to understand the cost of the payments, the acceptance for both you and your vendors, and your customer. It gives you more optionality, and at the end, it gives you more control because it gives you a greater understanding of when those payments will hit or leave, some greater information in terms of your ERP systems, et cetera. It should smooth out those crunch periods when you're experiencing a real crunch on liquidity. My answer would be the topic that we've talked about so far, to really explore the journey of looking at digital payments, whether you're at the beginning or just the tail-end, and looking to smooth out the last few pieces.

Eric:Thank you, Megan. Michael, I've got an excellent one for you. I think you touched on inflation rate, but the question here is how will the current inflation rate affect liquidity, and what's in store for mid to late 2022 and 2023?

Michael:That's a good question. Obviously, when I gave my presentation earlier, I talked about the liquidity of the household sector through savings, and as Derek pointed out, it's equally the same in terms of lots of liquidity, lots of cash balance for businesses on both sides of the border. As we get higher inflation or more persistent inflation, we're going to see some of that erode because you said we have to pay more for labor. You have to pay more for the inputs to your production. You're going to have to pay more to distribute your goods, so that liquidity will just naturally erode.

On top of that, the addition to it in terms of slower sales than we are experiencing now, I think that's also going to be phenomenal at the same time because the economy's not going to be growing at 5% and 6% into next year and the year after that. Finally, we have both central banks beginning to raise interest rates, and by 2023, regardless of what happens to Omicron, rates are going to be higher, and that's going to itself dry up some of the broader liquidity in the economy as a whole. I do think there are some natural offsets to excess liquidity right now that will unfold over the next one to two years.

Eric:Thank you, Michael. Fabulous answer. Derek, moving on to you, this one seems very aimed at you, what are some of the best practices to optimize short-term cash in an uncertain rate environment, although the one thing that seems to be certain is that rates are going up?

Derek:Yes, we've heard that, and Michael is usually very accurate in his predictions. Given the level of uncertainty that we've been discussing, you're going to have to be nimble in order to respond quickly. I think it's good best practice to hold on to some of that liquidity, but on the other hand, if you're going to hold on to some reserves, you may want to look at some term investment options, and perhaps going out a year, those typically are higher yielding. It depends obviously on your mix and your overall working capital needs.

Depending on your risk profile as a company and your investment policies I mentioned earlier, probably recommend also exploring other fixed income security options. Finally, I would say for our US customers that ECR rates are typically a bit higher than interest rates, so there's some economic benefit to offset some of your fees with some of those excess balances, so it might be something you want to talk to your bank about.

Eric:Thanks, Derek. Great advice. Michael, I'm going to come back to you with a question here. How is the recovery in Canada going to be different from that in the US? I know that you've covered much of that in your presentation, but if you were to boil it down to a couple of points, what truly is the difference between those two countries, and what should companies be aware of if they're operating in both locations and need to effectively have different strategies in different locations?

Michael:Well, obviously, there are the same factors affecting both economies, but the pandemic, of course, it doesn't care about the border. Canada has shown a proclivity to have more onerous restrictions and something to keep in mind that there's a little bit potentially more pandemic risk of government restrictions. As I mentioned before, as we saw even in the United States, is that even without restrictions, economies are impacted. Roughly, I would say the same on both sides of the border, but Canada has more exposure to the energy sector, it's a factor, and to what extent it happens to energy prices will affect that outlook.

The other thing to keep in mind is that with interest rates beginning to rise a little sooner in Canada than the US, we will begin to have that slow momentum kicking a little sooner in the interest-sensitive sectors. Finally, I think when you look at where the differential is now and perhaps why that may persist is we see a little bit more wage inflation. A lot more wage inflation in the US compared to Canada and I think a little harder to find workers. Supply bottlenecks seem a little more pressuring in terms of production there, and I'd say that's something to keep in mind as well.

Another [inaudible 00:33:20] is normal immigration flows that have occurred before just haven't been occurring because of the pandemic. As we know in Canada, they're planning on increasing those immigration flows quite quickly, so I think labor force dynamics are going to be a little more conducive to economic growth in Canada than in the US, but for the most part, we're looking at growth rates that are within a half of percent of one another. I think that the differences between operating in both countries apart from regulatory environments are not that material from a broad economic perspective. There's also taxation too you got to worry about, but again, from an economic perspective, I don't think that's going to be as much of an issue.

Eric:Michael, let me continue to pull the thread there on the rate hikes. One of our customers wants to know, there are obviously lots of economists that are out there that are laying out just as many predictions. You see many different things even from- just from the banking sector, what metric should we truly be looking at from a simple standpoint that's going to lead us to true indications that rates are going to really begin to move?

Michael:Well, I think for the first thing, it's the Fed stopping quantitative easing. They've slowed their purchases, they're signaling they want to pick that pace up. As long as they are continuing to add liquidity, they're unlikely to start removing it. That's the first thing to keep in mind. Just keep an eye on the whole tapering discussion by the Fed, and of course, they meet in a couple of weeks. They may actually make an announcement then about picking up that pace, but we think because of Omicron, that they may just wait until early in the new year.

Of course, beyond that, [unintelligible 00:35:22] inflation. I think we've come to the point where central banks are saying, "Yes, I want to get a more complete recovery on the labor market side but not at the expense of seeing inflation and inflation expectations takeoff." The key thing to be watching the surprises on the inflation side, the persistence of supplied bottlenecks, the persistence of labor shortages that are pushing up wage rates.

Watch those labor market primary reports as they come out. We do get another round of them both in Canada and the United States on Friday, this Friday, and what are we seeing about were wage pressures on both sides of the border, but more broadly, what are the inflations, particularly consumer price inflation, saying about where are those pressures are, are they stabilizing, are they continuing to get higher? Because the longer they persist or the longer they surprise on the upside, the speed's a lot shorter, which is why people are figuring maybe as early as April or even sooner, but April I think is the earliest we can probably get something from the Bank of Canada at this stage and maybe June by the Fed if they end QE earlier. I guess inflation, inflation, inflation, are the three most important indicators to be watching.

Eric:[laughs] That's great, Michael. I got to put all my trust in you. As long as I keep getting to see updates of those beautiful charts, then I think I'll know which way the economy's going. Derek, shifting over to you, you've seen the role of working capital change as we entered the pandemic, as we sustained through the pandemic, and now through the economic disruptions that are happening as we attempt to recover from the pandemic. Do you think that the role of working capital has truly changed, or is it being viewed the same?

Derek:In the early days of the pandemic, being conservative and having liquidity on hand was top priority and top of mind as businesses quite frankly were trying to survive and looking to invoke business continuity plans. Again, as I mentioned earlier, cash and liquidity is the lifeblood of every company, needing to pay their employees and run day-to-day operations, so we definitely saw a bit of a crunch there. Since the role of working capital has been largely dictated by the ongoing economic disruptions and the impacts that those have had on those business activity levels, we've seen changes, and we've all had to make changes to how we've operated in our own businesses, including investing in digitization. There's been a massive acceleration in investments and new ways of working and new ways of interacting with our customers across the entire business lifecycle, which has brought a very different approach to how we've traditionally been conducting business over the last many years.

I should also call out that companies have had to deploy additional resources towards employee well-being, and sustainability efforts focused on efficiencies, of course, are always important, and in some cases, have had to put a pause on some of the future large capital growth activities that they may have had underway. Overall, I definitely see, looking with a more optimistic lens moving forward, that there's many options that companies have in front of them, and important to keep tabs on all those important economic indicators that Michael mentioned. I think I'll leave it there.

Eric:Thanks, Derek. Appreciate it. Megan, we've got a deep dive question here for you. What's your take on corporates allowing the use of PAP and pre-authorized for utility payments? Sounds a bit specific, but--

Megan:Sure, happy to take that question. I definitely think there's a role for pre-authorized debit or PAD payments. You have to think about the risk profile of your payments coming in and payments coming out and those can be nuisance payments, if you will, very known beneficiary to your company. I think setting it up is a great time saver likely to you and your team. With that said, reconciliation activities are really important for you to keep up.

Again, moving to digital payments helps you reconcile faster in some cases the same day, in terms of the information coming in and out. I also think it's where we're heading as an industry when you think about payments. When you think about your experience as a retail customer, the Pay Now button is front and center. As we all did some Black Friday browsing or shopping Cyber Monday browsing or shopping, the Pay Now button is front and center. That is where we're going for commercial payments as well.

When we think about the evolution of real-time rails in both Canada and the US, that will enable more Pay Now buttons for commercial. The concept of being able to pull those payments quickly is more and more going to be the norm in the quarters and years to come, so I think it's a great idea.

Eric:Let me pull the thread a little bit further on that. Every company is using EFT and ACH, but it seems to always be that there's this batch of checks that still is in existence. You talked a little bit about that leap to 100% digitization. What do you think the hardest leg is to get there, and is it truly worth the investment, the effort to deck resources against it and solve it?

Megan:Eric, I do think it's worth the effort, and the reason I think it's worth the effort is obviously that's the way of the future in terms of checks are declining. They were declining 6% a year pre-COVID. They're declining closer to 15% during COVID, and that's probably the biggest driver where I would say get on the last leg of your journey in terms of your paper payments because the environment is ripe now for you to move them. Both your vendors and your partners and your end customers have more appetite now than they have in probably the last two decades to move to digital payments, so that's part of the effort in terms of your work with your own suppliers and your vendors and your own end customers, convincing them in some cases of the need to move to digital payments. While we have this environment that is very ripe to move there, I would push forward as hard and as fast as you can to get there, to eliminate as much of the cash, coin, and check out of your business as possible.

Eric:Thank you, back to the audience, just making sure that the chat functionality is open. If you've got a question, please get it in there. We will make sure that we get the experts here to give their view. Michael, back to you. I think you ended with inflation, inflation, inflation. I think that in your presentation, you pointed to supply chain issues. The question that's been asked here is can the global economy work through these issues and get beyond these new constraints? What's that going to do to your view if they're not able to solve them? Will that temper interest rate increases?

Michael:Fair enough. There's one thing that seems pretty clear, and even the Fed has acknowledged that those supply bottom are going to persist a lot longer and be larger than what was thought. It just takes time to work these things out, but importantly, working out they will. We've started already building microchip production facilities in America and it takes about two years to go from ground zero to actually making production, and they're well in that process, so these things will get done. It just takes a little bit of time.

You can think about the shortages on the agricultural side of things. Again, it potentially takes another growing season and you're done. Meanwhile, the distribution issues may take a little bit longer. There's a record shortage of truck drivers, for example, in America. You're going to have to hire more truck drivers, train more truck drivers, and that takes weeks and months and probably higher wages to do that, so these things will work out, but the consequence of them working out is likely higher prices.

Something else to keep in mind here; we're talking about inflation rates slowing, and maybe for lucky, but we can slip back under 3%, which would be very welcome from even a longer-term perspective, but when I was talking about those higher prices, actually levels falling, we're paying more for stuff for workers, for our inputs, for getting goods to market, and yes, it may increase. Those prices may increase. Those costs may increase at a more manageable pace, but they're not going down. These higher prices are here to stay, and I find it very ironic that ahead of the presidential election, much of the debate was moving the federal minimum wage again in the United States up to $15 an hour and stages, of course, and as we've seen, the private sector has done that well ahead and then some in terms of raising their base rates because of labor shortages.

The fact is those higher wages we have to pay to get even unskilled workers into our workforce are not going to go away. They're not going down. This is something we're just going to have to live with. Again, prices will get a little bit higher as we deal with these bottlenecks and these shortages and these supply chain disruptions, but they will get solved, the legacy permanently higher costs.

Eric:Well, thank you for that message. I've noticed it in the cost of grapes, the cost of my grapes every week seem to have gone up. Derek, back to you. [chuckles] I know way too much information. Derek, prior to the pandemic, I think companies had a view of working capital. Do you think that we're going to be able to get back to a world where we think of working capital as we did pre-pandemic, or has it taken a brand new direction, and has it changed our views of working capital permanently?

Derek:Eric, we're in a new normal. I don't think you can look back at how things were done before, I truly believe that. I don't see things reverting back. The pivots we've all had to make, again, around digital acceleration, new ways of working, dealing with supply chain disruptions, these are all here to stay. Obviously, hopefully, the supply chain disruptions will improve over time. I believe they will, but we're definitely in a new normal.

As I think back to working through the global pandemic, what's been most inspiring to me is thinking back to how quickly all of our teams adapted, how innovative they were to find new ways to help our customers and how we were there for our customers in some of their darkest days. What I learned from this experience, and I'm sure many on this call reflecting on their own experiences, is that with the right focus, we can really accomplish really, really big things and do them much quicker than we all ever thought pre-pandemic.

This pace of change, I think, will continue. In fact, I think it's going to continue to accelerate for years and years to come. Definitely not looking at how things were done pre-COVID, I think we're in a new normal, and I think that's just great.

Eric:Thank you, Derek. I tend to agree with you. I don't think that looking back in the mirror is going to help much. There's too much that has changed structurally. All right. Question from the field. Megan, how do you see same-day ACH versus real-time payments either complimenting each other or cannibalizing one or the other?

Megan:I think about all the new payment types and the new payment rails coming online in both Canada and the US as being complimentary for a long, long time to come. I'll use a bit of a silly example. In the US, you still have pennies in terms of coins. In Canada, we phased them out probably over a decade ago, but they served a purpose and lived alongside the rest of the coins in your pocket and the rest of the bills in your pocket. It took a long time for Canada to get there. I'm sure at some point, they will be phased out in the US.

I use that example to say, there's customer behavior, there's company behavior, there's all sorts of things to think about when you think about the use of a payment type and how it will be needed by your client base. There's other very practical things to think about as well in terms of how large the payment can be and the payment type and accept it on the payment rail.

Commercial Zelle payments have a very specific rate right now that goes up over time. We see the ACH dollar limits going up and they will go up to a million dollars and then not limited, but they're not there right now. I do think all of those different use cases can live alongside each other for now as people think about optionality, what they really want, what they want to offer their customers, what their competitors and peers are offering their customers in terms of different payment types. At some point, there will be cannibalization, but I think right now they can live very comfortably beside each other because, in essence, a lot of it is of a very specific business case in terms of 24/7 payments instant versus other more traditional payments.

With the appreciation that many of these traditional payments like ACH, EFT, wires, et cetera, are hard-coded and bolted right into your treasury workstations, your ERP systems, et cetera, I think they will live alongside each other for quite a while. What I would encourage you to do though is do a bit of an inventory and a payment optimization exercise to ensure you're using the right payment type for the right use case. That will make sure you maximize the benefits that we talked about earlier today.

Eric:Thank you, Megan. We've got one last question here, and I think it is directed again to you. You must be really scratching the itch for the audience. My company is driving to improve working capital liquidity. Should I view digital payments differently than ePayables, or do they have the exact same impact?

Megan:It's pretty similar to the last question. I think different payment types have different purposes. If we think about ePayables and everybody describes ePayables a little bit differently, so if you're thinking of a virtual card and things like that, I do think they all have their place in terms of where you want to make your payments incoming and outgoing. It's a matter of looking at what you want to get back in terms of your objectives from a financial point of view and a treasury point of view, and working through the use cases that make the best sense for you in terms of your structure of your team.

I do think there's really a place to have a mixture of payment types within any type of company for the most part regardless of size, regardless of industry, regardless of customer type. We just did an exercise from a payment optimization perspective where one client realized how many outgoing foreign exchange payments they made and we ended up connecting them with the FX desk to make sure they got preferred rates for those payments.

It's really digging down into your payment flows both outgoing and incoming to understand the finality of payment, how large are the payments, are they FX or not, do they need to be same-day, do they need to be real-time, what's the expectation and then what's the best payment type to enable that. Then I think you'll get the best value out of that in terms of predictability, information around your payments, and lower cost.

Eric:Thank you, Megan. Folks, we've come to the end of our hour. If we didn't get to your question, or if you actually didn't even reach out with your question but still have it, please reach out to your email representative, and of course, we'd be happy to connect with you. I would like to formally thank Michael, Derek, and Megan again for sharing their insights with us today. I know I found your insights to be incredibly valuable as we look ahead to 2022. Michael, I just take the "inflation, inflation, inflation" and I have to admit that that scares me a little bit.

Audience, I'd like to thank you all for joining us today. We know you have busy schedules, but we are grateful that you joined us. Please reach out to us if you have any questions or would like to continue this conversation. For those looking for CTP, FP&A recertification credits, please click on the link below the video window and save the confirmation of attendance documents for your records.

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Marc-Andre Bergeron Managing Director & Head, Global Corporate Transaction Banking

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