In developed countries worldwide, corporations are substantially increasing their holdings of cash assets. Pundits, regulators and governments are asking “Why?”
Those asking the question posit that this hoarding is slowing the recovery and destroying jobs. As a result, more fiscal stimulus, deficit spending, social programs and regulation are required. Thus, corporate cash hoarding is the
cause and a growing public sector is the effect.
Treasury Strategies’ work with the financial officers of companies provides a glimpse at the answer. We believe that quite the opposite is true.
Corporate liquidity is its most basic form is the sum of cash assets plus borrowing capacity. The amount of liquidity a prudently managed company requires is a function of its working capital needs, a cushion for the risk of the enterprise plus anticipated
capital investment.
To state this as an equation, corporate cash requirements are the sum of working capital needs, a risk cushion and capital investment minus borrowing capacity.
Our corporate treasury clients tell exactly what’s happening:
The requirement for liquidity has increased.
1) regulatory and economic uncertainty increase the required risk cushion
2) limitations on hedges and derivatives increase the required risk cushion
3) collateral requirement on derivatives increase required cash assets
4) economic slowdown is increasing investment in receivables and working capital
5) while capex has declined, it does not offset the above increases
On the flip slide, corporate treasurers believe their access to credit is becoming more limited.
1) public sector borrowing will crowd out private sector borrowers
2) regulation will lead to bank consolidation thereby limiting borrowing options
3) capital requirements will make lending to all but the most creditworthy companies less attractive to banks
4) restrictions on money funds will limit their appetite for commercial paper.
So the answer to the question of why companies are hoarding is both simple and rational. Their liquidity needs have grown as a result of many of the ‘solutions’ to the crisis. Yet they believe their access to credit will become restricted, also as a result
of many of the ‘solutions’ to the crisis. Thus, their only prudent alternative to balance the equation and achieve a new equilibrium is to increase their level of cash assets.
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