What’s true for the cliff face is true for the boardroom. As of mid-2011, U.S. corporations hold a record amount in cash. But corporations cannot be sanguine about these mountains of cash; cash is an asset that needs to be rigorously tracked and risk-managed.
Although the current record amounts of cash present numerous opportunities for corporations, there are also significant issues to consider. While it may seem counterintuitive that a company can suffer from being flush with cash, often overlooked are the risks that such excess pose. Excess cash can actually increase risk, offsetting the ostensible benefits of accumulating cash in the first place.
For companies with large cash balances, among the issues to be addressed are:
Visibility and Hedging. Generating and maintaining large international cash balances raises the importance of cash visibility and foreign exchange hedging. Large international banks have made enhancements to offer high-visibility, notional and physical cash management pooling programs that centralize and optimize overseas subsidiary cash at the end of each day and hedge the net amount. World-class companies place a premium on managing their FX risk and invest in technology that keeps close tabs on the banks managing these pooling programs.
Banks’ Dwindling Options. Basel III is forcing banks to collateralize their cash holdings. This is driving banks to limit cash and fund investment options. Limiting options will ultimately drive down yields or even push corporations toward non-stable investment options.
Tax Considerations. Despite ongoing lobbying for a “Homeland Investment Act 2.0” in the U.S., companies should not make their plans contingent on a tax holiday. While many developed countries, such as Japan and the United Kingdom, have territorial tax systems that leave overseas profits to be taxed in the jurisdictions in which they are generated, the U.S. has not followed suit.
This means cash held overseas by U.S. companies remains subject to a 35-percent tax rate, if repatriated to the U.S. Companies have issued debt to avoid this — even to fund dividends and buybacks — making it slightly less attractive to keep the cash abroad. But as long as rates stay lower abroad, there will be little impetus to bring the cash home.
Counterparty Risk. The bankruptcy of Lehman Brothers Holdings Inc., the Reserve Fund’s subsequent breaking of the buck and the run on money funds in the wake of those events demonstrated the importance of managing the counterparty risk of the institutions where corporate cash is deposited or invested. Today’s volatile economy, coupled with the web of counterparties and geographies that institutions deal with, demand new-world technology that can generate counterparty risk assessments that are both comprehensive and timely.
Banking Costs. Banks may begin to charge fees on cash holdings above certain levels. Bank of New York Mellon (BONY) last summer became the first to announce such a move, saying it would charge 13 basis points on balances of $50 million or more. This fee is driven by banks’ increased collateral necessities and Federal Deposit Insurance Corp. requirements mandated by legislation, as well as the simple difficulty faced by bank treasurers looking to put the deposits to work in positive-return, short-term investments.
Other banks may not follow BONY’s lead, since bankers traditionally see deposits as a cheap source of stable funding, and one that will help them meet Basel III liquidity requirements. This may offset the cost of managing the funds, especially when the value of client relationships is added to the mix. Nonetheless, BONY’s move has been a major source of uncertainty.
For companies holding significant amounts of cash, there are typically four options to deploy it: mergers and acquisitions (cash-rich companies do not have to rely on the capital markets to fund acquisitions); stock buybacks, reinvestment or holding onto the cash.
Although there are many benefits to holding on to cash, it is crucial that the decision to do so is made following a full analysis of the risks and costs involved. Whether the associated risks are with banks, regulation or FX, cash can easily turn from asset to headache. Cash is neither a static or risk-free asset.
Assessing the opportunities and risks of deploying or holding cash requires a high degree of visibility. Without the ability to clearly see where cash sits across an enterprise, chief financial officers and treasurers cannot maximize the effectiveness and value of cash as an asset.
Jason Torgler is vice president of Strategy for Reval, where he works with global teams to broaden the company’s offering across global markets.
Read more: http://www.financialexecutives.org/KenticoCMS/Financial-Executive-Magazine/2011_12/Scaling-an-Unstable-Mountain-of-Cash.aspx#ixzz3ckT8Ekxq