Pay attention to corporate cash

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Falling corporate cash levels show the credit crunch is starting to bite.

During the first quarter of this year, Chicago-based consultancy Treasury Strategies questioned 135 large US corporations about their cash and near-cash holdings. It has been an article of faith that most of these investment-grade corporations remain cash-rich – having retained a large portion of their healthy earnings for the past five years, reduced large-scale capital expenditure since the dotcom bust, seen off shareholder demands to return cash and avoided the clutches of avaricious private-equity acquirers.

That cash gives them a substantial buffer against the gathering credit crunch as banks cut new lending in response to asset write-downs, increased funding costs, regulatory pressure to de-lever and the accumulation of unwanted assets returning from the broken vehicular finance system.

Treasury Strategies conveys a warning signal. In the second half of 2007, fully $250 billion of corporate cash... disappeared. It’s not entirely clear what has happened to it.

This is not necessarily a disaster in the making. Huge though that sum is, corporates have a lot of cash. Corporations that had been sitting on $5.5 trillion at the end of June 2007 held $5.25 trillion at the end of December 2007. How those cash levels evolve over the coming months and years will become a key indicator of corporate health.What lies behind the disappearance of the $250 billion? Some has been caught in money-market turmoil that accompanied freezing of the auction-rate securities market. Corporate treasurers have also had their fingers burnt by the freezing of redemptions from certain short-term investment funds marketed as money market funds and the collapse of others. They’re in no mood for what the Japanese used to call zaiteku: rolling over short-term borrowings in the corporate commercial paper market to invest in higher-yielding dynamic money market funds.But it is also a fair bet that corporates are now beginning to draw down on their cash resources in response to or anticipation of reduced availability and higher cost of funding from external sources including banks and the capital and money markets. Banks tell Euromoney that treasurers are suddenly showing a strong appetite for discounting receivables: turning purchase orders due from customers into cash today.

If reduced bank lending and economic slowdown bite hard on corporate earnings in the months ahead, default levels will rise. The highly leveraged will be the first to suffer and private equity owners might have to put some of that famed wall of raised money to work by propping up egregiously financed portfolio companies. If defaults rise in the investment-grade corporate world then how much cash companies have and how well they monitor and manage it might become key indicators of credit quality for banks and investors to follow.

It’s intriguing that, according to corporate treasurers themselves, neither the banks, which have made such awful misjudgments of credit, nor investors, who have outsourced such analysis to the now hopelessly discredited rating agencies, take much interest in their management of cash when evaluating creditworthiness.

That should change.