Treasurers Brace for Market Turmoil

As Congress fails to repair the rift over raising the nation’s borrowing limit, smart companies are guarding against a liquidity crisis.

Congress  failed to make any progress over raising the ceiling on U.S. debt again on Tuesday. That has some finance departments preparing for the negative knock-on effects from a technical default on U.S. Treasuries or a downgrade of the country’s debt.

The federal government will not run out of cash on Thursday, the deadline for increasing the nation’s borrowing authority. But it may have to begin prioritizing its bills if the stalemate in Congress lasts more than a few days beyond October 17. By October 31, Treasury could be in a position to have to delay $6 billion in interest payments on its securities.

The potential effects for financial markets range from disruptions in short-term credit to a rapid fall in the value of the dollar to a spike in interest rates. Money-market fund managers like Fidelity Investments have already jettisoned U.S. Treasuries that mature between October 17 and November 15.

But there are other possible financial market disturbances that companies are anticipating. For example, Patrick Guido, treasurer at global apparel and footwear company VF Corp., told CFO that the investment-grade company has issued commercial paper “above and beyond what [it needs] to get through year end.” VF took the step “just in case a debt default disrupts short-term markets,” Guido said in an email. “The key here is to have extra liquidity and working capital on hand if you do not have excess cash.”

Treasurers should evaluate the amount of cash they have on hand and the status of contingent funding, says Goran Jankovic, treasurer of WellCare Health Plans, a publicly held managed care company. “Forecasting is critical,” he says. “Understand your payables. Absent any funding, how long will your cash-on-hand last?”

The contingent funding that needs evaluation includes revolving lines of credit issued by banks. “Make sure you have free and open access to those facilities,” Jankovic says. Many companies take access for granted, but if a credit agreement is written in a certain way a borrower may run into difficulties trying to tap its line. “As a borrower, every time I access [WellCare’s] revolver I have to represent to the bank that nothing materially adverse has affected my business,” Jankovic points out. “But what if you can’t make that representation? If you can’t make a draw, what then?”

Two of WellCare’s large banks recently asked Jankovic about the impact of the government shutdown on the company’s business. They told Jankovic if the company were to experience an issue and needed interim financing, they could provide a bridge loan or some other kind of temporary financial support. “Banks have ample capital and they may be looking to improve and foster the strategic relationship to gain some goodwill,” Jankovic says.

(WellCare’s business has not been affected by the federal government shutdown, he adds, because funding for Medicaid has been set aside until the end of 2013 and Medicare will continue to be funded in the short term.)

Other actions treasurers and CFOs may want to take include the following:

Avoid holding U.S. dollars in foreign subsidiaries that deal in the euro, the Japanse yen or the British pound, says Guido, who also writes a column for CFO. VF has taken that action where it can. “A U.S. default would be bad for the U.S. dollar,” he says.

Try not to hold any cash investment products that are closely tied to Treasuries and where principal is at risk. That includes Treasury-bill funds and short-term bond funds. “A default will cause a spike in short-term interest rates and losses on short-term investments,” Guido says.

Delay any stock repurchases. “Any companies engaging in share repurchases that are not in a blackout period may want to hold off,” Guido says. “A default could come with a 1,000 point drop in the [Dow Jones Industrial Average].”

With Congress still working on alternate plans to end the federal budget impasse, late Tuesday Fitch Ratings put the U.S.’s tripe-A rating on “rating watch negative.”

“The Treasury may be unable to [prioritize] debt service, and it is unclear whether it even has the legal authority to do so,” Fitch said in its note. “The U.S. risks being forced to incur widespread delays of payments to suppliers and employees, as well as social security payments to citizens — all of which would damage the perception of U.S. sovereign creditworthiness and the economy.”

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