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Corporate liquidity risk management in the tighter credit environment Back  
With difficulty in calling when markets may stabilise, the prudent working assumption is to approach the next few months with caution, says Rob Roughan. Flexibility for corporates is key to liquidity risk management in an environment where there is a tightening up on the absolute availability of credit. Roughan looks at ways that corporates can broaden and diversify their funding alternatives with necessary liquidity the overriding concern.
Since July 2007, there has clearly been significant disruption in the global financial markets. As a result, across the world there has been a tightening up on the absolute availability of credit, and the terms on which it is provided. Financing spreads have increased dramatically and several markets have closed.

The implications for the Irish corporate sector are quite wide ranging and continue to unfold. Inevitably those financial directors and treasurers that have the broadest range of funding options open to them are the ones best placed to weather this new environment. Given the difficulty in calling when the markets may stabilise, the prudent working assumption is to approach the next few months with caution. As a result, anticipating financing needs or refinancing requirements out as far as 2010/2011 and acting now may be the optimal course of action.
Rob Roughan

Traditionally, Irish corporates have relied on the bank loan market, with the top tier names supplementing this source with forays to the US private placement market. The significant volumes of financing that were seen over the period 2005 to early 2007 attest to the attractiveness of these markets at the time, with corporates generally securing favourable terms in borrower friendly conditions.

The recent adjustment in markets, however, led to a very quick and material increase in the issuance premia required by debt investors. This trend was evidenced in the capital markets accessed by corporates, for example, the Eurobond and US private placement markets, but has now spread into the bank loan market where margins, margin step-ups, participation fees and amortisation requirements have all moved sharply higher.

So how should a corporate treasurer approach liquidity risk management in this new environment? First and foremost, I would suggest that a recalibration of expectations on the part of the treasurer and their stakeholders is useful and indeed necessary - liquidity needs to be the overriding concern. A successful funding transaction in current markets is one that actually gets completed. As a result, raising liquidity, rather than necessarily only doing so if it can be achieved on the most aspirational terms desired, needs to be the core objective for treasurers.

Clearly, corporates will not want to lock in funding on unreasonable terms, but ensuring access to committed funding needs to be the No. 1 objective for any corporate with impending financing needs. It is interesting to observe the reaction to those corporates who have, for example, accessed the public rated capital markets in Europe since July 2007. As this is traded debt, in recent months there has been transparency on the extent of the higher funding levels that some corporates have completed transactions compared to one to two years ago. The initial scepticism as to why such corporates were prepared to pay the new issue premia being commanded by investors to get deals completed has progressively been replaced by a realisation of the sound judgement in their decisions to access markets given the ongoing deterioration.

Secondly, corporate treasurers need to widen the financing net as much as possible and ensure that they access or at least put themselves in a position to access a diverse set of financing alternatives. Rather than limit consideration to the bank loan and US private placement markets, it is now important to prepare to tap previously unexplored markets. While only a limited number of Irish corporates have sufficient scale that would enable them to obtain an investment grade credit rating and then access the rated capital markets, the list of potential candidates continues to grow as many attain the critical mass to justify this avenue.
While the rated capital markets have certainly not escaped the dislocation of the last few months, the sheer depth of liquidity associated with these capital sources has meant they have remained open and capable of being tapped by new and repeat issuers. For Irish corporates, these markets have for some time represented the next natural step in the evolution of their capital structure financing alternatives, with the difficult environment probably serving as the catalyst for diversification towards this new funding direction.

We have also seen another pool of debt capital and convertible bonds become more prevalent and, indeed, display the greatest resilience of any financing source through the difficult market conditions. Available to listed corporates and those coming close to listing, this equity-linked market is characterised by corporates issuing fixed coupon medium-long term (generally five to seven years) debt instruments on an unrated basis which have an equity option attached. Investors can finance at a lower coupon than straight debt and will be able to convert into the issuer’s shares at maturity provided the equity option is in the money. This market has become relatively more attractive in recent months as equity price volatility is a key pricing determinant and its recent increase means that the likelihood of an investor’s equity option being in the money has risen.

A further liquidity risk management recommendation for corporates relates to prioritising a strong and ongoing engagement with their relationship bank – ensuring that ancillary business opportunities are transacted with their core and supportive bank cannot be stressed enough. We have seen some banks, in recent months, participating in ‘relationship’ bank financings by entering the primary syndication at the lowest amount possible, but then using their approved credit appetite to purchase secondary market exposure to the corporate. Secondary market assets have generally been trading at a significant premium to primary relationship deal pricing, so while this may serve to average up their return from lending, corporates are best advised to continue ensuring that their ancillary business only follows their core ‘top level’ bank.

In these difficult times, flexibility for corporates is key to liquidity risk management. Those corporates that act now to broaden and diversify their funding alternatives, while recognising the value of a true relationship approach, will be best placed to successfully finance their businesses and meet their growth ambitions.

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