Features : Banking On Innovation

SYSTEMIC RISK

Businesses are finding imaginative ways to circumvent the credit crunch. The solutions they adopt now could have profound implications for their future operations.

 

For months this year, pessimists had been predicting a global financial meltdown. The gloomiest prognosticators suggested the subprime mortgage fiasco was just the tip of the iceberg and that a decade of easy credit and ever-looser regulation had led to the creation of a financial system that was merely a house of cards, waiting to collapse.

Even the pessimists, though, were surprised when Lehman Brothers abruptly collapsed, setting off a chain of events that threatened to explode into just the sort of systemic breakdown that they had been predicting. The string of bank and corporate collapses that followed Lehman’s demise exposed a dangerous level of interconnectedness and mutual dependence in the global financial markets—so dangerous that a gaggle of governments were prepared to throw almost anything they had into trying to stave off a global systemic meltdown.

Scary though it was, the meltdown of early October had other implications for corporations than just the prospect of financial market turmoil. Finding liquidity to fund their ongoing business operations, already a problem as a result of the credit crunch, was about to get a whole lot more difficult. With many banks refusing to lend even to other banks, corporations’ access to credit became even more limited.
 

Unlike the 1997 Asian crisis or the 2004 Russian liquidity crisis, or even the dot-com crash, the credit crunch’s impact is being felt in different parts of the world on an almost daily basis. “This is a systemic threat,” says one financial market insider. “Every bank is potentially vulnerable because the banking model depends on confidence. There are rumors sweeping the markets about every financial institution. Fundamentals don’t matter.”

Market observers are skeptical that the governmental efforts to manage the crisis will have a long-term beneficial effect. Mark Mobius, a long-time investor in emerging markets and managing director of Templeton Asset Management, says the US government bailout on its own will not stop the contagion from spreading. “Government bailouts will not weed out the dead wood,” he told a corporate treasury conference in early October. “A lot of institutions will be saved that should not be saved, and a lot of executives will be saved who should not be saved.”

The danger is that the systemic risk now sweeping the global financial markets will filter down to the real economy and affect consumer and corporate lending. “In Europe the financial crisis will negatively impact small to medium-size enterprises,” says analyst firm Financial Insights. Companies in that market segment are traditionally undercapitalized and dependent for short- and medium-term funding needs on banks rather than the capital markets. “Some of them are at the risk of bankruptcy or decreasing competitiveness,” the firm says, “as they will not have the financial resources to invest in innovation to drive exports and stay ahead of companies from emerging/emerged economies.”
 

Yet in some segments of the corporate financing market, despite all the gloom and doom, it appears to be business as usual—at least that is what global transaction banks were telling corporate treasurers at a recent conference in Barcelona. Transaction banking, particularly cash management and trade finance, still continue to earn credit-challenged banks substantial revenues, and banks stress that for the “strongest [corporate] relationships” capital is still there. “For a large global bank I don’t think these relationships are going to come under stress. It is a good time to be in transaction banking,” says Rajesh Mehta, head of treasury and trade solutions, EMEA, for global transaction services at Citi.

Damian Glendinning, vice president and treasurer of Lenovo, the Chinese PC manufacturer, says that from his perspective nothing much has changed. “Banks may have difficulty funding themselves, but none of the banks we work with said they would have a problem supporting us,” he points out. Andrey Rostovsky, deputy head of group treasury at OAO Lukoil Russia, says it took his company 10 years to build relationships with its banks, which continue to support it even now. “This is a long-term relationship, although we are paying higher margins,” he explains.

Underpinning the not-so-gloomy outlook from corporate treasurers are several factors. For one thing, a number of multinationals are hoarding billions in cash, which perhaps explains why they are not panicking—yet. According to a survey by treasury management training and event company EuroFinance, two-thirds of corporate treasurers expect the credit crisis to affect companies’ ability to move ahead with investment, and 72% say it has prompted a flight to quality. While 57% of corporate treasurers say they have experienced availability-of-credit issues, only 33% are very worried about credit availability in the next six months.
 

While difficulties in obtaining credit is not the headline issue some expected it to be, it is clear that corporate treasurers are having to tweak how they assess or measure counterparty, FX, hedging and interest rate risks. “Every day we are spending more time on counterparty risk, as there is more [banking] consolidation,” says Brent Callinicos, treasurer, Google USA, which has most of its cash invested in “safe havens” such as municipal bonds. “We are more heavyhanded with questions we are asking banks. It is not just about getting the best price from five banks; you have to worry about whether they are going to be there when you have to make good on a trade. You have to spread your trading around, as you cannot rely on credit ratings.”

Benoît Messiaen, treasurer at Cofinimmo, an investor in rental property in Belgium, says it has committed credit lines from banks that were recently nationalized. “We have long-term committed lines so we have no liquidity risk,” he says, “but what could happen in the next few years nobody knows. If there are further bankruptcies, maybe the credit lines will be gone.” Messiaen says corporates seeking financing from banks need to be transparent so that the banks have confidence in them. “If you have a good strategy, systemic risk can be avoided,” he explains.

Now is also a good time for corporate treasurers to look inward in terms of releasing capital trapped in inefficient accounts payable and accounts receivable processes. “The cost of funding has gone up, and companies need to work hard to release internal working capital tied up in processes,” says Anne Boden, head of global transaction services, EMEA, at Royal Bank of Scotland. “It is about having better visibility of their cash, doing things in an automated way and coming up with supply chain financing solutions to better facilitate international trade. It is important that corporates continue to grow and build their trade book.”

Trade finance and supply chain financing are expected to become even more important in the current climate, as now more than ever companies need to keep the wheels of global trade well oiled. “The credit crunch could be the catalyst we have been waiting for to get supply chain financing on the roadmap,” says Sarah Jones, CEO of SCF Capital, a boutique merchant bank. “For corporates it is about minimizing the risk among their supply chain partners to make sure they stay in business. For banks it is about getting back to basics.”

Speaking at the EuroFinance conference, Wayne Whitaker, director, international treasury, at Tampa, Florida-based Tech Data Corporation, which distributes IT hardware and software, said corporates see supply chain financing (SCF) as another way of financing their business. “The gap between traditional corporate revolving loans and SCF has narrowed,” he said. “SCF is more affordable than corporate revolvers, and maybe at some point SCF will be cheaper than a revolving loan.”

Even in these credit-challenged times, when banks are unwilling to lend to one another, it appears they are willing to lend to buyers and suppliers as long as they have the approved purchase orders and invoices and a strong delivery track record to back it up. “Trade finance is short-term working capital finance so it is more low risk; you know where the funds are going, what they are being used for and where your repayment will come from, so there is going to be more demand on both sides for trade finance,” says Stuart Nivison, head of trade and supply chain, Europe, at HSBC.

“Short-term working capital is 30 to 90 days,” says Daniel Schmand, head of trade finance, Western Europe, at Deutsche Bank. “Anything beyond 180 days becomes camouflaged working capital. The tenure has to be in line with the payment terms granted in the industry, and we need to understand the underlying transactions; financing simple traditional trade and not highly complex structures is the flavor of the month.”

Given that counteracting counterparty and settlement risk are paramount, HSBC’s Nivison believes banks will be able to “re-intermediate” themselves into open account trades where there is no bank letter of credit (L/C) to guarantee that a seller will get paid. “[In this climate] getting finance and getting paid becomes as important as the cost of producing the goods,” he says. But, says Schmand, while letters of credit make banks feel more comfortable about providing funding to companies, “the question now is, will a local bank provide funding on the basis of an L/C from a Western bank as the view on creditworthiness and credit ratings has completely changed?”

Anita Hawser