From the November 2008 issue of Treasury & Risk magazine

No Time to Panic

Rick Moss is concerned but confident. As treasurer of Hanesbrands Inc., a highly leveraged 2006 spin-off from Sara Lee Corp. that needs credit from both banks and the capital markets to survive, he is exposed to the unprecedented financial crisis marked by a vicious credit freeze. But he shrugs it off. "Things have to get pretty bad before people stop wearing underwear," he says in mid-October. Moss is riding out the financial storms pretty well because Hanesbrands has a well-stocked drawer of financial underwear. He points out that it will be three years before he has to renegotiate any of Hanesbrands' bank credit facilities. Some $500 million of bonds rated Ba3/BB- don't mature until 2014. Even the cost of Hanesbrands' Libor-based borrowings isn't a big headache. "We went out over the past few months and swapped $2 billion of our $2.4 billion of debt into fixed rates when we saw an opportunity to hedge at fairly low rates. And another 250 million is in an asset securitization program, so our exposure to Libor is modest," he says.

But that doesn't mean that it's business as usual in the Hanesbrands treasury. "We've re-evaluated how we think about liquidity and how we plan our refinancings," Moss says. "We always go into planning cycles with a best-case scenario and a worst-case scenario. Now we're rethinking our worst-case scenario. We had been planning to do some optional refinancing this year, but it looks now like we'll ride out the market turbulence." He is also investigating a wider range of financing options for $4.5 billion Hanesbrands, based in Winston-Salem, N.C. "It's a lot more work," he says, "but you have to do it."

September was a wake-up call. When the Association for Financial Professionals, Bethesda, Md., sent a survey to its members on Sept. 4 and collected responses by Sept. 16, 48% reported that they enjoyed the same access to short-term credit that they had two years ago. When AFP conducted a follow-up survey between Sept. 26 and 29, 40% said they had less credit available than they had at the beginning of the month. Companies over $1 billion in annual revenue felt the pinch more than smaller companies. And 62% indicated that they had taken direct actions during September because of the deteriorating credit situation. Common actions include moving most or all investible funds to bank deposits (41%), reducing capital spending (37%) and freezing or reducing hiring (22%).

Hanesbrands seems to be fairly typical of net borrowing companies that locked in long-term credit with bond issues and bank syndications. The times are perilous but the lifeboats are seaworthy. And while big borrowers would seem to have the most to fear, treasurers responsible for large investment portfolios also are feeling the gales.

Cadence Design Systems, with $550 million cash on hand, has been part of the flight to quality. "In the past few weeks, we've taken money out of prime money funds and put it in treasuries and government-only money funds," reports James Haddad, vice president-finance of the $1.6 billion Silicon Valley technology firm. "There were times when you could invest with confidence in a highly rated 2a7 fund and know the value was secure. You didn't have to worry about principal or be concerned with marking it to market every day," he says.

Investing in treasuries has meant a dizzying roller-coaster ride. The surge in buying pushed prices up and real yields down into negative territory briefly. "You had Libor rates above 4%," Haddad says. "Banks were charging each other 4% to 5% while treasuries were yielding 0.5%. It was crazy." For now, he's sticking with treasuries but has looked into offshore investments. "We do business in Ireland, where the government has guaranteed all the money in Irish banks. We've moved some of our money there."

George Zinn, treasurer of $60 billion Microsoft Corp. is careful not to gloat, but Microsoft is sitting pretty, on top of a $24 billion investment portfolio and $18 billion of free operating cash flow before dividends as of June 30. First, Microsoft turned conservative in its investment strategy over a year ago. "We went underweight credit and risky assets in 2005," he says. "We didn't look that smart then, but we feel a lot better now." (Conservative for Microsoft wouldn't be conservative at other companies.) In 2004, Microsoft diversified into other asset classes, including commodities, that would be out of bounds for the short-term, highly liquid portfolios most corporations have.

Now cash-rich Microsoft is prepared for a foray into the debt markets. "Our board has approved the use of debt," Zinn says. "Our strong credit quality and the market appetite for AAA and A1+ paper give us a unique opportunity to issue debt and enhance our capital structure." Choosing his words carefully, Zinn says, "I do not know what rate we might pay, if we were to issue, but people have speculated that our term debt might trade at a spread that recognizes our credit quality as increasingly close to the U.S. government's given all of the liabilities it has been assuming recently." And while he specifically said any proceeds were for general corporate purposes, he didn't contradict the suggestion that Microsoft could potentially issue debt and reinvest it at a positive spread while adhering to its investment policy. "As a company, we're uniquely positioned to come out on the other side of this mess in a stronger competitive position than we went in," he says.

Zinn doubts that market reforms will prevent more securitized trouble from reappearing. "We'll know we're out of the crisis when people show up trying to sell newly packaged, risky assets under a different acronym," he says.

Timing has also been fortunate for $6.8 billion Eastman Chemical Co., Kingsport, Tenn. "We've spent the past five years restructuring our company and selling off businesses and product lines for cash, so our balance sheet was strong when this storm hit," says Victor Allen, vice president and treasurer. "We haven't had to suffer through trying to get day-to-day funding in the commercial paper market." Investments do require attention. "We monitor the markets closely so that we can react and maintain our liquidity," he says.

If the watchword for successful borrowing is far-sighted planning, the key to successful investment might be quick reaction. Alert finance staffs normally watch market developments, confer and decide what actions to take. But when things happen this fast, investments can go in the tank while you're deciding to move them, Haddad notes.

If the scramble has been to protect investments, the more lethal threat lies on the borrowing side. Borrowers that comply with all the terms of a credit agreement are safe with one exception that could become significant if things get worse, warns James R. Simpson, managing partner of Corporate Finance Solutions LLC, Stamford, Conn., a corporate credit consulting firm and supplier of covenant management software. "Most credit agreements contain a 'market disruption' clause that essentially says that if the bank can't get money due to market disruptions, you may be out of luck," he says. Diligent treasurers and their legal colleagues may want to review loan agreements, paying close attention to market disruption clauses and what can trigger them. Borrowers must confirm that the credit they expect is really there, says Anthony J. Carfang, founding partner of Treasury Strategies Inc., Chicago. "Even if a bank is contractually bound to lend, it may lack the wherewithal to perform. Confirm everything to avoid surprises down the road," he recommends. "This is a terrible time to encounter nasty surprises."

While the market disruption clause has been invoked rarely if at all so far, treasury staffs drawing against their revolvers have noticed that they get the funds late in the day instead of early. That's because lead banks wait to receive actual funds from the other syndicate members before forwarding them to the borrower, says Jeffrey Glenzer, AFP's managing director.

Meanwhile, down in the trenches, adjustments are made calmly. While Greg Weigard, assistant treasurer at $10 billion Air Products and Chemicals, Allentown, Pa., isn't putting in longer days during the near-panic, he knows he's not in normal times. "There is a definite level of anxiety" around financial activity, he says. "This is a stranger market than any I've seen in my 27 years in treasury. A player who is solid today might not be tomorrow." Whatever funding he is able to do still has to be done in the morning, he adds.

And while Air Products enjoys its A1/P1 short-term credit rating, funding the company isn't exactly automatic. The company issues tax-exempt paper, some of which remarkets daily, as well as CP. "We find out by 11 o'clock whether our tax-exempt paper remarketed successfully, and then we know how much commercial paper we need to issue," Weigard says. There still were buyers for Air Products CP at press time, but that's partly because Weigard fishes in the short end of the market. "We might not be able to go out a month or two," he says. "There were a few days when the only option was overnight."

The disappearance of key financial players could have a permanent effect on credit distribution. For example, Hanesbrands' syndicated bank credit, led by Citigroup, includes both Bank of America and Merrill Lynch, which now is owned by B of A. "Bank of America has had to double down on its exposure to us," Moss notes. That could pose future capacity problems for Hanesbrands and other borrowers as active syndicate participants die. "I'm not convinced that a bank will take twice the exposure just because they're twice as big," Moss says.

Questions remain about credit pricing. Market volatility has exposed problems with Libor, the base rate for much corporate borrowing. Libor has been erratic, and there have been suspicions that banks were manipulating it, but it's likely to remain the cornerstone benchmark, Haddad says. "Banks are too smart to peg loan prices to artificially low treasury rates. Libor is the closest thing we have to a market proxy and the favored index for bank loan pricing."

Despite rampant uncertainty, one thing is clear: don't take your eye off the covenants in your loan agreements. Don't give a lender any excuse--not even overlooking an administrative detail--for backing out of your credit agreement, Carfang emphasizes.

A bank today is far more likely to take drastic action over a covenant violation than it would have taken a year or two ago, Simpson says. "Once you violate a covenant, negotiating leverage shifts to the bank," he points out. "You hear stories about corporate borrowers who breach one covenant and wait to tell the bank; the bank is now more likely to cancel the credit facility, putting the borrower in workout." One of his clients, he says, requested a little more time before a scheduled tightening of covenants and was turned down, even though the company was profitable and still complying with all covenants.

One bright spot in the banking crisis has been the reliable performance of bank-dependent treasury operations. "The Fed does a good job of keeping the payment system running. If companies couldn't pay each other with confidence, that would be cataclysmic," Haddad says.

While bank cash management services continue to perform as promised, treasury operations staffs are rethinking the popular strategy of consolidating banks to get the efficiencies of a single stream of information. Now they are looking more favorably on spreading operations risk by depending less on one or two banks, notes Mike Gallanis, a Treasury Strategies partner who heads up the corporate practice.

Where daily operations involve hedging and derivative trading, more scrutiny is required. For example, Hanesbrands' Moss is paying closer attention to the counterparties his firm uses for hedging. "We just did some derivative transactions. We were more selective about who we used, and we spread the risk among more counterparties than we normally would," he says.

Eastman Chemical has active hedging programs for interest rates, commodities and foreign exchange and is keeping a close eye on its financial counterparties. Attention to counterparties took Allen to Manhattan for a face-to-face visit with his insurance broker and account executives at AIG in August. That meeting resulted in a follow-up call with Rob Shimek the CFO of AIG's Property & Casualty Insurance Group to discuss their ability to pay claims. Eastman had no credit default swaps with AIG, just basic insurance coverage, but Allen was concerned about that coverage and was generally reassured that the insurance underwriting business of AIG was solid.

"They have a strong balance sheet, and I'm comfortable with their regulatory structure. I had a bad moment when the governor of New York proposed allowing funds to move from the insurance company to the parent, but that didn't happen." Allen was also in Manhattan the week that Lehman failed and AIG was taken over, visiting other counterparties. "The atmosphere that week in Manhattan was very different from the atmosphere in Kingsport," he says.

Companies that do plain-vanilla hedging are not reporting problems with counterparties, but treasuries that operate as profit centers and rely on valuation models are finding that their models are broken. "Those models work within a range of assumptions, but once the market goes outside that range, the hedges don't always function as they should," Carfang explains.

As might be expected, treasury executives are less worried about the credit and liquidity issues they can control (their own) than the ones they can't control (their customers). Hanesbrands biggest worry, Moss says, is its customers who rely on credit to pay for their socks and underwear. "We're looking more deeply into the status of our larger non-investment grade customers and when they might have to refinance," Moss says. "We're concerned about the increase in credit risk." It's not so much the top 10 customers, headed by Wal-Mart, that keep him awake; it's the mid-tier retailers. "They have fewer options," he says.

Allen also voices concern about the financial health of his supply chain. "If customers can't get money from normal credit providers, they will be tempted to try to turn their suppliers into banks," he says. "We won't do that, beyond offering standard payment terms. There's also risk on the supplier side, so we work with our procurement folks as well as monitor our A/R carefully."

Ultimately, how much the economy suffers depends on how deeply consumers cut back their spending. Underwear may not be optional, but consumers aren't likely to drive to the mall just to get some. And fewer mall trips means they're less likely to stock up, Moss points out.

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