O Liquidity, Liquidity; wherefore art thou Liquidity…?

Those familiar with Shakespeare’s Romeo and Juliet will recall that it did not end well.

As always seems to the case, it takes a crisis to ram home the point, yet again, that ultimately what matters to the survival of a business or market is the availability of timely and (more than) sufficient liquidity.

The speed and extent of the pandemic-induced recession (putting the D-word to one side for now) which most economies are now suffering provides stark evidence of the truism; “Lack of cash kills companies”. Not only that (unless you are a bank with access to a central bank’s discount window, or other undoubted liquidity-providing mechanism), preventive asset and liability management, in which your assets re-price and become available in cash faster than your liabilities fall due, is a fundamental and necessary skill. Several US mortgage REITs, which became functionally insolvent overnight when they could not meet margin calls, yet again proved that adage. As the FT’s Izabella Kaminska has written: “…the real economy has no lender of last resort”.

The unusually long economic expansion post-GFC, the fact of better-capitalized banking systems, and a search for yield by investors amid historically low interest rates and reduced spreads combined to create conditions in which a sudden economic shock, inducing what can only be described as a general and largely indiscriminate initial market panic, upended normal expectations in terms of the ability to adjust and prepare for a downturn.

It would be unfair to criticize CFOs and Treasurers for not foreseeing the reality and speed of the spread of the Covid-19 pandemic, even if there were partial precedents within recent memory. No business ever expects anything approaching an immediate cessation of most or all of its revenues.

Yet having access to sufficient cash and liquidity to meet unexpected shocks is something that could reasonably have been expected. Of course, it is the meaning of “unexpected shock” which has now been indelibly re-framed. Unfortunately, while large corporations do generally have access to significant bank lines, or the ability to negotiate more, many smaller businesses (SMEs) tend not to have that “luxury’ (in fact, necessity) –and they are the ones who employ the majority of individuals in most economies. Hence, the astonishing and unprecedented rising cascade of closures and unemployment across the world.

The behaviour of those who survive what lies ahead will undoubtedly change. One consequence is almost certain to be viewing a significant cash reserve, or paying for committed bank lines not as an opportunity cost or inefficient use of capital, but rather as an essential under-pinning of resilience.

It is also likely that manufacturing businesses will move away from “just-in-time” inventories and stockpile inputs to their processes, while re-examining their supply chains for true origin, diversity and hidden connectivities. All of this will increase the need for working capital and greater overall liquidity. At the same time, banks are likely to re-examine the scale and pricing of such products as Revolving Credit Facilities (RCFs) and “Swinglines”, or the like.

Amidst all this turmoil, it is worth pointing out that the Awbury Team has considerable experience in helping its clients with ways in which to enhance available liquidity and the efficient use of scarce capital.

We would be happy to discuss how we can help.

The Awbury Team

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