Sean Segar, Nedgroup Investments

ZAR534 billion on corporate balance sheets not efficiently utilised

With interest rates persisting at their lowest levels in 30 years, the 14% increase in corporate deposits in South Africa over the last year, is adding significant pressure to returns on equity for many local companies already sitting on huge cash piles, says Sean Segar, Head of Product: Cash Solutions at Nedgroup Investments…

The Reserve Bank recently reported non-financial corporate deposits to be ZAR534 billion, compared to the ZAR469 billion at the same time twelve months ago. While it is understandable that many corporates are adopting an overly conservative balance sheet in the face of market uncertainty, there are opportunities to capitalise more effectively on the potential returns their cash piles generate. In the prevailing low interest rate environment, “fortress balance sheets” - or surplus cash on balance sheets – creates significant drag on earnings and returns in equity.
 
Even if times dictate higher cash balances on corporate balance sheets it’s crucial that this is put to work as best possible.

I attribute these bloated balance sheets to a lack of confidence to commit to major capital projects and a perceived need to strengthen balance sheets in uncertain times while the economic recovery wavers.
 
For many corporate treasurers the memories of how suddenly banks froze access to funding following the 2008 financial crisis remain fresh. Part of these high cash balances exists because corporates want to be in a position to fund internally should banks again tighten up on lending.
 
As a result corporates have large cash deposits much of which are parked with banks and this  is not always the optimal way to achieve the best potential returns.
 
Many of these deposits sit in call accounts which offer immediate access to funds. However there is a price for having immediate access to funds and this comes in the form of lower interest rates.
 
It is more the exception than the rule that corporate and institutional investors require immediate access to their funds. “A small amount of planning and cash forecasting will, in most instances, allow cash investors to place their cash in a 24 hour notice account. This could result in a meaningful lift in their returns. Furthermore, treasurers that are able to forecast further into the future are able to place funds on longer terms at even better yields.
 
Call accounts offer 5.25% for large deposits, with same day access. However, conservatively managed income funds, which require a day’s notice in order to access funds, yield more than 1% higher than this.
 
Furthermore such funds offer arguably lower risk in that the counterparty exposure is spread amongst many banks as opposed to call accounts where investors have exposure to a single bank.

Alternatively, money market funds can be used for surplus cash as they can provide 3- month yields but offer immediate access to funds. He says money market funds and certain income funds are used extensively by astute corporate entities, sometimes even alleviating the need for an in-house treasury function in smaller entities.
 
Most companies have cyclical cash flows. In the same way that companies and other enterprises have an overdraft facility for times when their cash flow dips into the red, it’s advisable to consider having a money market fund account in place for the times when they have surplus funds.

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