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F R A N K B . J E H L ES E C U R I N G T H E U N S E C U R E D – G U I D E L I N E S F O R F U T U R E F I N A N C I N G

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A recent survey among industry stakeholders in the EU, the US, and Asia revealed high levels of insecurity about the future of financing. The global financial crisis has weakened banking and capital markets and monetary values. For this reason and due to the continued credit bubbles, financial squeezes are likely to shape the eco-nomic future. The rather bleak microeconomic implica-tions of the global macroeconomic developments demand that financing means are secured strongly and flexibly.

WILL WE ALL GO BANKRUPT?

The business environment in which global corporations operate remains volatile because it is not even close to recovering from the recent economic crisis. With the ex-ception of Germany and Austria, none of the major Western economies has succeeded in reducing its national debt over the last three years. In fact, national debt levels have been rising in spite of decent economic trends. And while macroeconomics doesn’t lend itself to definitive statements, it seems very likely that we will see a continued increase in public debt and pension liabilities in all possible scenarios. If governments do not increase efforts to lower their debt and pension liabilities, national levels will likely triple by 2040. However, debts will also rise if states do

implement reduction measures, even if they manage to freeze age group related spending on the growing number of retirees. Demographic development poses increasing macro- and microeconomic challenges for many econo-mies, including for “Old World” European ones as well as some Asian markets like China. A little ray of hope comes from the US where the private sector has managed to return to the path of long-term development and private debt has been stabilized. For most large economies, however, it will be very difficult if not impossible to stabi-lize domestic budgets and financial markets sustainably.

T H E A U T H O R

Securing the Unsecured – Guidelines for Future Financing

Frank B. JehleCFO & Deputy Chief Executive OfficerMANN + HUMMEL

Source: CESifo GmbH /IFO Institute, 2013-02, Long time-series for the ifo Business Climate for Germany

The Macroeconomic SituationThe business environment remains volatile (European Economy & Euro, US Economy, Asian Economy)

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Upswing Boom

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DownswingRecession

Business expectation

Business situation

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F R A N K B . J E H L E S E C U R I N G T H E U N S E C U R E D – G U I D E L I N E S F O R F U T U R E F I N A N C I N G

In this environment, it seems quite possible that many established countries will go bankrupt in the long run even if inflation helps them reduce their debt. As financial markets continue to be exposed to growing volatility, economic cycles will shorten. Crises will occur more often and have increasingly negative ramifications for public and private stakeholders.

While during the last financial crisis, many national econo- mies were stabilized by government-funded spending programs as well as rescue packages for large corpora-tions, this option will be available only to a limited extent during future crises given the precarious debt situation in many countries and the volatility prevailing on financial markets. This bleak scenario is further aggravated by the situation on the banking and capital markets where financing has shifted from bank to non-bank means. One of the reasons for this development is the Third Basel Accord. In an attempt to improve financial regulation, the increased requirements for banks under Basel III have led to higher costs and limited the access to financial means. Against this backdrop and because Basel III not only offers capital regulation but also dramatically tightened liquidity rules, non-bank financing, particularly through bonds, has boomed and is likely to continue to do so in the future.

It is unclear, however, as to just how crisis-proof and re-ceptive bond markets are. After all, banks are still the main liquidity providers. Crisis-prone industries like the auto-motive and machine branches are particularly threatened by the possibility that these capital sources may suddenly run dry overnight. In that case, banks will not be able to come to the rescue due to their limited capacity under Basel III to increase credit volumes. Similarly, weakened national economies are also not in a position to rescue at-risk industries. Under these circumstances, corpora-tions that lack sustainable financing measures are much more likely to disappear from the market than those that operate with secure or even excessive financing means.

So what are the consequences of these pessimistic progno-ses? Do we wait and see and bury our heads in the sand in anticipation of the worst? I suggest that we take appro-priate action instead.

SECURE YOUR FINANCING!

The main microeconomic implication of the broader situation is essentially simple. We need to keep our companies in good shape through secure financing. But what does sustainable financing really mean given such volatile economic circumstances? Handling the macro- economic challenges discussed above involves three pillars: solid financing, cash, and flexibility.

KEY #1: SOLID FINANCINGDiversification of external financing includes:

Core business banksInstead of relying on one house bank or on rather loose relations with several banks, work with a handful of core business banks. Cultivating relations with them will help you obtain credit lines during good times and secure long-term credits. Consider your local banks. They are still there and they need you, too, especially during difficult times. Think of the previous

Ireland

Chart: boerse.deSource: Bloomberg, Goldmann Sachs, EU

National debt in % of GDP

SpainGreece Portugal

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Expected Development of National Debt LevelsIn the long run, we’ll all be bankrupt

Italy

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Germany

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“old fashioned” roots of solid financing: they will help you now.

Capital market productsCreate hyper-liquidity by drawing on capital market products in addition to working with banks. Increase your visibility to investors. Don’t just consider obtaining a credit rating from an established (!) rating agency – get one! But come well prepared and with a good plan. That’s also what investors like: be down-to-earth. Issue corporate bonds early on. Stagger repayment dates. Agree on broadly defined terms and avoid stipulating intervention criteria. Ensure that the refinancing of due payments overlaps significantly. Balance your financing needs between opportunity and strategy.

Be prepared!Prepare action plans that can be adapted quickly. Keep in mind that there will be times when the CFO should make the final decision.

KEY #2: CASHThe second pillar of secure liquidity is cash. Cash has made a serious comeback and will continue to do so. Ensure high cash levels at all times and liquidity when you need it. Control your banks and your investments. Act like a bank when allocating your money.

KEY #3: FLEXIBLE COST STRUCTURESTo ensure liquidity, the key is to increase the flexibility of cost structures through variability, particularly in sales and administration and in overhead expenses. Many companies, including medium-sized ones, will have to face a new wave of cost reductions. The relevant instru-ments, such as bundling and/or outsourcing sales and ad-ministration, aren’t new. But the heightened necessity of making use of service center structures will create an unprecedented amount of pressure to cut costs swiftly. The same will apply for smaller and medium-sized corporations (below 5,000 employees).

Optimize your internal business processes, especially the payment conditions via factoring and supplier financing. For many companies, this used to be unthinkable in the past. However, a larger amount of working capital will be generated when sales go up and require financing. When inventories and receivables increase, payables will augment only marginally.

Secure business growth with a variety of financial means that can grow and shrink (“breathe”), including:

Factoring: Selling claims will create an automatic adjustment to growth.

Supply chain management will help to control inven- tories.

Reverse factoring: Use supplier financing for payables.

For starters, corporations in particularly crisis-prone industries are well advised to optimize their internal finance-related business processes. They should then find financing which keeps working capital to a minimum and creates excess liquidity as well as contractual safeguards. The rigor of safeguarding growth will separate the winners from the losers in a volatile economic future. A strong core shareholder/owner structure with a high interest in their company’s economic consistency will help you manage the new challenges. •