Liquidity Is Like Oxygen

This excerpted with permission from 2021 Governance Outlook: Projections on Emerging Board Matters from NACD.

Prior to March 2020, businesses in the United States were at peak earnings as the United States was enjoying the longest expansionary period in its history. All the hallmarks were in place: significant M&A activity, recapitalizations, IPOs, new start-ups, and general growth investments. The long expansion also meant that corporate leverage was at its peak, with the amount of non-investment-grade, leveraged debt in the United States more than doubling to $1.3 trillion between 2007 and 2020, and the dollar-denominated, high-yield bond market rising above 65% to $1.6 trillion during the same time period.

The combination of solid growth prospects, decreasing regulation, increasing valuation multiples, and an abundance of available capital fueled this growth. Credit markets were robust—bank and burgeoning nonbank lenders were very much open for business.

Liquidity is a little like oxygen: Organizations do not know how much they need until the supply is cut off. While leverage can be an incredibly cost-effective way to use capital to earn and to amplify returns, if an organization does not have a sound plan to survive a cash flow crisis, leverage becomes an anchor. Once growth stops, as happened in 2020 due to the pandemic, organizations must reevaluate the value of having a strong balance sheet and a prudent capital structure.

In some instances, the economic shock created by the pandemic exacerbated trends already in place before March 2020. Boards without a holistic view of forward-looking fiscal scenarios, including worst-case assumptions, were likely taken by surprise when the tide turned so dramatically. In more prosperous times, boards may not have been interested in seeing something as simple as a forward-looking cash flow analysis. As the tide has turned, this type of information has become a lifeline for the board and senior leaders, informing the tough decisions required by quickly changing circumstances.

Several months into the COVID-19 pandemic, some winners and losers had become obvious. Technology companies that enable working from home, e-commerce and online consumer services were some of the winners. Travel and hospitality, brick-and-mortar retail, higher education and the energy market were among the obvious losers.

Freeing Up Credit  

The full economic impact of the pandemic was blunted by trillions of dollars of federal funding through the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and the Paycheck Protection Program, directed at individuals, small businesses and large sectors like the airlines.

The Department of Health and Human Services provided health care providers with billions of dollars in either direct grants or advanced Medicare payments. The Federal Reserve intervened by cutting interest rates to their effective lowest level, conducting unprecedented quantities of asset purchases, and establishing a range of emergency lending facilities to free up credit to households, businesses, and state and local governments. Opening up credit markets has allowed at-risk companies to refinance existing debt—a lifeline to some as they work to reimagine their businesses and ride out a period of decreased business activity.

In addition, specialty finance and nonbank lenders that were active before the pandemic probably had sufficient liquidity to invest once the economy started opening up again.

Keys to a Rapid Recovery  

Regardless of industry, certain key ingredients will be required for an organization to execute a successful recovery after the blunt force economic trauma of the pandemic. While the ingredients for recovery are intuitive and simple, they can be elusive during a time of crisis:

• the right management team for a crisis
• liquidity
• a viable core business
• quick and astute decision-making

In highly functioning organizations, management will come to the board with their plan for coming out of or even thriving as the economy rebounds. The governing body will serve as a sounding board and provide their advice and perspective on the reliability of that plan.

The board is probably in the best position to assess the effectiveness and results of the organization’s crisis management. They may determine that the CEO’s skills are no longer best suited for the fast-changing environment or that the business may require a supporting role, such as a chief restructuring officer. The chief financial officer should know all of the financial levers to support business needs and be able to run different scenario analyses to best support the liquidity of the business.

Because the pandemic has altered so much of the business landscape, the board should work with management to reassess the relevancy of the organization’s current strategic plan. Organizations need to do more forward-looking financial analysis and engage in more scenario planning to figure out where they’re going to be one, three, and five years from now based on different underlying assumptions. Understanding a variety of possible outcomes will help organizations to become more flexible, more proactive and less reactive.

NACD elevates board performance by providing board members with practical insights through world-class education, leading-edge research and an ever-growing network of directors.

Apply It to Your Boardroom

• Is our strategy still appropriate, considering all we have experienced and our projections for 2021?
• What actions, including tough ones, do we need to consider, keeping an eye toward reputational risk?
• Does our organization have the appropriate financial structure and resources to execute its plans?

© 2021 by the National Association of Corporate Directors. All Rights Reserved. Materials are courtesy of NACD and should not be redistributed.