Contractors Assess Default
The Wall Street Journal: http://online.wsj.com/article/SB10001424053111903635604576472380486091522.html?KEYWORDS=NATHAN+HODGE
U.S. defense firms and government contractors are starting to prepare for the unthinkable: The possibility that the U.S. government, the ultimate reliable customer, may not be able to pay its bills on time.
As the clock ticks down in debt ceiling talks, defense industry officials say they are contemplating a range of options for surviving a potential government default. Some companies are reviewing their balance sheets to calculate how long that can get through any delay in payments. Others are scrutinizing contracts to determine what work they must perform if the government runs out of cash.
But when it comes to a government failure to pay IOUs, the U.S. is entering uncharted territory.
“Unfortunately, I’m not sure that the government has decided exactly what their plan is in terms of which government agencies will be allowed to work, and which government agencies will be allowed to pay bills,” said Bruce Tanner, chief financial officer for Lockheed Martin Corp., in an interview Tuesday.
Lockheed, manufacturer of the F-35 Joint Strike Fighter, is the Pentagon’s top weapons supplier and draws 85% of its revenue from U.S. government work. Mr. Tanner said Lockheed was “probably as positioned as well as we could be” to ride out a short-term interruption in federal payments, but would face serious cash-flow pressures if the crisis is prolonged.
On Tuesday, it reported a 3.9% rise in second-quarter profit, to $742 million, and lifted the top end of its full-year earnings’ outlook. Lockheed has about $3.5 billion in cash on the balance sheet, and solid access to commercial debt markets, Mr. Tanner said. But Lockheed also pays roughly $800 million a week, including payroll, payments to suppliers and the company’s pension plan.
Most big contractors are financially strong after a long military buildup amid two wars. General Dynamics Corp. on Wednesday said profit ticked up 0.8% on improved results in its combat systems unit. It reported income of $653 million on revenue of $7.88 billion.
But government contracting experts say firms may not be at the front of the line for payment if the government runs low on cash. Richard Ginman, the director of defense procurement and acquisition policy for the Pentagon, said Wednesday that if the government can’t borrow money, it will be the Treasury Department and the White House Office of Management and Budget that will determine what bills are paid as revenue comes in.
“We have the money, we’ll have the bill, it will go into a line,” he said. “How that’s chosen to be done is not a Department of Defense call.”
Mr. Ginman declined to disclose any of the internal discussions of how the Pentagon would handle a potential default situation, or what kind of guidance it might provide to its contractors.
Industry insiders compared the current drama to spring budget negotiations that almost forced a government shutdown. That created uncertainty about starting new contracts, but didn’t threaten payments. “What’s remarkable is there is no guidance,” said David Berteau, a defense industry expert and senior adviser at the Center for Strategic and International Studies in Washington D.C.
Smaller suppliers in particular may be more vulnerable in this case because they have smaller cash reserves. “The guys who are going to be hit first, because they don’t have the cash reserves, are the service contractors,” said defense contracting analyst Jim McAleese.
The Professional Services Council, a trade association that represents government contractors, recently hosted a telephone conference call with dozens of government contractors to discuss options.
“We’ve strongly encouraged our companies to look at their payment stream … particularly over the next 30 days,” said Alan Chvotkin, the group’s executive vice president and counsel. “That’s the window of risk.”
Mr. Chvotkin said the council has encouraged companies to offer discounts to accelerate payments, discuss extending commercial lines of credit and ensure that invoices to the government are up to date.
Pentagon spokesman George Little said the DOD was “engaged with the Office of Management and Budget and all other relevant administration components” on debt ceiling discussions.The Department of Defense didn’t respond to requests for additional information on how it might prioritize payments to suppliers.
The government’s “prompt payment rule,” which imposes interest penalties on agencies for late payment, could kick in if the debt ceiling isn’t raised. Marion Blakey, the head of the Aerospace Industries Association, said a government failure to come to resolution on increasing the debt ceiling would “jack up the cost of contracts” because of built-in penalties.
“In that sense it would increase the overall cost of the federal budget,” she said.
Michael Herson, president of American Defense International Inc., a defense-industry lobbying firm, compared the down-to-the-wire negotiations to “MacGyver,” a 1980s action show. “He’s not going to cut the red wire with 12 seconds left; he’s going to cut the wire with one second left. That’s the way we govern right now.”
