Under its treasury chief Ben Bastianen, Johnson Controls has built a highly sophisticated in-house bank, generating real savings with the help of the kind of technology that a medium-sized investment bank might envy

While the idea of the treasury as an “in-house bank” is nothing new, only a handful of even the largest manufacturing companies can claim to have built one. Ben Bastianen and his 21-strong treasury team at Johnson Controls, the Milwaukee-based automotive systems and facility management company, have shown how the concept can be realised on a global basis.

Johnson Controls’ treasury is playing a key role in managing the rapid growth of the company, whose sales hit $16.1 billion for the year ended September 30, 1999. And it’s no coincidence that Bastianen’s tenure as treasurer at the firm has seen nine successive share earnings increases, say his admirers.

In 1998, Johnson Controls embarked on a technology plan to expand its centralised treasury services from Milwaukee and Brussels by establishing treasury centres in Singapore and Sao Paulo, connecting them electronically and allowing them to consolidate and net cash and foreign exchange positions. Johnson Controls teamed up with Stockholm-based software supplier Trema to implement a treasury management system that enables straight-through processing of its transactions, and so offer centralised treasury services to its affiliates via the Web. For example, Trema’s Finance Kit software allows the treasury team to mark positions to market on a real-time basis, allowing the treasury to issue twice-monthly “bank statements” to business units.

But the key advantage of Johnson Controls’ treasury system is that it allows the company to separate its flows of money from its flows of goods, which means it can maximise the efficiency of its hedging. Each business unit has a bank account for every foreign currency in which it conducts business. Each account is centrally managed, and all the accounts are rolled up daily into a master account. By netting its positions globally each day, the company’s hedging requirements are boiled down to a few large transactions.

Johnson Controls’ primary risk management objectives are to protect cashflow after tax and to reduce earnings volatility. The business units and the treasury work together to manage longer-dated commitments created by automotive supply or service contracts. Interest rate risk and commodity price risk are also managed through the use of swaps and options.

To make the centralised treasury work, business units must view the treasury as their banker, where they keep their bank accounts, borrow from, exchange currency, and go to for advice on strategy and for assistance on long-term business deals. But there is a good reason not to take away too much decision-making from operating managers when it comes to risk. “Risk is inherent to doing business internationally,” says Bastianen. “We don’t want to take away risk management from the operating manager because we feel he has to learn to live with it in order to function successfully.”

Many companies claim that their treasury centre functions as an in-house bank, but few completely achieve this. Johnson Controls does, with the result that the treasury can centrally net all of its foreign exchange positions, and reduce the number of transactions that it needs to hedge overall foreign exchange exposures. “Reducing our transactions to a few large ones invariably allows us to command better terms than individual business units could achieve,” says Bastianen. “We pass this advantage on to them and, as an ‘in-house bank’, we don’t add any spreads.”

The advantages of this approach to the company’s bottom line can be seen in what Bastianen refers to as Johnson’s foreign exchange factoring programme. The company’s controls group has branches around the world, which buy product from its factories in Europe and the US. The treasury guarantees fixed exchange rates for periods of one year. It allows the factories to sell and the branches to buy in their own local currencies, contributing to more stable pricing.

Positions are normally hedged for up to one year. For longer-dated commitments, Johnson Controls may hedge beyond one year. It tends to use options, but if this is not feasible because of high premium costs it may purchase an option struck out of the money to lower the cost, or use cheaper basket options. In rare cases, it may also use knock-out options.

Johnson Controls is careful to maximise the information that the treasury needs to manage the financial exposures of its business units. For instance, business units now use a standard software module for proposals to submit to customers. “Every time the draft proposal involves currency risk, the module automatically sends an electronic message to the treasury to alert us that somebody needs assistance,” says Bastianen.

Johnson has also anticipated the effects the Financial Accounting Standard Board’s new FAS 133 rules could have on its use of derivatives – and consequently its hedging of non-dollar liabilities. In 1995, it began making acquisitions to expand its automotive seat business. In the case of its $180 million acquisition of Roth Frères in 1995, Johnson Controls raised funds through a $150 million 20-year corporate bond in the US at 7.70% and converted them with a cross-currency interest rate into a 4.00% French franc liability. “The swap amortises over a seven-year period, and the cash out-flows were designed to match up with the projected cash in-flows resulting from the acquisition,” explains Bastianen. “It provided us with acquisition capital and a hedge at the same time.”

Because of FAS 133, Bastianen took a different tack with the 1998 acquisition of Becker Industries, a German automotive engineering firm, for $900m. FAS 133 would have compelled Johnson Controls to mark to market an interest rate swap on a quarterly basis, adding to earnings volatility. So, instead, Bastianen arranged a straight five-year euro-denominated bank financing. “The accounting rules are resulting in corporations not using the capital markets to their fullest potential,” says Bastianen.

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