Credit squeeze has yet to hit the homeland security biz

News reports and commentaries about the pending financial meltdown are filled with doom-and-gloom predictions about its impact on every crack and crevice in the U.S. economy, but experts on the homeland security sector have yet to see much negative impact in that arena.

Last Thursday, I spoke with six keen observers of the sector’s financial landscape and was pleasantly surprised to hear that, at least in the short-term, the credit crunch that is squeezing Wall Street investment firms, major insurance companies, national banks and retail businesses up-and-down Main Street, has yet to be felt among the companies selling security products and services to government customers.

“Nobody is having any issues yet,” said Brian Ruttenbur, an analyst at Morgan Keegan & Co., a Memphis, TN-based investment firm, which monitors the financial status of 15 different public companies active in homeland security. “They’re all flush with cash,” he noted.

In fact, by Ruttenbur’s calculations, his 15 companies have received a total of $1.1 billion in contract awards during the last 30 days. He acknowledges that we’re in the midst of “awards season,” as Uncle Sam’s fiscal year 2008 just ended on Sept. 30 and federal contracting officials have been eager to spend their remaining appropriations, but he is nonetheless optimistic about the near-term.

Mark Shaheen, a managing director at Civitas Group, LLC, a Washington, DC-based consulting firm that focuses on the technology and financial aspects of homeland security, views it the same way. “What we’re seeing is minimal immediate impact,” Shaheen told me. In large part, that’s because government security initiatives are no longer seen as optional; they’ve become critical, ongoing enterprises and their budgets have remained intact.

The homeland security sector may also have escaped the initial impact of the financial “crisis” because most of its vendors are small or mid-sized companies that traditionally have not looked to the capital markets to raise funds. “The squeeze is having a bigger effect on the bigger companies -- the GEs of the world,” explained Mike McManus, a managing director for homeland security at Imperial Capital, a Los Angeles-based investment group. “They’re having a much harder time at the moment.”

Of course, when one pushes beneath the rose-tinted surface, there is ample evidence that all is not perfect in the homeland security space.

Credit is widely available to security companies if they’re looking for asset-backed loans, said John Mack, the head of mergers and acquisitions at Imperial Capital, but loans based purely on a firm’s cash-flow are virtually non-existent at this time, he added.

In part, that’s due to the recent spike in the London Interbank Offered Rate, known as LIBOR, which is the rate at which banks are willing to loan their money to other banks. A jump in LIBOR can cramp a security company’s ability to raise cash. “Is it enough to kill ’em?” asked Mack. “No. But it will definitely squeeze them.”

The prevailing shortage of credit in the capital markets can also put a damper on large companies’ hopes to acquire other companies.

“The jumbo transactions -- the billion dollar deals -- are the ones under the most pressure,” Bill Polk, a managing director of CapitalSource, Inc., a Chevy Chase, MD-based financial firm, told me last week. Capital Source has ample liquidity to finance such deals on its own, said Polk, but these days it would prefer to spread the risk among a group of financing partners. “It’s becoming increasingly hard to find those partners,” he acknowledged.

Even if the homeland security sector has proven itself to be relatively immune to the financial squeeze thus far, most vendors that participate in the government marketplace also sell to commercial customers, who are feeling their own pains.

“In our security integration business, we’re seeing a slowdown on the commercial side,” said Tom McMillen, the former NBA basketball player and former congressman who is now chairman and CEO of Homeland Security Capital Corp., an Arlington, VA-based holding company.

More so than any other corner of the security industry, the homeland security niche is dependent on the strength of government budgets at the federal, state and local levels. There was unanimous agreement that homeland security spending has gained widespread political support across the country since 9/11, and that future budgets are likely to remain robust.

Of course, in the short-run, with Congress still operating under a “continuing resolution” for fiscal year 2009 -- which holds security spending at last year’s agreed-upon levels -- there is some confusion and frustration within the contracting community, but that is expected to sort itself out in the next few months.

Such uncertainty could continue, said McManus of Imperial Capital, “for three to six months, until you get the new regime change,” which will put a new occupant in the White House.

Perhaps because both presidential candidates have been less-than-specific about their plans to safeguard the homeland, prognostications about the differences between a McCain and an Obama Administration tend to vary widely.

If Obama wins and installs a classically Democratic administration, McManus would anticipate a greater emphasis on government regulations than we’ve witnessed in recent years. This could lead to stiffer security requirements being imposed on chemical plants, energy facilities and other components of the nation’s critical infrastructure.

McManus also predicts that an Obama presidency would emphasize security spending at the grass roots level of government -- where it would help Democratic constituencies, such as local first responders -- rather than the larger national video installations and mega-programs often favored by Republicans.

Finally, Ruttenbur, of Morgan Keegan, noting that Democrats traditionally pull in most of their votes on the East and West Coasts of the country, said he believes an Obama victory would lead to greater support for security spending at seaports, which in turn would boost the cargo security end of the industry.

If McCain wins the presidency, however, he is likely to funnel more funds to the southern and northern U.S. borders, in an effort to staunch the flow of illegal immigrants into the country.

Even as the homeland security segment copes with short-term uncertainties on Wall Street, and equal uncertainties on the road to the White House, it seems likely that a new mood is overtaking the nation’s economy.

“We’re in for a several-year period where lending will be more conservative,” forecasts Mack, of Imperial Capital.

But the homeland security niche may persevere through the nation’s troubles relatively unscathed.

“Homeland security spending is well-supported in the legislative and executive branches, in both political parties,” concludes Shaheen, of Civitas, on an optimistic note.

So, here’s my bottom line: Thus far, the impact of the credit squeeze has been minimal on the homeland security sector, the next few months may bring continuing budgetary and electoral uncertainties, but the long-run future for government security seems strong, indeed.