Wednesday, 23 January 2019

Couples counselling

  • Print
  • Share
  • Save

Related images

  • Couples counselling
  • ?Leveraged finance: more bang for your balance sheet

As banks struggle to adapt to the post-crisis reality and maximise profitability, clients have found financing harder to come by via the traditional channels. This has put the relationship between bank and client under considerable pressure, but those that have survived are stronger for it.

To see the digital version of this report, please click here.

To purchase printed copies or a PDF of this report, please email


Gale force winds of change are blowing over the banking industry. Regulation, designed to ward off any repeat of recent financial woes, has dramatically undermined the profitability of some businesses, while pushing banks towards others. Meanwhile, banks and their clients are struggling to keep up with rapid advances in technology, globalisation and the rebalancing of the global economy.

The resulting storm is not only driving consolidation among Europe’s many banks, but is leading to upheaval in the relationships between banks and their clients, as both sides adjust to changing circumstances.

The decline of the old banking model – high leverage, big balance sheets and dominant prop trading desks – has forced banks to focus on their return on equity. There is a new emphasis on traditional fee-paying ECM and DCM work, founded on strong relationships. It is the start of a new period for bank relationships, and clients are likely to see more attentive banks competing for their business.

Both partners in the typical corporate-bank relationship have become more discerning about the value of that relationship. “We have moved away from the former cosiness of these relationships to something more calculated, a decision more grounded in its own mutual economic value,” said Hakan Wohlin, global head of debt origination at Deutsche Bank.

Although relationships collectively have come under considerable pressure, the power of functioning relationships has increased as the operations of corporates have become more complex, said Wohlin. “A valuable relationship bank is one that cannot only analyse its client’s risk issues but also solve them with appropriate solutions and products, across geographies and industry verticals,” he said.

Typically, relationships have traditionally involved enticing clients with loans in the hope of winning DCM business, earning chunky fees without putting their balance sheets at risk. It doesn’t always work that way. Sovereign relationships are sought after despite sovereign DCM business earning lower fees – or sometimes none at all. Deals arranged for some African countries and Ukraine, for example, saw banks waive all fees and generate revenues in the bookbuilding process. The incentive was the promise of more profitable business from the quasi-sovereigns.

While relationships with corporates can also be very strong, banks rarely, if ever, waive fees altogether. But the most desirable corporates and financial institutions may look to secure deals with covenant-lite terms. Conversely, for high-yield corporates the process is considerably more arduous in terms of documentation, and the fees will typically be 1%–2% higher at least. 

Not monogamous, but less polygamous

Corporates have traditionally maintained a broad array of relationships, but this has changed. “The recent trend has been for corporates to maintain a smaller and tighter group of relationship banks,” said Lewellen. Pre-crisis a typical FTSE 100 company would have relationships with around 20 banks, but now it is more like 10–12, he said. That works both ways, so banks can expect to get a greater share of the company’s business, while the company can expect more competitive terms from the bank.

Banks will look further down the market cap spectrum to make up the shortfall. The effect should waterfall down and improve relationships for corporates of all sizes, though much is still made of the difficulty SMEs have securing loans from any bank.

In some cases nationality has played a part in determining which relationships have survived. “Markets have become more inward-looking, less internationally agnostic,” said Sean Taor, head of DCM at RBC Capital Markets. “This is a small trend, but it has been evident, though it seems to have tailed off since the summer when the market got a bit more buoyant.”

But what really changed in Europe post-crisis was the demand for longer-term funding, said Tomas Lundquist, head of corporate DCM at Citigroup. “Pre-2008 there was a heavy reliance on short-term funding,” he said. “Now many European corporates are terming out funding, which is related to the historically low coupon levels and a realisation of the strategic importance of a well-balanced debt portfolio. Companies are addressing their asset liability management issues earlier.”

Frequent borrowers like KfW and Rabobank have always had an opportunistic approach to borrowing, funding in a multitude of different currencies depending on availability. The retreat of the bank market has forced other corporates to follow this example and to be more open minded.

This is not only, or even primarily, about pricing. Although every corporate has different priorities, typically the desire to avoid recourse to the cross-currency swap market, onerous reporting requirements and the simplicity of funding in the currency where underlying needs exist are bigger factors than price, said Lundquist.

“The market is so transparent, and is trading efficiently these days, that indicative prices are less important than they used to be,” said Florian von Hartig, global head of DCM at Standard Bank. “We, and that includes most clients, all know basically what the right price is. Surprises when you are off by more than 5bp are rare, and only happen in days of extreme volatility. The real variation is on fees, with some banks being much more aggressive than others, particularly if they feel it is important for them to win certain businesses.”

While fees for bond business are on average falling, for loans they are creeping up. Often derided as a loss leader, some insist their loans operations are profitable in their own right, even if it is a lower margin business. The crisis and the resulting regulation has pushed up the cost of capital, meaning banks are increasingly careful about the risk taken on their own balance sheets and charge appropriately.

The same is true for investors. Where banks were once typically willing to trade with their clients for their own book, make markets and hold stock on behalf of them, it is now much harder to justify these services from a cost of capital perspective, said Demetrio Salorio, global head of DCM at SG. Banks’ scope for proprietary trading has been severely curtailed, while their ability to provide liquidity to clients is also more restricted than it once was.

What’s in it for me?

If banks are putting their own balance sheets on the table they will be more careful about ensuring the return on equity is sufficient to make it worthwhile, said von Hartig. “If that threshold is not being met then it may not be worth their while, unless the client is very important to them.”

“To be successful, banks need to find a balance between products and relationships,” said von Hartig. “The relationship between issuers and banks is more crucial now than ever.” This requires flexibility and a certain breadth of coverage from the bank. “Banks cannot get away with being a one-trick pony, they need to be a one-stop shop,” he said.

Yet here again, banks are being pulled in two directions as they face up to considerable pressure to retreat from their less profitable businesses. Some banks have a niche focus on certain sectors, while others are strong in particular geographies. This is true of banks of all sizes, but is increasingly vital particularly for smaller and mid-tier banks that cannot compete with their top-tier counterparts on balance sheet.

“Each bank must have its own strategy and it must be dynamic,” said von Hartig. “It must play to its strengths: regional knowledge, industry knowledge or product knowledge. It must carve out its niche and become a market leader in it. Smaller banks will not survive without a niche.”

Even larger banks recognise this logic. UBS has scaled back parts of its fixed-income business to focus on its core area of competence, while RBS is also less active in leveraged finance.

A clearer focus forms the basis of a stable relationship. Expertise can be as valuable as capital to a client, said von Hartig. Mid-sized corporates will find they are better served by mid-sized banks. He added: “A second or third-tier corporate is not going to be the priority for a big bank. If they want to feel the love and attention they need to find a bank that is equivalent in size to themselves.” Corporates are already recognising this and the market will continue to move in this direction. Von Hartig said this would enhance loyalty in relationships and benefit both sides.

“A second or third-tier corporate is not going to be the priority for a big bank. If they want to feel the love and attention they need to find a bank that is equivalent in size to themselves”

This leaves room for a smaller number of truly global banks, to service the needs of corporates with a global network of operations, and requirements that span all asset classes and the full gamut of products, for whom a relationship with a niche provider is insufficient.

Much has been made of the squeeze on smaller and mid-tier corporates as banks compete for the most profitable business offered by the top-tier companies. But while it is true that bank loans can be hard to secure for smaller companies, they do have other options, such as the US private placement market or smaller exchanges in countries where their brands are well known.

“I don’t see many companies being left in no-man’s land,” said Salorio. “There is enough diversity in terms of the different banks of different sizes and with different areas of specialisation to provide services to everyone. Yes, the biggest corporates make great clients because of the cross-selling opportunities, but SMEs also make interesting clients for the cross-selling opportunities they offer, in payroll, private banking and lending for example. And micro clients are well served by retail networks.”

Since the financial crisis rocked the banking sector and bank relationships, those that have survived have in most cases been left stronger than before, said Taor. But these relationships have not always endured at the institutional level: with staff attrition in the sector spiking since 2008, bankers that have moved between institutions have often taken relationships with them.

This means a bank showing commitment to a region or a client is no guarantee of success. Relationships may be undermined by the loss of key personnel or teams which served as the face of the relationship to a particular client.

“The shift in market sentiment and the increasingly uncertain rates outlook has made intellectual property more valuable,” said Taor. “Clients want advice from someone knowledgeable who they trust. Experience is vital – there are many bankers in the market today have never seen a bear market before.”

Whether clients feel loyalty first and foremost to the individual ambassadors of banks they have worked with, or the institution itself, is debatable. “Over the course of time a relationship consists of more than a single face or department,” said Salorio. “Clients will deal with management, the risk department and others. Of course clients feel loyalty towards individuals, but they tend to value the institution more.”

Leveraged finance: more bang for your balance sheet

Sitting at the riskier end of the lending spectrum, leveraged finance generates higher fees and margins than traditional lending business. Relationships with such borrowers are therefore particularly attractive to the banks that have balance sheet to commit.

So far this year the leveraged loan market has grown significantly year on year and is on course to be the highest volume year since 2008, said Paul Bail, head of debt advisory at Baird. Over 60% of this year’s volume has come from refinancings or recapitalisations, though new deal LBO activity, while still being relatively low, has also shown signs of growth.

But it is not immune from the trends playing out elsewhere, and banks are increasingly selective about the deals they take on. Before the crisis when credit was plentiful, private equity houses could shop around for the best deals. When deal flow dried up or deals were smaller, the top-tier banks would look at smaller deals than would usually interest them to generate some income.

That balance of power has now shifted and banks can afford to be selective. As with their corporate clients, some PE houses bring more profitable business than others. Carefully considering the number of deals a house brings, the performance of those deals and the history of the relationship – how it has endured the oscillations of the market – banks have become more selective in their PE relationships. The priority is working with those they wish to maintain strong relationships with, at the expense of others. For the losers it is now harder to pique the interest of bankers than it was pre-crisis.

Leveraged finance has not been immune to the changing dynamic between bonds and loans. High-yield bonds have enjoyed a record breaking year of growth and have become increasingly prevalent in refinancings in particular, said Bail. This has been good news in general, with refinancings freeing up bank balance sheets for new deals, resulting in growth in both high-yield and leveraged loan markets, he said.

“It is possible to envisage a greater degree of competition between high-yield bonds and leveraged loans,” said Bail. “If bonds come to be used more for new deals it could eat into leveraged loan business, but so far there is limited evidence of it and the relationship has been more complementary than competitive. Where bonds have been used in new deals they have often come as part of a broader loan and bond package providing a subordinated element to the debt structure.”

  • Print
  • Share
  • Save