VideoIronically, the idea that banks demand assurance of proper accounting treatment from their customers was first proposed by Citigroup and, subsequently, JPMorgan Chase, in August 2002, in response to Enron. In a 2003 interview with CFO, then-CFO Todd Thomson reiterated this requirement, although he avoided repeated questions about whether such assurances would be required in writing. (Citigroup's own response to the guidelines focused fairly narrowly on certain definitions and, while endorsing a letter from the Bond Market Association, did not endorse the stronger objections of the ABA.)
So strong was the industry response that the agencies withdrew the proposed guidelines. A revision, expected in August, has yet to appear. "I'd guess we'll see some pretty significant changes," says Krohn. "I can't imagine they'll just fix some typos."
Despite the heated objections to the guidelines, says Krohn, banks are extraordinarily careful these days, particularly when corporate customers propose a transaction. "There is absolutely no interest in walking close to any line on any of these transactions," he says, adding that he has begun to see representations and warranties about accounting disclosure "creeping in" to structured-finance contracts.
Yet, all this demonstrates just how fine the line is between legitimate and fraudulent transactions. "Structured-finance transactions will continue to be an important part of the capital markets," says Krohn. "Banks are not responsible for customers' financial statements. But if they know their financial product is being used to manipulate or create misleading financial statements, then the elements of aiding and abetting have been met."
Skin in the Game
The debate over the structured-finance guidelines begs the question of who actually proposed many of the infamous transactions that got Enron et al. into so much trouble. Most likely, both sides were well aware of their intended purpose.
The irony is that despite their penchant for shifting financial risk, and despite their heightened aversion to financial-statement manipulation, banks still seek an insider role when it comes to managing the capital structure of their corporate customers. "Some banks have been keen to move toward principal finance, because the value is potentially high to the client while also being high to the bank," says Nick Studer, head of the North American corporate and institutional banking practice at Mercer Oliver Wyman in New York. "You can potentially structure some nice trades that earn highly profitable [spreads] from the issuer client. And when you've bought these slightly funky assets, you can restructure and sell them on to investors."
Just as CFOs attempt to shed risk and reduce inventory turns by having their suppliers hold the inventory, "my bank is a business partner in my balance-sheet-management process," adds Chuck Bralver, executive director and head of the strategic finance practice at Mercer Oliver Wyman.
Strictly speaking, this new partnership is nothing of the sort. A bank that provides an unsecured loan is more of a partner — in the traditional sense of sharing liabilities — than one that simply structures a securitization without taking risk onto its own balance sheet. Indeed, notes Studer, even as companies become more adept at gauging how much business they give their banks (see "Inside Your Banker's Head"), securitization "has the added advantage [for the banks] of having pretty opaque profitability."
Ultimately, then, companies must realize that as much as banks want to be their strategic-finance advisers, they also want far less skin in the game. Indeed, says Studer, "we shouldn't be pie-eyed here — it's never going to be a close partnership. There's always a bit of tension, and it's a client-supplier relationship."
Tim Reason is a senior editor at CFO.
Caveat Emptor
Credit default swaps may make creditors less sympathetic to companies facing insolvency, but that's not the only risk they pose to Corporate America. Companies, of course, also purchase credit-default swaps (though they account for just 3 percent of the market). The recent Counterparty Risk Management Policy Group II report warns banks and other sellers to make sure investors — which, in this case, include corporations — understand the derivatives they buy. That's a key issue, since corporations typically buy single-name credit-default swaps only when one of their major suppliers or customers is already clearly in trouble.
"The biggest thing we have to do is educate our corporate counterparties on the trigger events," says Joseph A. Chinnici III, managing director at Cleveland-based KeyBanc Capital Markets. While bankruptcy is an obvious trigger event, others — such as a non-Chapter 11 restructuring or the failure of a company to pay certain bills — must be carefully defined. Once a corporation determines that a credit-default swap is the best form of protection, says Chinnici, "90 percent of our time is spent talking to the customer about triggers, making sure they understand the idiosyncrasies of the contract." —T.R.
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