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Tired of being at the mercy of their banks, CFOs are working hard to regain the upper hand.
Vincent Ryan, CFO Magazine
October 1, 2010
When Bill Sullivan decided to improve his banking relationships, he engaged in addition by subtraction. The finance chief of ProLogis, a Denver-based real estate investment trust, had an army of banks — 41, to be exact — participating in the company's $3.6 billion line of credit. As banks are wont to do, many clamored for a helping of the firm's debt and equity underwriting deals. Sullivan couldn't satisfy them all, so in the summer of 2009 he cut the number of banks to 19, while shrinking the revolver. Each credit provider now gets a bigger slice of ProLogis's banking spend. More important, Sullivan gets something in return: "Once I whittled it down, I ended up with a core group of banks that are tremendously responsive."
Most CFOs want their banks to be responsive, but few are feeling the love as banks slowly emerge from two years of their own hell. In a new CFO survey, almost 25% (of 640-plus respondents) describe their relationship with their primary bank as "strictly transactional" — that is, their bank is interested in them only as a source of revenue. Another 20% classify it as "deteriorating" or "abysmal."
A substantial number plan to respond accordingly. Between now and the middle of next year, more companies — 19% of midsize businesses and 16% of small businesses, according to Greenwich Associates — will issue requests for proposals, a key step in switching to new banks. (Historically, only about 10% of firms switch banks in any given year.) As motivation, CFOs are most commonly citing dissatisfaction with customer service and a desire to reduce banking fees.
Other CFOs, however, don't want to upset the apple cart. After all, while commercial and industrial lending has fallen for six straight quarters, companies still rely heavily on banks for funding. Any move that weakens connections with credit providers, especially those that command large market shares, is dangerous in this economy. What's more, switching banks means moving "sticky" services like cash management, an expensive proposition.
So what's the alternative? Go the other way, according to many experts. Cement ties to your banks, work to stand out among the herd of clients, and figure out why your company should matter to them. And in a pinch, don't hesitate to play banks off one another. Those actions may give your company a leg up when it comes time to refinance.
By following some of the guidelines detailed below, a CFO stands a good chance of regaining the upper hand. At the very least the company will have a much better handle on whether it is currently doing business with the right financial partner.
The first step in bolstering a company's credibility with its bank(s), according to Craig Orchant and Reuben Daniels of EA Markets, a capital-markets and banking-advisory firm, is to perform a very basic analysis that quantifies the company's total banking spend and its different components. CFOs need to understand three costs in particular: hard fees (investment-banking fees that are disclosed and easy to calculate), "soft" fees (undisclosed, such as the spread a bank earns on an interest-rate swap), and "shadow" fees (noneconomic fees that enhance a franchise in a particular business line or league table).
Using account-analysis statements, a company can examine almost the entire mix of service-based activities it employs, says Mike Gallanis, a partner at Treasury Strategies, including such things as checks issued for disbursements, customer payments into depository accounts, wire transfers, and the information-reporting services provided by the bank. ProLogis's Sullivan closely tracks which banks get his capital-markets business and how they benefit from a profit and league-table standpoint.
Adding up those expenditures will enlighten CFOs as to how much business they actually bring each bank provider. Such information is power, because banks and corporations tend to hew to an unwritten rule that a borrower will also tap its lenders for other, more lucrative products.
"The day-to-day transactional business is the foundation of a [company-bank] relationship," says Greg Becker, president of Silicon Valley Bank and SVB Financial Group. "If you have a client's core banking, you will keep that client longer" and the lifetime value of the client will be higher. SVB doesn't "deliver" credit unless the ties extend past the credit facility alone, Becker says. "We want it to be part of a piece."
Diane Quinn, managing director of large corporate banking at JPMorgan Chase, says treasury teams are scrutinizing banking business awarded to noncredit providers. For example, corporate marketing departments that issue customer rebates often pick a third-party payment provider without consulting their finance departments, and the same often happens when procurement departments choose credit-card issuers. But as capital has become scarcer, finance departments are insisting that these "back-end" financial providers be among the company's lenders, says Quinn.
That kind of rigor can bolster banking relationships but may also present a dilemma: CFOs want their cash management, treasury, and other services to be cost-effective and efficient, but if a firm has multiple lending banks and tries to share the wealth, efficiency can suffer. "One could argue that the more banks you involve the less efficient the process will be," says Gallanis. On top of that is concern about counterparty risk exposure. If a company has all its cash management with one or two banks because they are its only lenders, but those banks don't have stellar economic profiles, the board of directors may pressure the CFO to diversify, says Gallanis.
Almost all of the banks in Pegasus Solutions's credit syndicate provide other services to the company, but the finance department separates that from the banks' status as a lender, says Mark Dubrow, CFO of the technology and marketing services provider. "I'm not giving them the business because they're part of the syndicate, [nor am I] trying to buy favoritism," says Dubrow. "But if they can provide the best service at the best price, I'll award them the contract."
Dubrow's approach did not hinder the company's pursuit of amendments to a term loan in 2008. "The banks could have said, 'I'm tired of this — they haven't thrown me a bone in two years so I'm not voting for an amendment,'" Dubrow says, but they didn't. CFOs who don't separate borrowing and the provision of other services leave room for their decision-making to be questioned, Dubrow insists. But that stance must be established early in the bank relationship.
Quinn of JPMorgan Chase says lending banks merely want an opportunity to compete for other business via an RFP. "It's then the bank's responsibility to provide a competitive solution," she says.
Walk a Mile
A more sophisticated approach to gaining leverage is to step into a bank's shoes by calculating how much value (versus business) the company brings it. From a qualitative standpoint, every bank has different business plans and different strengths and weaknesses, explains Orchant of EA Markets. "While they all want as many dollars as possible, some dollars are worth more than others. Each bank applies a different lens to the spend." Or, as Daniels says, "If you're spending money with a bank that doesn't really care about that particular revenue set, then you're wasting those fees."
A Japanese bank, for example, that wants to grow its derivatives business in the United States might be content to take the fee associated with its participation in an underwriting deal, but it would much rather handle an interest-rate swap.
Quantifying the profitability of a bank relationship is also important. For that, a business can model its banks' RAROC (risk adjusted return on capital). RAROC is used to evaluate the profitability of a transaction or a relationship given a company's risk profile and a bank's resulting return on capital. As the financial crisis deepened last year, more banks embraced some form of this metric. "There has been a lot of soul-searching by banks to identify and focus on the companies within particular industries that they can make money on," says CFO Sullivan.
To calculate RAROC, a CFO has to know each piece of business awarded to the bank, all fees associated with services, and the minimum capital-allocation requirements for credit-related products. Commercial bankers will have a certain minimum RAROC result that they have to hit — one they are often not likely to divulge to customers, says Ron Box, finance chief of Birmingham, Alabama-based Joe Money Machinery. "If I could find out the exact equation with all the exact weightings so that I could calculate it myself, I certainly would," says Box. Failing that, finance departments can at least discover the model's inputs so they can apportion business accordingly.
For example, while a company's credit risk is not something it can directly affect — except through performance — areas like deposits and fee-based services can be reallocated or adjusted. As a heavy-construction-equipment company, Joe Money Machinery has a high average balance in its low-interest-bearing operating account (an account through which funds pass quickly as clients pay for equipment that JMM then buys) because it sells high-priced products. That's a positive for its bank's RAROC even if the bank is flush with cash. "The more it costs the bank to maintain the deposit relationship the less [the relationship] is going to add to its capital structure," says Box. On the other hand, a high-rate certificate of deposit would hurt the bank's RAROC.
But CFOs have to be careful not to over-rely on this metric. "I wouldn't tell you that a RAROC of 25% is an automatic yes and a RAROC of 5% is an automatic no," says EA Markets's Daniels. "It's only an initial hurdle."
Take the Lead
Relying too much on a lead bank can create conflicts of interest and leave a CFO uninformed about alternate credit products and pricing, say experts. "If the guy giving you advice is also sitting on the other side of the table as an investor, there will be a series of conflicts about the participants in the bank facility and the aggressiveness of the pricing," says Daniels. And the lead bank may not always be thinking about the best outcome for the company in areas like covenants.
To create what Orchant calls "competitive tension" and greater leverage with a lead bank, a CFO should identify alternate sources of capital and even go so far as to obtain serious counteroffers. EA Markets aided Checkpoint Systems, a developer of retail packaging and labeling products, in refinancing a $125 million revolver whose terms were relatively unfavorable. The lead bank offered Checkpoint refinancing terms that were conservative compared with what was available in the debt markets. So Checkpoint and EA Markets began speaking to an agent bank in the facility. The talks helped Checkpoint's management speak far more articulately about prospective terms and pricing with the lead bank, which came back to the table with a better deal. The refinancing was completed without disrupting the makeup of the facility's bank group. "They helped us understand where we could influence our banks to improve pricing and terms. In the past, our banks would say, 'Here's our plan for restructuring the deal,'" says Checkpoint CFO Ray Andrews.
Lead banks often don't put much energy into renewing credit facilities, because they don't generally view lending as a profitable business, notes Daniels. "If the CFO tells the lead bank, 'I talked to the [other] banks in my facility and I think the clearing price is significantly better; here's what I think it is and here are the comparable transactions that support it,' the lead bank will realize its position is at risk," he says.
Does a bank partnership begin and end with the bank's relationship manager? That can be trouble. Companies that achieve the best outcomes with their banks conduct them at the highest levels, "closest to the decision-making points," says Orchant. If the most-senior-level executives from the company are assigned to key banking relationships, then the bank will be more likely to reciprocate.
CFO Box goes out to lunch with the credit decision-makers at his relationship bank often, "so we're not just another file on the table," he says. Upper-management ties are also cultivated. The credit committee is like any other political organization, he says. "When they see that the bank president or a senior officer is clearly in favor of a particular issue or company, the whole dynamic changes," says Box.
CFOs can glean a lot from just knowing who sits on a credit or capital commitment committee, says Daniels, though that information isn't easy to come by. If the committee is stacked with capital markets product managers, such as the head of debt-capital markets and the head of equity-capital markets, it will likely be most focused on winning underwriting business, says Daniels.
Obviously, the relationship manager cannot be ignored, especially if he or she is a valuable single point of contact. Frequent informal conversations are important, Box says, because the banker may be periodically asked by his or her boss about the company's operating performance. If a corporate client suspects it will trip a covenant and doesn't tell its relationship manager, for example, then the banker can't relay the warning to his or her superior. "It's hard to recover a good relationship if you've made your banker look bad to his bosses," Box says.
That said, high turnover and industry consolidation have eroded many carefully crafted long-term relationships even as stricter credit policies increasingly dictate or limit lending decisions. CFOs are not likely to get a long-term fixed-rate loan from any bank these days, regardless of how often they lunch with their banker.
Ultimately, who you know counts for less than how reliably you pay. At the beginning of its loan restructuring in late 2008, Pegasus Solutions lost its lead-bank account representative to a downsizing. And Pegasus had been with the bank for only 18 months. But CFO Dubrow was still able to push through amendments to prevent covenant violations. And when Pegasus's bond debt had to be restructured, the bank helped convince the fixed-income holders that the company had enough value behind it. "We always made our interest payments on the term loan regardless of what else we were doing or funding operationally," says Dubrow. "That maintained our credibility with lenders."
While the touchy-feely nature of banking relationships may be all but gone, companies can still earn their way to well-structured, reasonably priced transactions — and the backing of their banks in times of crisis. But smart CFOs won't stop there. For companies that want to make their banking relationships more than transactional, a near-term future in which banks' profit streams are in flux will create plenty of potential leverage points.
Vincent Ryan is senior editor for capital markets at CFO.