As bank after bank has merged and vanished over the past decade, corporations have worried that they would have less choice, higher prices, and scarcer credit. In fact, there’s evidence that at least some of those fears have been justified. And with more consolidation likely ahead, this could be just the beginning.
To be sure, some corporate services, such as bond underwriting and non-investment-grade lending, have benefited from new nontraditional market entrants. However, corporate customers have watched options fade for other services, including securities settlement, cash management, certain term loans, and credit facilities.
The pricing impact of consolidation has been somewhat mitigated by brisk competition among surviving banks and new nonbank participants. “There are fewer suppliers in some areas,” says James Wolf, a senior vice president at Mellon Financial Corp., but elsewhere, “competition has gotten fiercer.” Certainly, with the U.S. economy flagging, defaults on the rise, and banks out to earn more on their capital than is possible on low-margin loans, lenders are warier. Still, having the number of banks and thrifts fall by almost a third, to 11,495 since 1989, doesn’t help.
Banking consolidation has hit lending the hardest. “The bottom line is that the appetite of banks has gone down because there are fewer of them,” says Bruce Ling, global co-head of syndicated loans at Credit Suisse First Boston (CSFB).
That’s especially clear in credit facilities. “They are much more interested in things that do not require them to commit their capital for substantial periods of time,” says Joe Maurer, treasurer of Levi Strauss & Co. There’s also limited enthusiasm for joining loan syndicates. When Ames Department Stores Inc. needed an $800 million asset-based loan earlier this year, three banks offered to lead the deal instead of the six or seven that came by in 1999 with $650 million in similar loans. “Consolidation has clearly limited choice and competition,” says Ames CFO Rolando de Aguiar. “It has limited flexibility in terms of going to different people for leasing services, asset-based finance, and checking and depository accounts for our stores.” He also worries that his ability to negotiate better terms is being hurt.
Newly merged banks also tend to reduce their loan holdings to any one borrower. Take First Union and Wachovia. When they merge this fall, they plan to cut exposure to the 13 percent of their corporate customers that overlap. “We are going to be actively managing that exposure,” Wachovia’s chief risk officer told analysts at the April deal announcement.
So if you are one of these borrowers, you had better find another loan source. You will also have to look elsewhere if one of your banks merges with a competitor that has tighter credit standards, or if your lender has credit woes of its own.
Non-investment-grade corporations may be luckier than investment- grade borrowers, although the latter can easily tap the capital markets. For non-investment-grade companies, nonbank lenders are filling the gap.
Even so, borrowing costs have risen in some non-investment-grade categories. CSFB’s Ling points to how BB credits may be priced as high as LIBOR plus 250 basis points to meet minimum return requirements of institutional buyers. He contends that spreads on such credits would be narrower if borrowers still were able to arrange such financing without institutional investors. “BB spreads have widened because commercial banks have exited the market,” says Ling.
Whatever the rating, all corporations must be increasingly agile seekers of funding. “It is tougher to syndicate,” says Geoffery Merszei, treasurer of investment-grade Dow Chemical. “Today a treasurer must be more innovative to compensate for having few players.”
With nearly 60 percent of its business outside the United States, Dow now uses its own global financial experts to this end. “We do not rely exclusively on the banks to find participants in the syndication,” says Merszei. Instead, Dow’s finance team must have good contacts with at least two banks in each country that Dow can approach when it needs funding.
Rosemarie Loffredo, assistant treasurer at investment-grade International Paper (IP), echoes Merszei. “We have to take a more active role,” she says. Knowing the investors for credit products and communicating IP’s story to them “makes them more inclined to invest in our debt, equity, and loans,” she says. One supplier these efforts have unearthed is European pension funds, which want more U.S. investments since the advent of the euro in 1999.
Still, the trend toward fewer, less-willing bank lenders makes it crucial to reward lending with other, more-lucrative business, such as securities underwriting or cash management. “Many banks have indicated that they will reduce the number of relationships that they bank unless they can get more fee-based business,” says Richard Arrington, head of loan products at Mellon, who notes that Mellon is one of this group.
Some banks pursue this goal quite aggressively, although they avoid explicitly tying loans to other business, as that is illegal. “Banks use credit facilities as a loss leader,” says Larry Tomlinson, treasurer of investment-grade Hewlett-Packard. “Everybody knows that if you have a group of banks on your standby facility and don’t also provide them with additional business, they might not be willing to renew their line.”
Dow’s Merszei agrees. “Certain institutions that help us in our revolving credit lines will undoubtedly be favored when it comes to selecting an investment bank for capital market activities,” he says. Dow plans to renew its revolving credit line this month.
Amkor Technology has already rewarded its lenders. In May 2000, Citibank, Société Générale, and Deutsche Bank led the syndication of a $900 million secured bank facility consisting of two term loans and a $200 million revolving credit line. Amkor CFO Ken Joyce says that in conjunction with these loans, the non- investment-grade company hired Citibank for cash management, and gave each bank fees for certain foreign trade activities, such as letters of credit and foreign exchange forward contracts, as well as custodial fees for holding collateral in various countries.
Any extra cost may not be readily apparent to corporations redistributing existing fee business. Indeed, the cost may be the same, but if a CFO hires an extra bank for a second fairness opinion on an asset sale or adds co-managers to issue debt, that loan may cost more than the interest rate alone suggests. There may be unnecessary fees or an opportunity cost if business goes to a bank without the requisite execution skills.
There are other, subtle ways that pricing can rise. To avoid paying higher interest rates to reluctant lenders, some firms issue more expensive bonds and use the money to reduce commercial-paper programs and credit facilities. Banks sometimes keep rates stable but increase yields by charging higher commitment fees or setting rates higher on part of the loan, says Ames’s de Aguiar, who learned this lesson firsthand. The first $750 million of Ames’s recent loan was priced at LIBOR plus 2.5 basis points, while the last $50 million was priced at prime plus 5.
The impact of consolidation reaches beyond the credit markets. Scale businesses, such as processing, have become more concentrated. Richard Thornburgh, CFO of CSFB, sees fewer options when his investment bank needs securities and foreign exchange settlement and clearance services, although he says there are still sufficient providers to keep prices low. Loffredo sees a similar pattern for securities settlement, cash management, and custodial services.
Perhaps most unexpected is that mergers have left fewer banks to provide liquidity as counterparties for generic foreign exchange and equity swaps. “From a counterparty point of view, it is causing some interesting by-play. It is becoming a concentration risk,” says Thornburgh. To offset the risk, CSFB uses netting arrangements more actively and spreads counterparty exposure across legal entities within the group. Thornburgh sees no customer impact, but arguably, if the trend continues, some types of swaps could become less available or more costly.
Mergers have also clearly helped Corporate America. Dow’s Merszei says that for bonds, multiple managers are becoming outmoded. “Any one of our large underwriters can take a billion dollars without blinking an eye. It is a function of size,” he says. And commercial-banking firms eagerly underwrite bonds, since no capital need be set aside to cover them.
For equities, initial public offerings, and mergers-and-acquisitions advice, combining investment banks has created stronger players, while commercial banks joining the fray have fanned competition. “Because investment banks are hungrier, they are calling us with better M&A candidates and more good capital ideas,” says Mark King, chief operating officer of Affiliated Computer Services.
Moreover, some investment/commercial bank combinations have simplified getting funding advice. “The merged entities have really expanded product capabilities because they can offer financial advisory and capital-raising services along with more traditional banking services,” says Amkor’s Joyce. Citigroup’s Salomon Smith Barney and Deutsche Banc Alex. Brown, part of Deutsche Bank, helped Amkor issue $500 million of senior notes in February, despite a tough market.
Larger, more-global banks also can more easily serve clients across far-flung empires. For HP’s Tomlinson, this is key. “We need banking partners that take a global view and are willing to extend capital on a global basis,” he says. “We have better account coverage than before with many institutions.”
That said, consolidation hasn’t yet run its course, and until it does, treasurers and CFOs may just have to keep worrying.
Alison Rea is a freelance writer based in New York.
WHY CFOS LIKE CDOS
Over the past decade, a robust new market for non-investment-grade loans has made capital more easily available to corporations than it otherwise might have been.
These new institutional investors include mutual funds, pension funds, insurance companies, and hedge funds. They can buy loans directly from banks or indirectly by investing in the debt or equity of structured vehicles called collaterized debt obligations (CDOs). The CDOs in turn are active buyers of corporate loans. “Over the past five years, the banks have built a substantial business where they package up the term loans and syndicate them out to a number of institutional investors,” says Levi Strauss & Co. treasurer Joe Maurer.
Why the focus on non-investment-grade loans? The institutional buyers, including CDOs, buy only fully funded loans, and typically must earn a spread of at least LIBOR plus 250 basis points. Most investment- grade loans are unfunded credit lines that back up commercial-paper issuance. Other investment-grade credits tend not to pay the required spread.
When Levi Strauss went to market earlier this year, it was able to raise a $1.05 billion credit facility with the help of these investors. The facility was broken into three pieces: a revolving credit and a term loan held principally by banks and a broadly syndicated term loan bought by mutual funds and other nonbank investors.
“There are a number of institutional investors as well as bank loan mutual funds out there that have an appetite for paper, and banks are more than happy to feed that appetite,” says Maurer.
CDOs are set up by a variety of firms, including various mutual-fund or money managers, or even private equity funds. Usually these investors start by committing some of their own money as equity in the CDO, and they often raise additional equity from other U.S. and European investors. Then they turn to the debt markets. The CDO, with the help of the committed equity, issues one or more classes of bonds that are secured by the loans to be acquired.
Depending on the level of risk they wish to assume, the institutions can invest via equity or various types of debt with different credit ratings. The equity investors lose money first, if money is to be lost, followed by the holders of the lowest-rated bonds up to the highest.
For CFOs and treasurers of non-investment-grade companies, the increased institutional-investor appetite for their paper has meant lower costs and more flexibility, which allows borrowers to balance their capital structure more advantageously among loans, high-yield debt, and equity. Bruce Ling, managing director and global co-head of syndicated finance at Credit Suisse First Boston, says the growing institutional market provides “more liquidity, more portfolio- management discipline, and more ability to withstand downturns than the bank market offered in its prior form.” — A.R.