Inside Your Banker’s Head

Companies are starting to figure out how their banks make money. Banks actually like that.

Some banks just can’t take a hint. When a large apparel maker renewed its multibank credit facility a few months ago, the company’s treasurer also saw it as an easy way to trim its outsized group of 13 banks. Only three years earlier, several bankers had complained bitterly that the apparel maker’s business wasn’t meeting their hurdle rates. Given today’s tight spreads, thought the treasurer, surely those getting next to none of the company’s other business would simply walk away rather than continue lending.

But, alas, even the banks getting bupkis wouldn’t budge. With nary a word about losing money, they all signed on.

Welcome to the loose end of the credit cycle. But beware. Bankers obviously expect something in return for the favorable five-year backup credit lines they’ve been handing out lately. And when the credit cycle turns tight, complaints about hurdle rates will again make life awkward for companies that try to maintain access to credit through a diverse bank group. Such discussions have strained personal banking relationships in the past, yet they’ve also increased corporate awareness about the way banks calculate their returns. Going forward, companies that adopt this sort of quantitative analysis for themselves may find that it not only supplements traditional relationships, but strengthens them. Indeed, banks are surprisingly willing to help CFOs build models that can distinguish between legitimate gripes and sales pitches.

RAROC and a Hard Place

Some 20 years ago, Bankers Trust Co. first began using a risk-adjusted return on capital — or RAROC — model to evaluate the profitability of a transaction given the risk profiles of its commercial borrowers and the resulting return on the bank’s capital. Today, such return models have become all but ubiquitous in the banking industry. So accepted are they that regulators are in the process of allowing banks to determine for themselves how much regulatory capital they must set aside for each transaction (see “Basel Faulty?“).

For many corporate customers, however, RAROC has a bad reputation. Most first heard the term used as a cudgel, with bankers telling them that they weren’t profitable customers and then pressing for other business in exchange for credit.

“Most banks began to internalize the idea that large corporate lending is unprofitable about five years ago,” says Nick Studer, head of the North American corporate and institutional banking practice at Mercer Oliver Wyman. The 1999 repeal of the Glass-Steagall Act, which had formerly separated investment and commercial banking, was quickly followed by flame-outs in the M&A market, the IPO market, and the last generous credit cycle. “It’s these last five years that made bankers realize that cross-selling is not a luxury, it’s a necessity,” says Studer.

But handled clumsily, particularly by the investment banking arms of newly formed universal banks, cross-selling irked many corporate customers. Indeed, in the past few years, the Association for Financial Professionals has been surveying its members about such practices, strongly hinting that they might constitute illegal tying. “Cross-selling is what retail bankers do well,” notes Studer. “On the investment banking side, honestly, it’s not something they do well. It’s boring, and not as sexy as chasing deals.”

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