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.
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.