An investment bank’s misfortune is a corporate borrower’s joy, or so the reasoning goes. Corporate finance directors are bracing themselves for another tough year, hence even the bulge bracket banks, such as Morgan Stanley, are waking up to the need to open their balance sheets to customers in order to pick up whatever business is on offer. The received wisdom on Wall Street is that banks will have to lend hundreds of millions of dollars to customers in order to obtain mandates for M&A and corporate advisory work.
But there is a flaw in the assumption that borrowers can look forward to dipping into the pockets of Merrill Lynch and Goldman Sachs. For one thing, the banks may claim they are prepared to take a substantial amount of credit on board, but in fact they are highly reluctant to keep it on their balance sheets. This is a reflection of the risk of major insolvencies, especially after the Enron collapse.
“We’ve seen all this before,” says Ian Linnell, banking analyst at credit rating agency Fitch. “The trend of investment banks leveraging business off their balance sheets comes and goes with shifts in the business climate.
The big banks tend to melt away when the good times come back and they don’t need to keep these credits on their balance sheet. But it comes as no surprise they are pitching for corporate mandates through lending now. The market is tough and any sort of instrument helps them to win business.”
Not only are the Morgan Stanleys and JP Morgans of this world putting cash on the table with the hope of securing capital markets business, corporate clients increasingly consider this part of their birthright in dealing with banks. A recent survey by Greenwich Associates reveals that more than half of US corporates consider credit facilities a key factor in rewarding banks with M&A business. Europe has followed suit.
A EUR 5bn euro equity issue last November by KPN was mandated solely to those banks that had participated in the Dutch telecoms group’s EUR 2.5bn credit facility.
There are two main reasons why, in the corporate credit market, investment banks find themselves at a disadvantage to their commercial bank rivals.
First, the Wall Street heavies lack clout in terms of balance sheet capitalisation.
This was one of the chief motivations behind the ill-fated attempts by Barclays and NatWest to build up an investment banking capability in the 1990s. They had hoped to create a global business that would leverage off the parent’s balance sheet – but neither bank had the stomach to provide their investment banking subsidiaries with the resources to take on the global players. The more recent round of mergers a la JP Morgan-Chase Manhattan, Salomon Brothers-Citigroup and Deutsche Bank-Alex Brown stands as further example of this strategy at work.
The bulge bracket players face another handicap versus the commercial banks, in that they have shown themselves to be a lot less reliable when the chips are down. This is particularly true in the case of mid-cap corporate clients. However, a number of the sub-bulge bracket European investment banks have been successfully playing the dual-advisory lending card with small corporates for years.
Ishbel Macpherson, managing director of investment banking at Dresdner Kleinwort Wasserstein, says the small and medium market has always been a key element of its strategy. “Relationship and focus are the keys to our business,” she says. “You’ve got to always support them, in bad times as well as good. Nothing ticks off a small or medium company as much as being made to feel unimportant. We’ve been successful because we are focused on them.”
The commercial banks are unfazed by the investment banks’ attempts to muscle in on the lending business. “Our ability and willingness to use our balance sheet for our corporate customers has been much greater than in the case of the investment banks,” says Alan Dickinson, managing director corporate banking at Royal Bank of Scotland. “The investment banks have what they would call a one-stop shopping offer. However, companies are increasingly saying they can choose the best debt and equity packages.
They don’t want to be boxed into a corner and told that if they want the money they have to take everything from the investment bank, and therefore at a higher price.”
Fitch’s Linnell says there is a lot of truth in the adage that good relationships with lenders do pay dividends. He points to the risks a mid-cap corporate runs in getting involved with a global investment bank. “Corporates should try to build up banking relationships,” he says. “Relying on the big investment banks for lending can be a dangerous path to tread. Sooner or later, the tap is likely to be turned off.”
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