Managing Banking Relationships
Banking relationships are not like a marriage, there is no ’till death do us part’, or even the old fashioned ‘love, honour and obey’. They are more equivalent to polygamy with rather harshly structured pre-nuptial agreements. In fact, most corporate-bank relationships are rarely entered into on a truly equal basis and regardless of the nature of the relationship when initiated, it is most likely to change over time. This change is due principally to the change in the credit relationship.
Credit is the backbone of the corporate-bank relationship, if not in the short term, almost always over the long term. Even the investment bankers with traditionally miserly rationed balance sheets (at least for corporate lending) founded most of their relationships on capital raising through equity or public debt.
When it comes to credit, the playing field is rarely flat. In fact, it is so uneven that banks are often accused of only wanting to lend money to those that don’t need it. This has an ironic ring to it in these times of the credit ‘crunch’! While not wishing to focus on the extremes, it is the extreme that shows that the corporate-bank credit relationship is almost always biased one way or the other.
In good times, a large strong corporate has little need for bank borrowing and would usually prefer to access the cheaper public debt markets. What little bank lending is used comes at rates that banks can hardly make an adequate shareholder return on. The focus shifts to the slightly lesser strong corporate with no or limited access to the public markets and the supply of lenders drive margins down there too, and so on.
In the bad times, some corporates look like they are going to fail and banks, unable to determine which ones are vulnerable, cut back lending across the board. So we have, in the extreme, the credit crunch. It is in this situation that the ‘relationship’ is tested and in many cases the value of a strong and well negotiated pre-nuptial agreement most valuable. Great care should therefore be taken when negotiating agreements with banks, and attention given to the extreme situations and not just the probably fairly comfortable status quo.
It is fair to say that not all corporate-bank relationships are based on credit, but it is fair to say that the first and most important relationships for most corporate should be founded on their credit requirements. Only after these are properly arranged and structured should other more transactional relationships be developed.
The best time for the corporate to negotiate the credit facilities is when they are not needed. This means paying for something that is not required. We are prepared to do this for fire insurance, but over the past years of easy money it became easy to believe that when bad times were coming there would be plenty of warning and time to make arrangements. But this was not the case. Whereas, once upon a time, public borrowing by corporates in, for example, the commercial paper markets were fully supported by bank back-up facilities, in recent times these have fallen short of adequate coverage and proper pricing. Judging by the number of companies with difficulties refinancing their borrowings, there has been a lack of conservativism in this respect.
The first principle of managing a corporate-bank relationship is to ensure that the appropriate credit facilities are in place, properly priced and documented and, thenceforth, properly managed.
But it is rarely as easy as that because, even though banking services are theoretically purchased separately, in practice banks that provide credit are usually looking at the returns they make on the overall relationship. This has become even more the case as loan margins have shrunk. In fact this has become so significant that in September 2003 the Office of the Comptroller of the Currency in the US investigated the issue of ‘tying’, which is prohibited under US banking law, and it published a paper, ‘Today’s Credit Markets, Relationship Banking, and Tying’. They concluded that it was not inappropriate for a bank to expect a hurdle return on the portfolio of services that it offers a corporate client and that it was acceptable to offer the services as a portfolio. So the bankers may well expect the corporate borrower to purchase other banking services (almost invariably non-asset based services) to improve the overall relationship return. In some cases it can be investment banking and advisory services but in most cases it is the provision of operational services that banks provide to improve the RoA on the relationship.
Operational services, transactional services, account services, cash management are all terms used for basically the same group of products based around money handling. Banks make money on these services in two or sometime three ways. They charge fees on payments and sometimes receipts, they earn on balances (either spread or float) and they may also make spreads on smaller amounts of captive FX related to inter-account transfers.
Far more than the significance of this income as a supplement to the banks earnings on assets is the importance of these services to the efficient day-to-day operations of almost all corporate customers. Whereas a loan may (not should) be drawn and used for some investment and hardly considered from one quarter to the next, transactions are processed by the thousand every day for the large corporate and typically every transaction earns a small fee for the bank. Even though the individual fees are small, errors can be very expensive, both in charges and in operational disruption and lost goodwill. Of the thousands of banks that provide credit almost all provide transactional services. Of these only hundreds provide them on a truly national scale and only a few dozen are capable of the efficient international services expected by today’s multinational corporations.
Up to the late 1980s, it was the norm for the providers of credit to also provide the transactional services. In fact in the US this was so institutionalised that it was normal for banks to leave compensating balances (free balances) on an account with their lending banks as part of the compensation for the loan.
In the early 1990s, a few global commercial banks started offering cash management as a specialised service provided on a pan-continental or even a pan-global basis. They invested large sums in developing specialised cross-border capabilities and invested even more effort in persuading the largest corporate to divorce the cash management purchase decision from the credit relationship. This dislocation has continued since then so that now many corporate regard their cash management relationships as separate from their credit relationships, although there is frequently a large area of overlap, whether by accident or design.
The nature of this transaction service relationship is very different from the borrowing relationship. It typically impacts the corporate in multiple subsidiaries, often at a clerical level, in areas that are well out of sight of the senior management. The compensation taken by the bank is virtually impossible to track, for although fees are visible, float and FX spreads can be virtually invisible without analysis. When things go wrong they are usually thankfully fixed by relative juniors in the organisation and the costs are frequently never calculated.
If the bank puts a lot of faith in the corporate with a lending relationship, the corporate puts a lot of faith in the bank for a transactional relationship. The common factor is that in both cases the “faith” must be based on honesty and openness. This is therefore the fundamental requirement for a good corporate-bank relationship. However, in reality there is no single corporate-bank relationship. The relationship is between a multitude of people in both the bank and the corporation, and all these relationships have to work in the same open and honest way to be effective.
Both types of organisation appreciate this. Banks create relationship managers to co-ordinate and orchestrate their organisations delivery of services to the corporate. Corporates create banking managers to do the same in reverse. It is not an easy issue, and just because a treasurer gets on well with his principle banker does not mean that the organisations enjoy a good banking relationship; it helps but it is not sufficient.
For the relationship to work well it has to work wherever the touch points are, right down to the clerk in the P&R department. In order to achieve this some formality of reporting is necessary within the corporate organisation. Ideally the company undertakes a formal annual banking review whereby everyone who has contact with the banks completes a feedback form that is summarised and used in the annual review. The review should score the banks on the services they provide. It should provide positive and negative feedback. It should not be a price negotiation forum or a selling opportunity for the bank.
This is a key part of developing and open and honest relationship with the bank. Annual reviews are the minimum advised; some companies do semi-annual meetings. But it is also important to have an escalation process whereby one-off events (unfortunately these are usually transactional ‘problems’) are escalated to a senior level for communication to the bank at a senior level. The bank will want to correct relationship issues as quickly as possible but often these get hidden from view.
Equally important is for the corporate to provide the bank with an annual review of its credit standing and business outlook. This may also be an opportunity to alert the banks to forthcoming business opportunities, either for extending the relationship with additional services or in new geographies. But again this should not be a sales discussion. Such conversations should be a part of a continuous communication process, but it is good to have one formal review usually after the annual results are announced. These days the corporates are well advised to request the same of their banks.
Corporate-bank relationships are based on credit and transactional services. Key to a good relationship is open and honest communication at all levels. This is best supported but good formal documentation and review processes.
And it goes without saying the this type of understanding is not developed overnight – a good mutual understanding of each others organisation at many levels is required to make this happen.