The DIY approach to corporate borrowing

The structural reforms imposed on global banks after the financial crisis of 2008 has meant there are new opportunities and challenges facing corporate borrowers that didn’t exist before. A do-it-yourself (DIY) credit application using publicly available information can help corporations better understand how they are seen by lenders and cuts the risk of financing not being available when it’s most needed.

The Basel III capital adequacy regime, intraday pricing, changing collateral structures and just generally a higher volume of more tightly enforced regulations all mean banks are no longer operating like they used to prior to the 2008 crash. For instance, restricting sales of capitally intensive products such as loans may sometimes be necessary to preserve a bank’s capital base, causing it to temporarily prioritize other products ahead of a stress test.

Corporates need to know these new ways of operating at banks better and may even want to adopt a DIY approach to credit applications, so that they can scope out this area more fully and master the new risk implications and players in the field.

Background

As a result of the 2008/9 financial crisis banks are required to reserve an increasing amount of equity as buffer for potential future credit losses. The size of that buffer is calculated as a percentage of total loans and other credit instruments weighted by the risk default for each loan or credit obligation.

Regulators need every bank to assess the risk in their credit assets the same way so they can compare one bank to another and to the standards set by the Bank of International Settlements (BIS) in Basel, Switzerland.

Regulation encourages banks to outsource credit decision-making

Rather than maintain their own systems and data to support credit risk assessment and loan portfolio monitoring – and in order to keep up-to-date with changing regulations – banks can instead rely on external providers.

The main external risk and credit decision data providers that banks use are the credit rating agencies (CRAs) like S&P and Moody’s, which many treasurers will be familiar with. CRAs are in an ideal position to provide this service to banks because they also provide the risk rating frameworks and data used by national and international regulators.

Banking is highly leveraged. Until 2010, banks needed only $2 of equity at risk to be allowed to use $100 of depositor’s money in their credit related businesses. After the financial crisis the minimum was increased to $4.50 and will increase to $7 in 2019. Banks will have to significantly increase their margins on credit related products if they are to sustain the returns to shareholders they have achieved in the past.

Banks track return on capital for every product & service

Banks are trying to calculate the return on capital for every credit product and service they offer. For large borrowers, the calculations are part of the credit approval process and drive the pricing required to meet the bank’s targets.

Services, such as cash management, trade finance and other fee-based services, require little or no equity for the bank to sell them and can appear to be much more profitable. From time to time a bank will instruct its sales force to push the products and services that require less capital and restrict sales of capital intensive ones such as loans.

A bank will go through periods when it appears to believe its profits come from short term transactions with customers, instead of from long term relationships with clients. When that happens, a loan that is unprofitable on a standalone basis will be declined – even if the overall relationship is a profitable one.

This can be happen inside any bank, at any time. The challenge to corporate treasury and other borrowers is understand when it might be a significant factor affecting the way that their bank deals with their banking requirements.

Standardization across banks creates opportunity for borrowers

The opportunity for corporate borrowers comes from the way credit assessment is being standardized across banks, often using the major CRAs, who in turn are required to make their rating methodologies and much of their information public.

This public domain information means borrowers can find out what the key issues, benchmarks and comparisons that apply to their company and industry are. This allows them to get a better idea about where they stand.

The DIY credit application

When considering a major transaction, or just ‘trouble ahead’ in the relationship with its lender, it makes sense for a company to prepare what is effectively a do-it-yourself (DIY) bank credit application, with all of the information, financial data and forecasts that a lender would have to prepare to get a loan approved on their behalf.

Leaving it to the bank to prepare a credit application from scratch is inefficient and prone to errors that the company may never know about since banks typically don’t share their analysis with borrowers. By coming to the first meeting with a comprehensive draft application, a borrower can be confident that facts are accurate and presented in the best possible way.

Your banker might thank you

Your banker will thank you for the DIY approach, in my opinion, since writing up even a one-million-dollar loan application is the most time consuming part of the process.

The credit manager who reviews your application will also thank you. Taking the time to fix applications where the credit analyst had to start from scratch and finish in a hurry is the bane of their existence. If they see the basis for a sound loan, and have the time, they will often do it but why would a prudent borrower take that risk?

The risk is not reduced by simply going to multiple banks. Without a borrower-prepared draft they would have to start from scratch to prepare an application that would have less chance of being accepted, so their motivation is commensurately less.

Of course, if a borrower has done the work of preparing that draft credit application, the effort required for the alternative lender is much less and they will be able to provide a proposal conditional on the details of the draft application being confirmed in due diligence.

The DIY approach to financing is now available to borrowers who want to have a deeper understanding for how they are perceived by prospective lenders, and are serious about reducing the risk that financing might not be available when they need it.

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