As the world enters the fifth year of economic growth, regulators, shareholders and creditors of international banks must be starting to wonder what horrors are building up on the banks’ balance sheets. Disturbingly, the problem loans if they exist will probably be hidden from public scrutiny in the form of bilateral lines. No doubt they are being justified to the banks’ internal credit committees by that well-worn excuse that they are essential to maintain relationships with clients that offer other, more profitable business.
Banks continue to lend their money at thinner and thinner margins, even to riskier borrowers. Take Hungary. In September 1995, the National Bank of Hungary, rated Ba1/BB+ by Moody’s and Standard & Poor’s, paid 150 basis points over Libor for five-year money. By August 1996, it had pushed its banks to lend at 50bp over Libor. By the end of last year, it was renegotiating terms to as low as 20bp over. There has been no credit rating upgrade in the meantime to explain this dramatic improvement. If National Bank of Hungary can push for such terms, what price are strong-rated corporates or supranational borrowers able to achieve?
And there are few corners of the lending business where banks will not tread nowadays. Early last year, Russian banks, despite their opaque reporting, began raising small six-month loans paying 550bp over Libor. By the end of the year, margins were headed below 400bp and the amount of each loan was approaching $100 million.
Whenever loan syndication managers sound the alert on a supposed market-testing syndication whose failure, they say, will set the bottom for pricing before a slow upturn the deal obstinately succeeds.
Away from the illogical business of primary loan syndications, three separate developments are under way that illustrate how banks are at least striving to manage their loan portfolios more actively and more sensibly.
Since the last banking crisis at the start of this decade, the theory that banks should construct better-diversified portfolios has gained favour. Now banks, pressured by their shareholders, are putting theory into practice.
The clearest sign has been the huge number of securitization deals including, most notoriously, that announced by NatWest for a mixed bag of its own corporate loans.
Offloading unwanted or unprofitable loans to capital markets’ investors is one way to free up capital that might be put to better use. All the better for a bank if it retains a large customer’s favour for having originally made the loan, long after it has transferred the risk to bondholders.
Equally telling is the founding of the new London Market Association by seven leading international banks to trade loans in Europe. This association complements New York’s Loan Syndications & Trading Association which was founded early last year.
Significantly, certain LMA founders, such as BZW and NatWest Markets, were dismissive of attempts to promote a secondary market in non-performing loans in London in 1992. Now they are keen enough on secondary trading of performing loans to want an association to handle the day-to-day details of standardized documentation, trading and clearing procedures, and dispute resolution.
Probably the single-biggest task for the association will be to persuade borrowers that there are advantages for them also in allowing ease of transference in their loan documentation and in encouraging a secondary market to develop. It is not impossible that borrowers could be convinced: more trading and better liquidity means more potential investors in their loans and therefore better pricing. But the knot between lending risk and banking relationships is a tough one to cut. Some borrowers will want to know that their lead banks retain a significant exposure to them.
Perhaps a cleaner and easier way for banks to manage loan portfolios will be through the much-hyped, but still underdeveloped, credit derivatives market. The British Bankers Association, in a recent survey of leading dealers, suggested that the notional principal outstandings of the London market might grow from $20 billion at the end of 1996 to $100 billion in 2000.
To date, the largest users of credit derivatives have been securities firms and interbank swap dealers reducing their credit exposure to each other. The dealers surveyed by BBA predict that, increasingly, regional and specialist banks might use default swaps and credit spread options to rebalance the geographic and sector concentrations of their loan portfolios.
Holding a loan and selling a credit derivative against it has another obvious advantage for the lender: the borrower needn’t know that its bank has reduced its ties.
When the next banking crisis comes and, make no mistake about it, it will sooner or later it should be of some comfort to those worried bank regulators, creditors and shareholders that banks are working so hard to pass on much of their credit risk. Maybe the bondholders (and credit derivative stuffees) are the ones who should be most worried.
