That Goldman Sachs feels it must write to the Federal Accounting Standards Board (FASB) to ask that it consider making banks mark loans to market is telling. It’s the clearest signal yet that the pure investment banks are, finally, concerned at the potential which lurks within the large commercial and universal banks.
The latter have been a threat for several years now, but only in recent months has it become truly worrisome. That is, in part, due to consolidation. Citigroup, JP Morgan Chase, Bank of America, Deutsche Bank, even CSFB with the addition of DLJ’s top-notch leveraged finance team, now all offer a wide range of credit products, with a balance sheet to back it up.
Another reason is that only in the past year has the extension of credit in whatever format – loans, bonds, commercial paper – returned to the centre stage of the investment-banking business as a result of the stock markets crash and consequent drop in M&A and equities transactions. And pure debt houses are proving that the traditional view of credit as a less profitable business than equities and M&A is no longer valid; Barclays Capital, for example, brings in over 20% return on capital. Companies have realised the strategic importance of debt amid recent economic and market volatility.
Manage your debt well and you achieve your strategic goals and keep your share price up: mismanage it and you destroy shareholder value. Universal banks now talk of debt advisory bankers dealing with companies at the same level as mergers and acquisitions advisers.
Glass-Steagal used to prevent too much linkage between credit products, and excluded the providers of credit as principals from equity, and by extension M&A, transactions – the higher-margin staple diet of the investment banks. Now each of those universal banks is allowed to chase those businesses, and to a greater or lesser extent will be able to do a good job of it. What’s more, companies are responding. A large European bank tells how it is offering to double its credit lines to select large US companies.
Grateful companies are promising mandates in return. The investment banks realise that relationships are forged from using the balance sheet in a harsh economic environment such as the one we’re in now. And they cannot compete effectively in that arena.
They can and do lend selectively. Witness Morgan Stanley’s willingness to extend $2.5 billion to Lucent in February for its debt restructuring. But it was a short-term deal, with no intention on the firm’s part of becoming a principal provider over the longer term.
That increases the risk of a client being forced to go to the capital markets to replace that debt not because it’s in its own interests, but in the interests of the investment bank.
Curiously, the investment banks have done little to take advantage of the freedom brought by the end of Glass-Steagal, other than to hire a few loan syndicaters to underwrite and distribute large, well-priced and short-term acquisition-related loans. Merrill Lynch has done more than the others by transferring money-market assets in its cash management accounts into Merrill Lynch Bank, which it launched just over a year ago. That’s helping to build a robust liabilities line on the balance sheet, but doesn’t suddenly grant Merrill the ability to use and understand credit in the way a commercial bank does.
The others have done nothing, although there are continual rumours that the senior chaps at Goldman Sachs and Morgan Stanley are wondering whether a tie-up with a commercial bank might have to be their next move. Merrill, meanwhile, is perpetually said to be walking down the aisle with HSBC.
The alternative of course is to try to level the playing field; hence Goldman’s letter. If banks were forced to mark their loan commitments to market, it would have a direct impact on earnings and share prices. That might force banks to reconsider how much to lend and to whom and lead to a major repricing of loans. Clients are not going to be happy at the prospect of paying higher fees for their credit lines. But credit is a commodity that no one can live without.
Goldman’s general idea is a good one, and several universal bankers have said so, including officials at JP Morgan Chase, the largest loan house. Marking positions to market forces institutions to be more rigorous in their risk management. But to try to have credit lines accounted for under FAS133, and thus treated as derivatives used as hedging tools, is clearly intended to provoke debate. It’s not a proposition to be taken entirely seriously. It could make for a clumsy series of rules trying to determine when a loan is or is not a loan.
What no proposal to mark loans to market will achieve, however, is a levelling of the playing field between investment and universal banks. The latter will still have the balance sheet and knowledge of how to use it as a principal lender. Investment bankers don’t. And any attempt to build principal lending business will take too long and might lead to big mistakes.
That leaves the ball firmly in the court of the investment banks. They still provide some of the best M&A advice and have many of the best equities bankers in the world. But that world is changing around them, and they can’t simply sit there and observe for much longer.
