Global financing 2003: Selling more products to fewer clients

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 Methodology SO FAR, 2003 has been a banner year for the debt capital markets. As they wound down for the holiday season, bankers were surprised and relieved at the range of borrowers raising capital and at the amount they had borrowed.

Low interest rates and rallying credit spreads have meant borrowers can access the markets on decent terms, regardless of maturity. The tightening of spreads on 30-year corporate bonds shows how investors are still looking to spread and to duration to make money. Sars and the US-led invasion of Iraq did not have the macroeconomic impact that many feared, though rising government bond yields may yet take their toll on investors.

Miles Millard, co-head of Deutsche’s European corporate coverage, says: “We thought European corporate new issuance volumes would be flat, but volumes have increased even without a pick-up in corporate activity.” Even at a time when companies have not been financing capital investment, they still have reason to be issuing busily. Millard says: “Companies have taken full advantage of historically low rates and investor appetite for credit.”

In June, Deutsche worked on a €400 million subordinated debt issue by German gas and engineering company Linde. “Companies are issuing attractively priced, ratings-friendly debt to refinance their balance sheets and term out liabilities,” says Millard.

Financial institutions have issued around 70% of total debt raised so far in 2003, a significant rise on last year. On the public-sector side, as well as governments, European regional and municipal authorities are issuing again. What one DCM head calls “a resurgence of the historically boring markets” promises more business.

Booming debt business For debt-focused houses, the upshot is simple. “Total returns to August 1 are unprecedented,” says Christian Wait, Lehman Brothers’ head of debt capital markets for Europe.

Just as reassuring for the big banks is the consistency of their performance. An apparently immovable top tier is the first choice for capital-raising deals across the board. Nine of the banks in 2003’s overall top 10 in Euromoney’s capital-raising poll of issuers also featured in last year’s top 10.

ABN Amro is this year’s only new entrant. The Dutch bank scores at the expense of Merrill Lynch, which drops from fifth to thirteenth place. And there are some notable movements within the top 10 in the overall poll of issuers. Goldman drops from fourth to tenth while Barclays Capital rises from ninth to fifth. It’s good to know that borrowers differentiate between banks. After all, banks try hard to stand out from one another.

That can be hard. “Most banks have balance sheet. Everyone’s got solid syndication teams. Everyone’s got good distribution,” says Joe Dryer, Dresdner Kleinwort Wasserstein’s global head of capital markets origination. To sell themselves, banks now need to combine and present these services as effectively as possible. Some issuers take a close interest in how their bank providers organize themselves.

For one multinational corporate, a bank’s team structure and organization is more than just internal plumbing. It has a direct impact on quality of service. “There are differences between how banks operate,” says a treasury official at this borrower. “They need to have clear lines of communication, for example between the syndications desk and the derivatives desk. Some are better at it than others.”

Hand-in-hand with restructuring of capital-raising teams at banks is the theory that, as far as your client list is concerned, fewer is more. “Every bank has to hit their Raroc [risk-adjusted return on capital] target numbers, and one of the best ways is to concentrate on a smaller number of clients to whom you can effectively sell your bank’s suite of products,” says Charles Pelham, head of syndicated capital markets at Banc of America Securities. The mantra is: more products, fewer clients.

The best relationships to start pruning are often those based on lending. In the absence of profitable, event-driven loans, banks have reassessed the direct and indirect returns that they get from providing liquidity backstops.

Dresdner Kleinwort Wasserstein rises from 22 in the overall capital-raising poll in 2002 to 15 this year. When it merged its bonds and loans business in 2001, deploying its balance sheet in a more rational way was a key part of the process. The bank identified around 800 clients to which it would lend. These were most likely to use a broader set of DrKW products.

“That represented a big contraction,” says Dryer. Previously, the bank lent to around 1,500 clients in the US alone. “The balance sheet is used as a means to an end. Differentiating those clients requiring multi-product coverage versus those that only required the loan product was a crucial part of putting bonds and loans together.”

In May, Deutsche Bank’s well-publicized withdrawal, on the day before syndication began, from a e10 billion revolving credit facility for Volkswagen – apparently in response to being overlooked on bond issues by a company to which it had hefty loan exposure – suggested that European banks had spectacularly revised their approach to relationship lending.

Deutsche’s behaviour was not an aberration. Its rivals had been waiting to see which bank would be first to make such a move with a high-profile borrower.

“It should have been amazing that Deutsche pulled out of the VW loan,” says the head of European debt capital markets at a US bank. “VW is a big German corporate and a major borrower in the capital markets and Deutsche didn’t extend credit. But now it is all about the cross-sell and only covering clients relevant to you.”

Deutsche points out that it is still committed to relationship lending. “We have a Raroc model that tells us, based on a credit scoring system, what sort of return we would require on a pure lending deal for the transaction to wash its face,” says Sean Malone, managing director in loan capital markets. “Generally the transactions that we look at fall short of the mark, that is, it costs us money to make that loan. But in a lot of cases we do lend because we have a broader relationship with the borrower.”

More selective approach But it is more selective in its lending. “Now we are looking to target our balance sheet a bit more effectively at counterparties with whom we have a multi-faceted relationship,” says Malone. “We’re probably scrutinizing this a bit harder now. And our product portfolio is as wide and as high quality as anybody else’s, so if anything we feel less of a need to use credit as a loss-leader, because we have more to offer in other areas.”

Refining its approach to lending hasn’t dented Deutsche’s reputation for high-quality service. It returns to the top of the overall table after being pushed down to third place last year by Citigroup and UBS. Issuers also vote it top of 14 of the individual product categories, including international bonds, high yield (where it didn’t make last year’s top five) and international equity offerings.

Though banks may be becoming more scientific about measuring portfolios of credit exposure and calculating the capital costs of lending to issuers versus revenues from other services, relationships are still important. When Linde mandated Deutsche Bank and overall runner-up Citigroup as lead arrangers of its e400 million subordinated debt issue, it was dealing with banks that it knew well – both are dealers in Linde’s MTN programme – and could trust on a more unusual issue that was triggered by Standard & Poor’s new pension liability evaluations.

“We needed to stabilize our rating. This was a first for a German non-financial issuer,” says Guenther Jakob, Linde’s head of corporate finance. “We talked to a range of banks and heard a range of proposals. Deutsche and Citigroup are very well known houses in the capital markets and they gave us comfort that they would run a good deal for us.”

Linde’s banks are expected to provide credit. “Balance sheet is important to us,” says Jakob. “Although we do over 90% of our funding in the capital markets, we want to use various markets for funding and if necessary access the loan markets. A commitment to that is important if they want to get other business from us.”

Other borrowers echo Jakob’s point that a bank must be prepared to lend to its key clients. “We think it is very important that people are willing to use their balance sheet,” says Egil Steinberg, head of long-term financing at Norway’s Statoil. “That has defined our core relationship banks for at least 10 years. The basis for the relationship is that we have banks out there that are willing to step up and use their lending capacity if we need it.”

Lending can also help build relationships from scratch. DrKW’s relationship with one large European utility company, for example, was founded on its balance sheet. Now DrKW is on its MTN programme and has done some investment banking work.

Although it uses its balance sheet to target new business, DrKW does so on the basis that successful cross-selling must follow. “Our client relationships are now driven on the viability of an acceptable risk/reward ratio. If we can’t cross-sell our capital markets products or advisory capability to a balance sheet-only client then we will think twice,” says Dryer.

There’s no guarantee that lending can be used as an entry point into broader bank relationships. Not all issuers feel under any obligation to reward lending banks with other work. Some treasurers still strive to pick the best provider for whichever service they require at any given time rather than bundling up their purchases of capital raising and related risk-management products.

“We treat our businesses as entirely separate,” says one treasury official at a UK-based multinational. “We don’t give business based upon the services that banks provide in other areas. If a bank is giving us back-up lines, it doesn’t mean we’ll use them for something else.” Issuers value distribution strength and structuring capability across a range of markets as well as willingness to lend.

Access to global funds a plus With the development of the Asian retail market and European issuers keen to help US investors diversify, a bank that has access to a global pool of investors can offer borrowers what they need most.

“The investment banks that are winning are the ones who know what the top 25 investors in Europe, Asia, and the US are doing,” says Lehman Brothers’ Wait. “If you make a loan and say to a borrower: ‘OK, I’m your new best friend,’ you’ll still be waiting two or three years for the bond mandate.”

That is time that European banks increasingly won’t allow themselves. The interval that banks can allow for lending relationships to deliver more lucrative work is being compressed.

“Banks in Europe have become more disciplined in their approach to client relationship development,” says Tim Ritchie, head of global loans at Barclays Capital. “They have shortened the time frame during which they are prepared to provide balance sheet commitment without receiving more rewarding ancillary business down from as much as five years in the 1990s to a maximum of one to three years now. Relationships which don’t develop according to plan are increasingly being reassessed and in some cases severed.”

Borrowers, for their part, are more closely attuned to what other business different banks value. A bank won’t appreciate being picked to do bond deals if it would rather win M&A advisory mandates, for example. “Clients now have a better feel for how individual banks value various types of ancillary business, which makes for a better-informed and more commercial relationship,” says Ritchie.

If it’s clearly in a bank’s interests to sell as many products to a client as possible, less immediately obvious are the advantages that cross-selling offers to a borrower. But they are there. UK bank HBOS has been one of this year’s highest-profile borrowers. As well as diversifying its investor base with the UK’s first covered bond programme, HBOS raised $1 billion with an Asia-targeted retail trade, and raised ¥60 billion ($500 million) with the first public lower tier-two yen deal.

“If you look at the capital transactions we’ve brought this year, they’ve all been targeted at different places, both by investor type and geographically,” says Richard Shrimpton who, together with HBOS’s head of funding and liquidity, Tony Main, manages the bank’s term funding.

With a larger funding programme demanding a more systematic approach to issuing, HBOS also needs a more systematic approach to instructing its banks. They in turn need to offer it a range of financing options. “We’ve made it clear to the investment banks what we value,” says Shrimpton. “We assess their ability to touch us across the whole treasury dealing area. We also want regular updates on market developments that we might miss because we are busy issuing.”

Starting 18 months ago, HBOS set up an internal league table of its chosen banks’ performance, based on the products and services they can offer. “The last 18 months have seen our mandates increase, so we had to adopt a considered approach,” says Shrimpton. “As individual entities, Halifax and Bank of Scotland weren’t big users of the capital markets. Our reliance on wholesale funding has increased.”

If cross-selling drives a bank to look at how best to integrate its different teams and products, this can make the day-to-day running of deals easier for a borrower. Late last year a leading German insurance firm considered issuing a subordinated bond. The project then evolved toward an equity capital markets solution in the form of a mandatory convertible. In the end the client opted for a straight equity issue. Dresdner kept the same team on the deal through its various incarnations. “In the past, that job would have required three different coverage teams each with their own set of objectives, marketing three different products,” says Dryer.

Borrowers are using more eclectic combinations of financial products and contacts. UK utility Southern Water’s £2 billion whole-business securitization at the end of July brought to a close a deal that saw Citigroup combine its debt capital markets and private-banking teams. Back in January 2002, when Vivendi Environment was looking to buy Southern Water, the acquisition was held up by regulatory problems. To stop Vivendi missing out on its desired target, Citigroup set up First Aqua with six of its wealthy private-banking clients. First Aqua acquired Southern Water and ran it for a year until a sale could be arranged to RBS Private Equity and Vivendi.

“First Aqua was a very interesting example of cross-selling,” says Citigroup’s Mark Watson. “The funding and capital structure consisted of debt, preference shares and real equity. We underwrote a sterling issue of preference shares, we used our asset management and loans business to arrange credit distribution institutionally, and for the equity we turned to our colleagues in the private bank.”

At a time when private-equity houses might have taken a month to get approval to invest, Citigroup’s private-banking team raised $100 million in six days. “There are very few banks in the world that could have done all that,” says Watson.