Practical challenges faced by CFOs and treasurers today
By design as well as intent, there have been areas within the banking landscape that have remained obscure and complex over the years. Companies have struggled to effectively manage these areas, which often result in sub-optimal terms and a significant outflow of fees. Companies could easily overcome these situations if they took control of the process and if banks offered greater transparency.
Unfortunately, most companies continue to believe that their banks are always working in their best interests and that their advice is unbiased, independent and can be blindly relied upon. The reality is that banks have to work within limited confines of their business and risk environments, and their advice is often skewed in favor of what would pass the smell test in their respective organizations.
Credit agreement inclusion
A common clause included in most credit agreements relates to the banks having “no advisory or fiduciary relationship.” This implies that the borrower is capable of evaluating, understanding, and accepting the terms, risks, and conditions of the underlying transactions. Further, the agreement stipulates that the bank is acting solely as a principal and will not be acting as an advisor, agent, or fiduciary of the borrower. The agreement also states that the bank may be engaged in a broad range of contradictory transactions. Such transactions involve interests that differ from those of the borrower. Lastly, the agreement states that the banks do not have any obligation to disclose these conflicting interests.
This is contrary to what most companies believe about their banks working in their best interests. The banks advising the company are explicitly stating that they are not acting as advisors and that they are not responsible for disclosing any other conflicts of interest that drive them to advise the company in a specific direction.
Alignment of interest
Bank compensation is not aligned with the interest of the company but rather with the closing of the transaction. This drives banks to close transactions without considering how it might affect the company, be it now or in the future. Market flex is a perfect example where banks can unilaterally increase the rate of interest of a credit facility to make it more marketable to investors.
Borrowers unprepared or unaware of these practices are usually pushed into a corner at the last minute. Such borrowers are incapable of negotiating favorable terms, resulting in inflexible capital structures and higher costs of financing.
Nature of bank groups
A large banking group may mean adequate liquidity; however, the cost and terms of having this liquidity is often driven by one or two banks, which could mean higher costs and sub-optimal terms, even though most of the other banks in the group would be keen to offer better terms. Large investment banks will often need higher returns on capital, resulting in higher cost of financing for the borrower.
Term sheets through precedence
Companies that do not regularly access the markets usually depend on their lawyers to obtain term sheets of recent deals. This approach fails to consider the flexibility that some banks may be willing to offer due to several factors, including changing market dynamics and the discount for breaking into a new relationship. There are no precedents when it comes to financing, and everything is always up for negotiation.
Bank relationship profitability
Another underestimated area is the profitability of banking partners.
Profitability is the bank’s return on its risk-adjusted capital. It is typical for large global investment banks to have returns over 25%, which is usually achieved through mergers and acquisitions, and lead appointments on financing transactions while keeping minimum commitments in their books. In a large bank group, oftentimes commercial banks are not willing to sustain these large discrepancies in returns, especially when liquidity is hard to come by, which makes it imperative for CFOs and treasurers to ensure equitable distribution of their wallet for longer sustainability of their banking relationships.
Key considerations for a successful bank financing approach
- Build your own conviction on your credit standing and the implied profitability of your banks. This will enable you to have a clear view on your capacity to negotiate.
- Plan your financing months ahead of time, even if there is no immediate requirement. This will prevent you from giving in to last-minute inclusions by banks.
- Negotiate terms based on your specific business requirements.
- Always look for ways to have flexibility, which can offer multiple options in any given situation. Remember, there is no market practice when it comes to agreement terms. Everything is subject to negotiation if presented in the right manner. While lead banking relationships are determined by several factors, it would be prudent to negotiate pricing and terms with each bank within the bank group and converge the banks including the leads towards the most favorable terms.
- Finally, always drive towards having equitable share of wallet among the banks to ensure sustained liquidity and long-lasting bank relationships.