Creating a win-win situation with Wallet Distribution
Bank relationship management
With a shift in risk awareness and a trend for corporates to diversify their banking partners, Zanders has devised a model to objectively review banking relationships from a corporate perspective. So what is the Wallet Distribution Model and how does it work?
The worldwide financial collapse following the sub-prime crisis and the current economic slowdown in the industrialized world have caused a shift in risk awareness from both a bank as well as a corporate perspective.
Lots of banks made tremendous losses and some were bailed out by their governments. Those new shareholders themselves are facing increasing deficits and are now in the position of having to justify to their electorate why government funds were used to help the once ‘untouchable’ financial institutions.
The ‘casino’ banking days are gone and to avoid history repeating itself, all stakeholders agree that new rules should be adopted to ensure that financial risk measurement and management solutions become efficient and that potential casualties are detected at a very early stage to allow proactive remedial action.
In line with this approach and to support it, the Basel Committee has been strengthening its set of Basel II rules and sooner or later it will enforce the mandatory implementation of the Basel III regulations that will oblige the banks to be more risk-sensitive and to hold more equity to guarantee their assets.
This is likely to cause an upward shift in the cost of borrowing and getting access to bank credit lines will become more expensive for the majority of corporates. Because of the higher capital reserve requirements, banks will need to realize a ‘return on equity’ return on a higher amount of equity.
Hence banks will become more critical in granting credit; they will not only focus on tightening the covenants they are imposing and credit ratings but credit committees will need to know in advance the total banking revenue that can be realized on the global relation with a corporate customer. In other words, banks will focus more on which part of the total banking business wallet is being made available by a corporate customer and what share of the fees in this wallet it can tender for.
But it’s not only banks, from their credit lending perspective, that are reviewing their relationships. The credit crisis also made it clear for corporates that depending on a limited number of banking partners can be risky. One can just imagine the sheer impact if one of your core banks collapses and subsequently the credit facility is withdrawn or, even worse, your cash management structure fails to operate.
How are corporates coping with the new approach to bank credit?
First of all corporates will use their traditional kit of tools to reduce their need for external borrowing facilities by optimizing their financial supply chain (reverse factoring, factoring, focus on stock rotation, DPO and DSO, accurate cash forecasting).
However, though these efforts make a difference, they will not allow a corporate to realize a level of 100% auto financing. Hence, a corporate should safeguard its access to external funding resources.
To assess which instruments a corporate can use to deal with this, one has to differentiate between corporates benefiting from a triple-B rating (or higher) and corporates having a rating below investment grade or not having a rating at all. A lot of mid-cap corporates are in the latter category because they cannot justify a public rating (small capitalization, not stock-quoted).
Corporates in the upper tier of the market have the luxury of not having to rely only on banks to get access to funding. With a credit rating they can tap both long- and short-term capital markets themselves. Though they will still need banking services (e.g. cash management, hedging), they can leverage their name and reputation to obtain competitive terms and conditions from banks; banks will probably be happy if they are able to recover the cost of the relation.
Lower tier or mid-cap companies may still have restricted access to capital markets but will have to rely on their banking partners to get the appropriate banking credit facilities in place. Next to the limited availability in funding instruments we also see that the lower tier and mid-cap companies have to rely on more domestic banking relationships. The blue chip companies are still served by a wider group of international investment and bulge bracket banks.
As outlined above, they could be facing a liquidity risk if they are not willing to pay higher credit spreads or if they cannot offer nearly risk free income to their banks that will enable them to accept a lower interest rate spread. Besides the margin issue, the financial crisis gave the corporates a wakeup call too with respect to risk diversification. Until the first half of 2008 we noticed a rationalization trend among big corporates to reduce the number of banking partners. Technically it had become feasible to cover the globe with two or three banks. Nowadays the new mantra is diversification.
The liquidity risk in combination with a mandatory risk diversification has triggered an interesting dilemma for corporates when they assess their banking relations strategy: “What is the optimal number of relationship management banks we need to have versus the credit commitment we expect them to make in exchange for a fair portion of our business banking wallet?” This is where Zanders pioneered the Wallet Distribution Approach. In this approach, we use our Wallet Distribution Model as a transparent and objective starting point to review the bank relationships from a corporate perspective.
The Wallet Distribution Model
Based on a predefined structure customized for client-specific requirements, the bank’s services and fees are individually analyzed and given a score. The assessed bank service areas cover, for instance cash and liquidity management, investments, foreign exchange (FX) and interest rate (IR) derivatives, debt capital market, insurance, leasing and funding facilities. Besides qualitatively scoring those bank services, we analyze fee structures and margins earned by the bank. The definition of fees and margins for the Wallet Distribution Model is quite broad and encompasses all direct and indirect fees earned by the bank on its relationship with its client.
An example of direct fees includes credit spread, commitment fees, fees related to cash management and payment services, advisory and underwriting fees etc. Next to the direct fees we assess the indirect fees and margins made by the bank, such as bid-ask spread on derivatives trading, float in payments and debit/credit interest on cash pool structures.
The last components to consider in the model are the current committed lending facilities including credit lines, bank loans, leases and trade finance instruments. The combination of the assessment of bank services, fees and margins and committed lending facilities are input into the Wallet Distribution Model. As an output of the model, various analyses are available top-down to assess the win-win situation and reveal room for negotiations, such as:
- General score of each bank including all considered and weighted information
- Scoring each service of a bank and benchmarking with the others including further breakdowns
- Market/country coverage matrix of a bank
- Reporting unique services/representative offices of a bank in relevant exotic countries
- Computation of key performance indicators such as bank’s RaRoC
- Calculation module to price loans and margins earned by the bank
The credit commitment matrix
One possible report from the model is the credit commitment matrix, which relates commitments to the bank profits from the corporate.
Banks are graphically categorized into a matrix with four quadrants to identify the corporate-to-bank relationships, whereby banks are categorized as ‘enigmas’ and ‘free lunchers’ might indicate there is a need for action in order to become ‘balanced partners’ or ‘goodies’.