Corporates turn their backs on banks

NEWS LAST MONTH that German conglomerate Siemens had reportedly moved €6 billion from a French bank to deposit it with the European Central Bank was greeted with the all-too-familiar chorus that a long-feared run on the eurozone banks had begun. Exactly what was moved where and when is hard to clarify. Initially Siemens was reported to have denied the story. However, it subsequently changed its stance to one of no comment. The move to the ECB would have yielded the company a higher rate of interest (around 1.01%) on one-week money than it would have done at the French bank.

By depositing cash at the ECB Siemens was behaving very much like a bank – although moving deposits to the ECB, rather than borrowing from it, is unusual in many banking quarters these days. This will come as little surprise as Siemens is a bank, having applied for a banking licence last year.

The episode is noteworthy for two reasons. The first is that Siemens has this volume of deposits to move around. According to Standard & Poor’s, Siemens had $20.7 billion total cash and short-term investments on hand at year-end 2010. However, 17 global corporates had even larger balances.

Secondly, and more worryingly, the traditional practice of banks assessing the risk profile of corporates and deciding whether to lend to them is being superseded by corporates assessing the risk profile of banks and deciding whether it is safe to deposit money with them.

So are top-tier globally diversified investment-grade corporates beginning to act like banks? They are certainly having to be far more active in their treasury function. "Since 2007 corporate treasury has become a much deeper risk-management function," Richard Veffer, group treasurer at Dutch telecoms operator Koninklijke KPN, tells Euromoney. "We thought we could relax a bit a year ago but this has not proved to be the case. Counterparty risk used to be our prime focus – now it is also liquidity risk."

He is, however, cautious on suggestions that corporates should be more active in the CP markets to invest their cash, describing such developments as "inevitable – but I don’t like it. It involves so much hassle. If I want to invest in corporate CP I would rather do it through a money market fund."

He warns that the trend of corporates asking banks for more and more collateral could also turn against them, especially given the impact of long-term swaps. "If you have credit-mitigating clauses in there that require parties to post cash collateral, you could find yourselves replacing a counterparty risk with a liquidity risk," he says.

But the market might start to see well-funded corporates encroaching on areas more traditionally associated with financials. High-grade multinational corporates have already been dubbed the new sovereigns thanks to their insulation from the sovereign distress of their domiciles; many certainly have enough cash to set themselves up as banks.

So will we see more follow Siemens’ lead – reckoning that they can probably make a better fist of it than some of the existing players? Banking is surely not the most attractive new business line available to cash-rich corporates but there is no shortage of concern among them over the state of some of the banks with which they deal.

One initiative in the pipeline is the Corporate Funding Association, a project to set up a new corporate bank sponsored by 22 investment-grade-equivalent firms in Europe. The idea was first mooted in 2009 and has taken some time to get past the rating agencies. It also lost some momentum when the credit markets seemed to recover their poise at the beginning of this year. But the market paralysis generated by the intensified sovereign turmoil over the summer has re-invigorated the scheme with a new sense of urgency.

The plan is to set up a bank sponsored by corporates that will lend to those corporates – along the lines of the co-operative Genossenschaftsbanks in Germany or Rabobank in the Netherlands. But this is a multinational initiative, including companies from France, the UK, the US, Germany, Ireland, the Netherlands and Switzerland. The bank will lend exclusively in euros and will be domiciled in France under the supervision of French financial regulator the Autorité de Contrôle Prudentiel. Philippe Roca, one of the two-man project team tasked with establishing the bank, tells Euromoney.

Roca, along with Arnaud Chambriard, is a veteran of Natixis. "Twenty-two firms have sponsored this project not only to diversify their funding but also to anticipate the consequences of Basle III on banks’ regulatory capital and liquidity," says Roca. "This will be a simple, transparent bank that will function solely as a tool for corporates. It will not have the same return on equity objectives as a traditional bank and will be strongly capitalized."

The bank will offer term loans and credit facilities to corporates that are also shareholders. The CFA needs at least 100 corporate members to start operations but may launch before year-end. Roca explains that "for a contribution of €10 million to the capital of the bank, along with the rights attached, a corporate member rated triple-B plus can expect a credit facility of €140 million."

"This leverage of 14:1 for a triple-B plus borrower should be for the first four or five years roughly, as long as the bank is subject to the Basle II standardised approach," says Roca. "Once CFA is allowed to use its internal rating models, the leverage for a triple-B plus rated borrower should range between 20 and 25 instead of 14."

As companies become more nervous about some of the banks with which they deal this may become an increasingly attractive proposition. Schemes such as this demonstrate the strength of the corporate sector compared with the beleaguered bank sector, and the extent to which concerns about bank solvency might prompt firms simply to take their business elsewhere. "European companies have been taking their money out of banks since 2008," says Veffer at KPN. "The decision is very straightforward for a corporate – why would you leave money with a bank if there was any question over its solvency? The risk is completely asymmetrical. Although it may hurt the relationship if you transfer your deposits, that’s better than losing your cash."

Cash rich

Investment-grade corporates are certainly in an enviable position. According to BNP Paribas the top 50 European corporates are sitting on €310 billion between them while corporates worldwide have astonishing cash positions. It is not only large multinationals that have hoarded cash. Companies across the investment-grade space have bolstered their balance sheets, cut their debt levels and extended the duration of their liabilities. As such, many have never been in better shape.

The obvious use to which excess corporate cash can be put is a share buyback. There has been a rush of buyback activity in the US, with volumes 50% ahead of where they were last year.

Indeed, after having tapped the market at such an attractive rate in the summer, Air Products & Chemicals announced a new $1 billion buyback programme in September – even though it had already bought back $649 million of shares so far this year.

And even Berkshire Hathaway, Warren Buffett’s famed investment firm, announced its first share buyback programme on September 27. But, again, opinion is mixed as to whether Europe will follow suit.

For many eurozone corporates this will hardly seem to be the right time to be reducing equity. Europe has seen a series of share buybacks but not the deluge of activity that has characterized the US. Rio Tinto, GlaxoSmithKline and Vodafone have all recently stepped up their share buyback programmes, with Rio Tinto buying back £185 million-worth of shares in a week during August.

"There have been some share buybacks but there is more of a corporate finance consensus that buybacks are not value accretive," says Dominic Kerr, head of European corporate origination at HSBC. "The only time to do them is when the firm is trading at a significant discount to intrinsic value."

Undrawn risks

While companies in the US are taking advantage of huge demand for their paper to lock in historically low funding levels, Europe’s corporate debt sector is suffering a long-lasting drought.

One explanation often given for the different approach taken by European and US corporates to current funding opportunities is the relative competitiveness of their bank markets. (see Oceans apart: What’s behind the divide between the US and European corporate debt markets?, Euromoney October 2011)

And corporates continue to make use of the cheap European lending markets, to the increasing annoyance of banks that have seen their own funding costs soar.

Bank lending has always been a far greater part of corporate funding in Europe than in the US and these entrenched relationships have proved a hard nut to crack for the bond markets. A favourite gripe of the underwriting community continues to be that despite the shocking state of many bank balance sheets across the region banks continue to write relationship business with corporates at completely irrational levels. "European banks are still pitching their balance sheets offering cheap loans – so why would corporates do an expensive bond when they can do a cheap loan?" asks one bank syndicate head ruefully.

Uneconomic lending by European banks is as old as the market itself, with domestic ties usually trumping economic rationale in many corporate relationships. But this practice is still entrenched despite all the capital and liquidity constraints that the sector has faced.

"Europe is very different to the US as there is still a bank market that is crowding out investment-grade bonds," says Jamie Hamilton, senior portfolio manager, institutional credit, M&G Investments. "Banks have such a remunerative relationship with corporates that they are doing large chunks of business at uncompetitive rates."

The bond markets might not like it but this practice has always been tacitly accepted across the market. Writing a cheap revolver for a corporate cements a relationship that will bring in a far more lucrative piece of business elsewhere. Swiss food company Nestlé (rated double-A) inked a €4 billion one-year revolving credit facility in late September with a margin of just 10 basis points. The loan, which was co-ordinated by Citi, was off-market and syndicated to relationship banks with a commitment fee of 1bp and front-end fee of 0.5bp. When Citi itself came to the market in November last year for €1.25 billion five-year money it paid a margin of 178bp over mid-swaps. In June 2009 the bank paid 437.5bp for five-year money.

Banks have committed themselves to substantial volumes of undrawn lending at uneconomic rates – unfunded commitments that could present them with a further headache should they be drawn (under Basle III all undrawn commitments will have capital held against them via the liquidity coverage ratio).

Indeed, the regular practice of banks under stress calling their corporate clients to request that they do not draw down the lines that they have been given has entered market folklore in recent years.

"Banks continue to commit money at levels that are uneconomic," says one banker. "The vast majority of these loans are unfunded, undrawn commitments. But we have gone through periods as bad as this before without there being widespread drawings – in 2008 there weren’t widespread drawings even after Lehman."

With investment-grade corporates hoarding cash rather than drawing it, these revolvers are not at the top of European banks’ most pressing list of concerns. But in late September French utility GDF Suez caused consternation among some banks when it drew down one-third of two revolving credit facilities to deposit the capital with a non-relationship lending bank.

The firm’s undrawn credit lines mature in 2012 but were refinanced in March via a €4.5 billion, five-year multicurrency line from 24 banks. The single-A rated corporate did not draw down the funds for working capital – it did so simply to deposit them elsewhere. This is presumably a procedure that the banks will not want to see widely adopted.

The provision of cheap undrawn capital such as this is something that companies can no longer take for granted. Under Basle III banks will be required to hold capital against their undrawn facilities, which will choke off much of this type of credit for their customers.

Veffer at KPN explains that he refinanced the firm’s revolving credit facility in July, conscious that time was running short. "We refinanced at very attractive pricing that was substantially cheaper than the bond markets – but we probably would not be able to get the same deal now," he says. "Banks weren’t really accounting for Basle III yet, but now they are more and more."