Strategies for improving credit access: A study by the FEI research foundation finds that credit is once again the key product that companies seek from banks - but that its often subject to tough scrutiny. (Financing).

Credit access and availability have become key priorities as banks continue to tighten credit reins in today's uncertain economic environment.

As credit agencies begin to focus on potential downgrades, credit is reemerging as the power center of banking. A recent FEI Research Foundation study, Access to Credit: How Corporations Are Changing Strategies to Ensure Growth and Sustain Liquidity in Good Times and Bad, provides insight into dealing with current market trends and improving access to credit. (A related article, "Tough Times and Tougher Banks," appears on page 21.)

Based on discussions with executives from several prominent corporations, author Frederick C. Militello Jr. reports that that risk-adjusted return on capital (RAROC) requirements are the key drivers when banks determine if a company is granted credit. "Companies must be prepared to illustrate how they provide an adequate return on the total portfolio of business opportunities they bring to the relationship," Militello states.

Negotiation for adequate credit is further complicated during times of economic contraction when companies must still provide their bankers sufficient fee - based income and deal flow. As a result, bankers are making company assessments with greater scrutiny and seeking added protection.

"Doing business with banks -- in terms of gaining access to credit -- was becoming more difficult," notes Tod Christie, Treasurer of Sealed Air Corp. "A quid pro quo attitude was clearly becoming evident, and we just couldn't be sure that we could continue generating the deal flow necessary to keep each of them [bankers] sufficiently satisfied." Indeed, most of the companies participating in the study have experienced noticeable changes in negotiation of debt maturities and loan covenants in recent months.

In addition to more restrictive covenants and increasing credit spreads, Militello observes that banks are obtaining greater flexibility in the ability to enter into loan sales and participations. Furthermore, companies that might normally oppose loan syndication are agreeing to the bankers' conditions in the hopes the terms will either not be exercised or will be done in close consultation with their bankers.

With bank capital allocated under the more disciplined RAROC approach, company bank groups get smaller, the study says. "Specifically, if companies are going to get the credit access they need, then they must be important customers to their banks -- a trend that points in the direction of still smaller bank groups," Militello explains.

The consolidation of the banking industry has also contributed to this development. Participating companies agreed that the consolidated credit appetite significantly decreases after a merger of two banks. Furthermore, fewer people control the credit fate of any particular company. Tony Pearl, CEO of System Capital Corp. (the finance arm of McDonald's Corp.), elaborates, "With consolidation, we notice that the individuals actually making the overall decisions on credit are tending to move further away from the actual customer. This is not a positive development, as they simply don't understand the business as well."

Formulating a Plan

The current challenges have spurred companies to look for alternative sources to traditional bank credit. In recent years, the use of synthetic credit facilities, such as the extendible commercial note (ECN), has been on the rise. First developed by Goldman, Sachs & Co., the ECN accomplishes the same purpose as a backstop credit facility provided by traditional commercial banks. In fact, the study notes that in some cases, credit rating agencies have looked favorably upon such structures.

Other alternatives include seeking out bankers in foreign countries with more experience in a particular industry or the use of asset securitizations. Militello highlights System Capital Corp., which represents an alternative to direct bank lending. Organized to provide financing for McDonald's franchisees and suppliers, as well as to McDonald's itself, System Capital was structured as a hybrid finance company and structured finance vehicle that is active in the asset securitization market. Although System Capital still relies on its bankers for credit, the capital allocation required is much lower and affords the supporting banks the ability to earn management and security issuance fees. Today, the company has approximately $1.6 billion in loan assets funded primarily in the commercial paper and private placement markets.

In lieu of seeking alternative credit instruments, Sealed Air Corp. has taken major steps toward using bank credit more judiciously. In 1999, the company gained name recognition in the global capital markets through a $200 million public Eurobond issue. Additionally, Sealed Air has a revolving credit facility agreement for approximately $200 million with a 364-day maturity. Put in place for working capital and general corporate purposes, its maturity of less than one year would not require allocation of bank regulatory capital for funds not drawn.

The study also focuses on the changing relationship between n company and its bankers. Companies are increasingly refusing to deal with banks that are not in the credit business. Eight out of the 10 companies interviewed for the study were shifting relationships toward banks able to provide both investment banking expertise and the lending power of their balance sheets.

As such, positioning, rather than straight term negotiation, has become the norm. Corporations are focusing more on the relationship selection process, and taking a more holistic approach, Militello says. In addition to promoting increased awareness of bank RAROC requirements, companies consider several factors, such as bankers' history of commitments when managing relationships. For the Movado Group, keeping existing bank groups happy is a real challenge. Currently, the company's bankers represent a balance between commitment and capabilities -- two banks receive most of the foreign exchange and cash management business, while the remaining banks benefit from secondary fee-based opportunities.

Frank Kimick, Movado's treasurer, admits the company's long-term banking relationships count when allocating compensating business. He adds, however, "It behooves me to also look toward the economics of each situation to see where the company can secure the best services to meet our primary and secondary fee-based business opportunities."

The study further examines company observations on one-stop shopping for credit. Though generally a positive development, in that companies would be better positioned in bankers' eyes, corporations are beginning to view the trend with some skepticism. System Capital's Pearl comments that banking has become more of a commodity business as many banks try to become one-stop shops. Furthermore, he prefers dealing with more experienced and specialized banks. "In my opinion, one-stop shopping leads to less customization and innovation in financial product solutions for the corporate customer," he says.

While Kimick admits that at first blush, the prospect of one bank offering a wide range of services is attractive, he feels it opens his company up to too much exposure. "In today's world of consolidation and uncertainty, no company can afford to give too much of its business to only one or two banks, regardless of how many services those banks might be able to provide. It's just too risky."

Cheryl de Mesa Graziano is manager of research for the FEI Research Foundation. To obtain a copy of the full survey, visit the Web site: www.fei.org/rf/publicist.cfm