Tough Times/Tougher Banks: Bank consolidation and the recession have made it more difficult for companies to find lenders ready and willing to give them money. (Banking).

A decade's worth of consolidation has so altered the country's banking system that U.S. corporations are being forced to structure their relationships with lenders in a profoundly different way. Gone are the days when commercial banks would compete for a company's business like raucous rug merchants at a Middle Eastern bazaar. In a trend that has strengthened during the current recession, large banks are seeking deeper and more profitable relationships with their corporate borrowers -- and turning away those who aren't willing to play along.

Recessions come and go, just as this one most surely will. There's one thing that won't change, however: Companies will find themselves under increasing pressure to deepen their relationships with bank lenders, whether that's an opportunity to manage their foreign exchange exposures or underwrite a stock or bond offering. Banks are intent on boosting their returns to shareholders, and lending is a low-margin business to begin with. And now the nation's economic downturn has made most banks even more reluctant to lend money to corporations, resulting in a credit crunch for many borrowers.

"Your typical middle-market Fortune 1000 company just doesn't have enough business to go around to a large number of financial providers," says R. Charles Shufeldt, an executive vice president for corporate and investment banking at Atlanta's SunTrust Banks Inc. "They just can't satisfy us, and we're becoming more demanding."

From a bank's perspective, the advantage of forging a deeper relationship is obvious. When it can sell fee-based services like cash management or the administration of a 401(k) program, the relationship becomes more profitable. "The benefits to the customer should be obvious, too," says Jack Neal, a managing director in charge of corporate banking relationships at Bank One. "If they don't do that, they won't have a bank."

Still, from a borrower's point of view, there can be advantages to working more closely with a smaller number of banks. The reward may be a greater measure of loyalty during times of economic stress -- which, of course, is when loyalty counts the most. "To use a baseball analogy, the tie goes to the runner," says Arthur McDonald, a partner at Tatum CFO Partners, a consulting firm for finance departments. "If you're a valuable business proposition for the bank, it's going to help you."

In part, the trend towards relationship banking has been driven by the banking industry's sharp contraction over the past 10 years. One statistic pretty much says it all. There were 11,927 commercial banks in 1991, according to the Federal Deposit Insurance Corp., compared to only 8,315 at the end of last year -- a 30 percent reduction.

But even these numbers fail to tell the entire story. Following a long series of high-profile mergers, the ranks of the country's largest banks has undergone a profound change since 1991. In New York alone, four giant banks -- Manufacturers Hanover Corp., Chemical Banking Corp. Chase Manhattan Corp. and J.P. Morgan & Co. - have been condensed into just one enormous institution, J.P. Morgan Chase & Co. The same trend has been evident in California, where the state's four largest banks have all been acquired since 1991, although some of their corporate identities have survived.

Merger-driven consolidation has been just as intense among regional banks, which serve the middle market. The result has been a drastic reduction in the number of U.S. banks that cater to both large and middle-market businesses, and this consolidation has placed the survivors in a much stronger position to push for what they want.

While the country's largest banks were merging with one another, many of them were also acquiring securities firms, thanks to relaxed federal regulation and, ultimately, a change in U.S. banking law. Not only did this reduce the number of independent securities firms, but it expanded those banks' product lines and made a relationship banking strategy more viable than ever before, A perfect example is BankAmerica, which finished 2001 with high league-table rankings in both high-grade and junk bonds, convertible securities and syndicated loans.

Prior to its acquisition a few years ago of San Francisco-based Montgomery Securities, the bank was not a factor in securities underwriting. Its integrated business model, where lending and underwriting have effectively been combined under one roof, makes it easier for BankAmerica to press the relationship argument to its business customers, according to Edward Carter, who heads up corporate and investment banking at the Charlotte, N.C.-based company.

While the banking industry was consolidating, it was also feeling the heat from shareholders who wanted to see higher returns on their invested capital. Corporate lending is a low-margin, capital-intensive activity where it's possible in bad times to rack up huge losses. Blue-chip borrowers, many of which have higher credit ratings than their bank lenders, can raise money more cheaply by accessing the capital markets directly. And, providing these same companies with emergency liquidity is a poor use of a bank's balance sheet. "Getting paid eight [basis points] for a backup line of credit - that's no way to make a living," moans Shufeldt at SunTrust.

Even higher-priced loans to below-investment-grade companies can have their profits wiped out by losses over an entire business cycle. Banks crowded into the leveraged loan market in the late 1990s, when the booming technology industry drove up demand for credit, but that sector's subsequent crash - which created significant loan losses at a number of large banks earlier this year - probably wiped out much of the profit that many of them had made. Says one corporate banker, "You've got to be really good not to lose your a- in the lending game."

Occasionally, the impetus to form deeper relationships with a smaller number of banks comes from the customer side. When Toronto-based Newcourt Credit Group merged with CIT Group in November 2000, the two commercial finance companies had nearly 70 banks in their combined credit facilities. The company, which has since changed its name to Tyco Capital, wanted to pare that number, in part because of the sheer complexity of dealing with so many banks. But company executives also worried that with CIT's business now spread out among so many providers, few were getting a large enough share to consider CIT a truly important client.

While Tyco declined to comment about its bank program, a published report in 2000 detailed how CIT's treasurer eventually put together a group of 17 lenders by identifying those institutions in the best position to meet all of CIT's corporate finance needs. Four "senior agent" banks -- Citigroup, J.P. Morgan Chase, Barclays Bank and BankAmerica -- were asked to commit $500 million apiece to a new $7.5 billion credit facility. A larger number of "managing agents" were asked to give $375 million commitments.

In return, the company promised the participants a fair shot at all of CIT's corporate finance business, which includes a large volume of unsecured corporate debt in both the U.S. and abroad, and also a significant flow of asset-backed securities. "Backstop lines [of credit] just don't meet the return-on-equity hurdles [that banks] need," Glenn Votek, CIT's treasurer, said in an April 2000 interview. "The banks need to finance other business opportunities as well."

The participating banks received no guarantees in return for their commitments to CIT's credit facility. For that matter, federal banking regulations forbid any tie-ins between the granting of credit and the purchase of related services. One banker calls it "the dance" -- where an institution makes it clear that it wants to do more than just lend money, but stops short of explicitly demanding additional business.

What most banks seem to ask for in return for the use of their balance sheet is a first look at any opportunities. "We're going to be satisfied with that because we've got the products," says H. Jay Sarles, vice chairman at FleetBoston Financial Group. "As long as we get a shot at it." Agrees McDonald at Tatum CFO Partners: "The important thing is that your bank perceives that it's being given a fair shot."

Clearly, some banks are beginning to force the issue, even in the face of customer resistance. Over the past year, Chicago-based Bank One has dropped clients in both the large corporate and middle-market sectors when efforts to expand those lending relationships failed. The catalyst behind that effort has been CEO James Dimon, who has been struggling to raise the company's sagging profitability. Neal claims that the movement towards a relationship banking business model has been largely successful. "Only with about 15 percent of our customers have we had difficult conversations," he says.

Other large banks are driving toward the same goal. At BankAmerica, the goal of the corporate and investment banking operation is an internal rate of return of 20 percent or better -- an objective probably shared by most large banks today. The more noncredit products BankAmerica can provide, says Carter, the greater the likelihood of hitting that goal. For their part, both SunTrust and Fleet are striving for a more even balance between interest-based income and fee income. "We're at a 60/40 split now, and we're heading for 50/50," says Sarles.

While many Fortune 500 corporations' funding requirements are substantial enough to keep several large banks busy, it's a different story in the middle market. As a result, many regional banks aren't interested in having a second-tier relationship with a middle-market company. "Clearly, on the middle-market side, you have to be the lead bank," says Sarles.

But does a middle-market company give up too much leverage by limiting itself to just one institution? "As with anybody, you want people competing for your business," says Tatum's McDonald. But McDonald stresses that bankers will always be examining the relationship from their own perspective. "Do they see it being profitable and valuable to them?" he asks. The bank may walk away from the business if it feels it's getting too little in the bargain, which could cost the customer even more in the long run.

"A CFO certainly has to make sure that his company is spending money wisely," adds McDonald. "But a good CFO knows the value of a professional relationship."

Sarles believes that even after many years of bank mergers, enough competition remains in the marketplace to keep most banks from becoming arrogant. "It's a competitive market, even with consolidation," he says. "There are opportunities to move the business. We have to be competitive or [the customer] will take it somewhere else."

And developing close ties with a single bank can be especially important in a recessionary environment like today's, where many lenders have cut their funding commitments. "We're going to make credit decisions based on the creditworthiness of the customer," explains Sarles. "But if a [valued] company is struggling, we're going to do our damnedest to support them."

At the core of the relationship between a company and its bank is communication. Bankers and corporate financial officers alike talk about the importance of honesty between the parties. "Where relationships break down is when one party has one set of expectations and the other party has a different set of expectations," says Garter at BankAmerica.

He sees a growing number of "enlightened treasurers" who realize they must give a little to get something important in return. He cites financial services, telecommunications, health care, energy and natural resources -- industries with substantial funding needs and therefore a reason to be clued in to banks' needs.

Indeed, the other crucial ingredient in a successful, long-term banking relationship is an understanding that it can't be structured as a zero-sum game, where one side's gain is the other side's loss. This is a game where both sides must win. "The relationship has to be mutually beneficial," says Carter. "If it's not, someone will wake up one day and be very unhappy."

Jack Milligan is a freelance business writer in Charlottesville, Va., who has written extensively about banking.