Where Did the Credit Go?

The common wisdom taught in graduate school is that banks allocate funds to creditworthy borrowers. To provide a total "relationship" for clients, they offer a range of non-credit corporate services at reasonable prices. Recently, however, due to the confluence of several factors, many U.S. banks are retreating from commercial lending and ancillary non-credit corporate services.

Until the 1980s, banks were limited to "traditional" banking operations due to restrictions dating to the McFadden Act of 1927 (prohibitions on interstate banking) and the Glass-Steagall Act of 1933 (investment/ commercial banking restrictions). Changes to these laws (most recently in the Gramm-Leach-Bliley Act of 1999) ended the limitations on the financial activities of banks, securities firms and insurance companies.

Major banking mergers have significantly reduced the number of willing business lenders, with the five largest banks now arranging over three-fifths of the large loans in the U.S. (up from one-fourth in 1990). The smallest participants in loan syndications -- including Japanese financial institutions and regional banks -- are no longer interested in participating for a paltry share of commitment fees. And the large merged banks are lending less even to creditworthy borrowers, due to regulatory limitations on the loans that can be allocated to a single borrower.

Bank Capital Seeks Higher Returns

Banks are now able to allocate capital based on the comparison of returns from lending activities to other financial service company activities. With sophisticated costing systems, banks have finally realized that commercial lending is a marginally profitable activity, and that their resources may be more profitably allocated to activities such as financial services for merger and acquisition activities and consumer banking. The emerging oligopoly in commercial banking has also led to the abandonment of non-credit products -- such as cash management, custody, trade and finance and treasury information systems -- which achieve marginal returns or lose money.

As a result, treasurers are increasingly facing chilly receptions when seeking new sources of funding. A recent Association of Financial Professionals survey indicated that bank lending, until recently about half of all corporate borrowings, is expected to fall to about 37 percent before year-end. Treasurers are becoming the "salesmen" of the financial world, selling their stories to rating agencies, lenders, investment bankers and journalists. Because of banks' reluctance to lend, the number of potential credit contacts has had to be significantly increased, sweetened by promises to reassign non-credit business from long-time relationship banks.

In one case, a New York Stock Exchange-listed company that enjoyed a 100-year relationship with a money center bank was told that a line of credit would no longer be available, despite its investment grade rating and superior balance sheet. Credit lines are used both as standby sources of credit and as support for the issuance of commercial paper. In this company's case, the credit line backed commercial paper issuance, which funds the company's liquidity requirements. Lower-tier banks in the relationship provided some relief, but the aggregated credit the company sought was not attained.

What's a Treasurer to Do?

The old assumption about creditworthy borrowers having ready access to capital has changed to one of the corporate treasurer as a supplicant, pleading for a loan. Successful financial managers must arrange funding from various sources, some of which are not traditional lenders; consider strict capital rationing for new capital projects; ally with partners to meet the company's strategic mission; and be prepared to motivate credit sources with equity sweeteners. Inevitably, allocation of capital will be based on creditworthiness, size and profitability, with treasurers competing for the finite amounts of capital available.

Financial managers should not expect bank pricing to continue being offered at unprofitable levels. Economic history clearly shows that product prices rise faster than general inflation as oligopolies emerge, particularly when there are other uses of capital offering higher returns. Treasurers are advised to plan accordingly and prepare their managements to face this new set of financial challenges.

James S. Sagner is senior managing principal of Sagner/Marks, a treasury consulting firm and author of Financial and Process Metrics for the New Economy (AMACOM, 2001).