View from the Top: Tim Ritchie, Barclays Capital

Published: Oct 2001

In the View from the Top series, we usually interview a senior treasurer but in this month’s issue, we are interviewing a banker, Tim Ritchie of Barclays Capital, who is also chairman of the Loan Markets Association in London. The reason for this is simple. All treasurers need to arrange funding from time to time and when negotiating with another party, it is easier to reach a mutually beneficial agreement if you have an understanding of the other party’s needs.

Tim Ritchie

Chairman, Loan Market Association

Banks’ risk management strategies are under scrutiny from their regulators, both nationally and internationally. The most recent pressure comes from the Bank of International Settlements in Basel, which has proposed a series of changes to the way in banks allocate capital. Under the current regime, banks are required to have capital ratios of 8% to cover the possibility of default and to protect the banks against failure. Essentially, this means that for every £100 lent, the bank had to have capital (or equity) of £8.

As risk management has become more sophisticated, banks have become more able to differentiate between the risks of default by different borrowers. The banks argue that lending to a strong credit should need less capital than lending to a more risky customer. The Basel proposals reflect this and it is increasingly likely that whilst stronger credits may have to pay relatively less for their borrowing, weaker credits may well have to pay more. This interview with Tim Ritchie explains some of the reasons why.

Can you outline what the Loan Market Association is?

The LMA was formed in late 1996. Initially, our main aim was to create a firm foundation, in terms of both documentation and market practices, on which a viable European secondary loan market could be established. Since then, our horizons have broadened and the LMA is now the trade association for lenders in the Euromarkets, covering a range of issues, both primary and secondary. The timing of the formation of the LMA was a key factor, since demands on the market have grown dramatically in the intervening period, and, as a result, the question of how to raise the quantum of liquidity required by clients has become a much more crucial issue than it used to be. We have endeavoured to build and maintain a dialogue with the borrower community on topics such as transferability, which are still somewhat emotive, but I believe that most borrowers now recognise that transferability has its positive aspects, in an environment where banks are more concerned about managing their asset base more dynamically, and particularly where borrower requirements exceed the capacity to lend of established relationship banks.

Are corporates distinguishing between megadeals and general financing?

Yes, I think they are. Of course, what is an unusually large transaction for one client might not be for another. This may not be anything to do with the scale of the borrower itself, but might reflect more the number and scope of the respective banking relationships, usually based upon historical needs. Certainly, clients are, for the most part, less concerned with who is providing the funds for a large acquisition than they are with obtaining the financing on attractive terms, or, for that matter, who is part of their core liquidity facility.

Does the LMA concentrate on the secondary market?

Not exclusively; we are looking at an increasingly wide range of issues, which are relevant in both a primary and a secondary context. For example, working with the ACT and the BBA, we have produced a standard form primary loan document for use under English Law. We believed that loan documentation has suffered from unnecessary over-customisation for some time. Although things were referred to as boilerplate, there was in truth no accepted standard; we have addressed this through our document.

The English Law document has become the reference point for the negotiation of most of the syndicated lending activity, which is taking place today. With boilerplate items reduced to standards, there is more time left to tackle the aspects of documentation, for example covenants, which need to be tailored to individual circumstances.

Can we talk about the new Basel proposals? How will the proposals affect the loan market?

From a wholesale lending perspective, the biggest change in the proposals is the closer alignment of regulatory capital requirements with economic capital consumption. The existing regime does little to encourage bankers when pricing loans to be sensitive to the real risk of the underlying counterparty.

Most major banks will be anticipating applying an internal ratingsbased model. It is likely that, as you go down the risk spectrum, the smaller increments in capital required under the standard model will be dwarfed by much greater increases in capital requirements under an internal ratings-based model. This will lead to price decompression in the market. This has, in any case, been developing for several years as banks have generally begun to apply more sophisticated analytics to their lending activity.

Are you saying that the new accord, whenever it is implemented, is allowing the banks to do what they want to do or is it a case of driving them to do something they wouldn’t have done otherwise?

In terms of loan pricing, it encourages trends, which are already evident in many areas of the market, though not all. It is likely to serve as a catalyst and accelerate changes, which are already underway.

The first accord was very straightforward – 8% minimum capital requirement – the new one seems much more complex. It requires regulators in different countries to apply it. Do you see that being an issue?

It could be, depending ultimately upon the degree of control delegated to local regulators and the way in which they use it. The LMA wants to see the playing field as level as possible and our response to the Basel proposals highlights this potential issue.

Will banks themselves approach their decision-making any differently?

Changes are already taking place. Many banks have a more centralised approach to pricing loans than was once the case. Some have introduced portfolio management techniques and many are actively looking at this discipline, which is relatively new to lending, with a view to implementation in the near future. Those making pricing and other decisions are better informed than ever about relative value and thus more aware of any opportunity cost of lending. Hence there is a heightened focus on the levels of ancillary business available to complement lending relationships. Relationship managers within banks are still involved in the decisions and are responsible for building the business case for lending, but, in many instances, no longer have a free rein to price loans to acceptable credits as was once the case.

Might a relationship bank now turn round to a company and say no, we won’t give you a loan?

Quite conceivably. Banks are increasingly evaluating relationships across a broader front of product delivery and potential. Lending is most frequently the platform upon which the relationship is built. Each new lending opportunity gives the banker a chance to reassess the relationship from both a risk and reward perspective. In many instances, relationships have not developed as had originally been hoped and bankers are becoming much more disciplined in the way in which they measure returns and are showing less and less tolerance for perpetuating unprofitable relationships.

That said, there is still plenty of competition for clients’ overall business in Europe and there are quite a number of banks which are aggressively leveraging their lending capacity to gain access to other product opportunities. With markets in Europe still developing, this should continue to be the case for some time to come.

Will the stronger corporates start to question your charges because of Basel II?

It is all very well modelling risk and return, but ultimately supply and demand factors in the market will be the major determinant of pricing levels. Overall, I anticipate that less-risky borrowers will expect to get a better deal relative to their riskier counterparts and I doubt that they will be disappointed.

Is there any possibility that more of the funding that is done in the capital markets will come back to the banking sector because of the weightings that would be applied?

Given the way that the capital markets are growing in Europe and given the commitment that major banks, as well as institutional investors, have made to their further development, I very much doubt it. While bank financing will continue to be required for working capital purposes and will often provide either a bridge to the capital markets or the liquidity insurance required for short term issuance of, for example, Commercial Paper, I don’t think the Basel proposals will slow down the trend which is generally seeing an increasingly large proportion of permanent funding requirements of European clients successfully met in the capital markets.

At the margin, the ratings could be split. If you are the lead bank selling the loan on, how will this work?

The market already deals with split ratings in situations where ratings grids are deployed. I don’t foresee any problems here. I do expect an increasing incidence of ratings grids in Europe, which will provide the framework for pricing to develop under Basel II, making synchronisation of individual bank models a moot point.

One of the key questions is how competitive the market will be for the various levels of rated business?

I think the absolute levels of risk appetite in the market will continue to be largely cyclical and broadly in line with levels of economic activity. To the extent that lenders can get paid more fairly for taking an increasing amount of risk then one would expect increased appetite to develop. For example, the European leveraged loan market will continue to expand. The LMA has been very supportive of efforts to attract new institutional investors to this part of the loan market, and has lobbied successfully for various tax disincentives to be removed, so as to deepen the available liquidity for clients and enable larger financings to be executed.

As I noted earlier, lending activity will increasingly be targeted as part of a suite of solutions and products, so the Basel weightings in themselves are unlikely to drive banks’ business plans in isolation.

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