Banks boost deal testing amid pandemic, sources say

22 May 2020 - 05:55 pm UTC

Investment banks have tightened up committee procedures for bankers seeking approval to take on mandates while implementing heightened scrutiny of deal proposals in response to the coronavirus pandemic, said four sources familiar with the matter.

 
The increased scrutiny of both capital raise and M&A assignments comes as a raft of the banks’ clients have sought options for funding and relief on debt covenants.

 
In response, multiple bulge bracket banks have taken steps ranging from the creation of new committees that screen proposals to looping in senior management early in the approval process in order to both handle the deluge of potential deals and ensure that Federal Reserve regulations and risk are appropriately managed, these sources said.

 
Unlike in the 2008 economic crisis, which saw multiple banks face questions about their solvency as iconic firms like Lehman Brothers fell, investment banks are now seen as a key pillar of support for the economy, said Greg Lyons, co-chair of the financial institutions group at Debevoise & Plimpton.

 
However, given the severity of the developing economic recession, banks are having to adjust the way they evaluate credit risk, Lyons said.

 
“Unemployment was low, the stock market was doing well, and generally all the trends were looking positive until the beginning of March,” he explained. “So the banks could largely focus on the parties that were involved in a deal and whether they were creditworthy. Now you have to look at that and ask: how will they perform under general economic stress?”

 
As the coronavirus crisis initially swept the world, financial institutions found themselves in the position of re-evaluating proposals to provide leverage, Allan Marks, an infrastructure project finance attorney at Milbank, said. “There was the question of: have the fundamental assumptions on these deals changed?”

 
While there are many stages to an investment bank’s internal approval process and some differences between the major banks, in general a proposal from client-facing investment bankers to take on an assignment from a client must pass through a key test by obtaining approval from a product committee – such as a credit committee or ECM committee – before the bankers can move forward.

 
Access to that committee during times of lessened stress on banks and a strong economic backdrop is relatively straightforward, two of the sources said. However, as economic conditions have worsened and both the volume and relative risk profile of proposals has changed, banks have begun to more strictly formalize preliminary stages on the way to gaining approval, these sources added.

 
In order to address the increased volume of proposals, banks are formalizing pre-approval steps and new committee structures to effectively “screen” proposals so that product committees are not overwhelmed or spending time on deals that have little likelihood of being approved in the current environment, the first three sources said.

 
For instance, an initial business acceptance approval might have previously been a pro forma step handled quickly over email, the first source said. Now, by contrast, it becomes a place to do more stringent upfront evaluation of the broad spectrum of possible risks – not only financial, but also reputational, the first two sources said.

 
Lyons agreed that reputational risk is an important factor. “The banks want to show that they can successfully market deals in this environment, so the criteria for taking something on have increased,” he said. “No one wants to be the bank with four deals that went bad in a row. But also, frankly, it’s a fact that regulators expect them to manage reputational risk.”

 
Given the high stakes and the need for a top-level view on something as broad as reputational risk, some bulge bracket banks are bringing senior management into the approval process at an earlier stage, the third source said. This includes looping in a team that reports to the bank’s treasurer, as the increasing risk profile of credits requires strict management of a bank’s liquidity profile to maintain compliance with Fed regulations, this source added.

 
Indeed, a proposal to extend certain types of credit to a low-rated issuer could hypothetically require a bank to post a greater amount of collateral than the principal of the underlying loan, the second source said.

 
“To me, the biggest tool an investor or lender can have is to distinguish clearly between risk and uncertainty,” Marks said. “Risk is something I can quantify, I can model it. Uncertainty is different. It cannot be modeled, and usually when faced with that, people will sit tight and wait until they have better information.”

 
Reflecting this distinction, requests from borrowers that are well understood by their lenders for durationally limited loosening of certain covenants in their credit agreements are still relatively easy to get approved, two of the sources said.

 
When considering these requests, it is generally in the interest of a bank to help ensure that its clients are set on a sustainable path and that they can handle the ongoing demand shock, Marks said.

 
by Jonathan Guilford