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| Worthy Notions: From the Editor |
Are You for Sale?
Dwight Cass
05/01/2006
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If you aren’t now, you will be soon. And it’s not a bad thing.
Bankers are
increasingly desperate to acquire the insights their corporate finance
counterparts obtained through painful experience over the past quarter of a
century. Their clubby, often ingenuous businesses are being squeezed between the
pincers of growing price transparency and competition, much like the clubby,
often ingenuous corporate finance world was squeezed in the 1970s and ’80s. And,
in much the same way that those pressures revolutionized the corporate banking
business, setting off an arms race of product development and price
rationalization, they are now radically transforming the private wealth
management business.
Do you know how your wealth managers determine their
fees? No? Do you ever suspect they don’t know either? That was essentially the
situation in the corporate market 25 years ago. But as deregulation and
improving technology led to the availability of ever-larger amounts of
historical and real-time market data, and credit and market-risk analytics and
benchmarks evolved, banks began to realize that they were mispricing their
products. Fleet-footed boutiques and nonbank institutions swarmed in to offer
customers a broader array of more attractive deals, leaving the white-shoed
dinosaurs gasping to catch up.
This trend culminated, eventually, in a
remarkable realization that the industry’s core business line—corporate
loans—after adjusting for regulatory capital reserves and client risk, did not
make money at all! When the banks finally grasped that they could sell loans to
insurance companies, hedge funds and other investors, the realization set off a
paroxysm of securitizations and secondary loan activity. Today, most banks make
money as loan originators, not warehouses, and this has been a boon for their
clients, who benefit from better pricing and greater access to credit.
So the same thing is happening now in the world of private banking.
Think of that $20 million loan you received from your private bank. You may be a
nice guy and a generally successful businessman, but what if you get hit by a
bus? Your business partner turns out to be incompetent? As a borrower, you
have, from the bank’s point of view, a fairly complex risk profile—you may not
be GM, but you’re no Treasury bond either. Your bank would probably prefer to
collect the loan origination fee and sell the actual asset to someone
else.
This type of transaction is set to explode over the next year or so due
to a new set of global banking regulations (dubbed Basel II) that will allow
sophisticated banks to set their own capital reserve levels for loans and other
assets. Generally, this is a good thing; banks know more about loans than do
regulators, and Basel II requires more transparency so that if a bank cuts
corners, its stock will sink. Most banks will see their capital reserve
requirements for credit risk fall; many believe this will be offset by a new
reserve requirement for “operational risk” (losses from human screw ups).
But
private banks find it hard to analyze their clients, and so many hold excess
reserves against a rainy day; the new operational risk charge will make it even
less attractive for these institutions to warehouse loans. If this leads to
widespread loan sales and the development of a liquid secondary market for
private banking assets, it will be a boon for Worth readers. The old-line
private banks that fail to make this transition will become acquisition fodder
for their more agile competitors. But no matter who actually ends up owning your
loan at the end of the day, you will enjoy greater access to credit and more
price competition.
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