Corporates Awake to Bank-Counterparty Risk

The implosions of major regional banks this year prompted reexaminations of risk management not only in the banking industry, but also among corporations concerned about their bank-counterparty risks and how they will be affected by future bank failures.

If corporate treasurers track metrics beyond credit ratings more diligently, they might better anticipate, and pull back from, a problem situation like that of Silicon Valley Bank (SVB) before its crisis escalates.

In a survey by NeuGroup, 73% of responding Fortune 500 company treasury executives said they acted immediately after SVB failed in March to add new bank-counterparty risk metrics. Those mentioned most often were credit default swap (CDS) spreads (88%), deposit base (43%) and stock price (43%).

Two dozen other indicators were less often mentioned by 43% of the group, among them changes in bond spreads, credit valuation adjustment, capital, liquidity coverage and unrealized losses on held-to-maturity (HTM) securities.

More Advanced Analysis

Amol Dhargalkar, managing partner, chairman, and global head of the Corporates sector at Chatham Financial, said that measuring the mark-to-market values of HTM and available-for-sale securities against the bank’s capital is getting more emphasis among his firm’s corporate clients.

 Chatham Financial’s Amol Dhargalkar

“That, of course, is looking at the last challenge and not necessarily the next one,” Dhargalkar acknowledged.

A bigger, current concern is “higher for longer” interest rates. One of the more advanced concepts Chatham has noted, he said, is corporates tracking bank exposure to industries that may suffer in an extended high-rate environment, especially commercial and residential real estate.

Another key metric, though a challenging one, is the volume of term loans a bank has provided to highly leveraged companies that may flounder in a prolonged high-rate environment. “Typical corporate treasuries may not have enough staff and access data to adequately track those metrics,” Dhargalkar cautioned.

Rates and Spreads

Joerg Wiemer, co-founder and chief strategy officer of Treasury Intelligence Solutions and former head of global treasury at SAP, looks at a bank’s deposit interest rate. A high rate may indicate urgent funding needs. CDS spreads are a more standard metric, and problem signal, for large bank’s credit standing.

“When you see CDS spreads exploding, it may be too late to do much, because everybody is moving in the same direction at the same time,” Wiemer said.

 Joerg Wiemer of Treasury Intelligence Solutions

Other metrics have increased in importance, according to Amit Vora, global head of CRISIL’s buy-side practice, including a bank’s proportion of uninsured deposits and the liquidity coverage ratio (LCR).

“Any breach in standardized liquidity requirements should trigger a prompt remediation plan to address the shortfall and, importantly, provide an early-warning signal for a risky liquidity profile,” Vora said.

Risk Appetites

Consolidation of bank relationships – using fewer banks – can heighten concentration risk. A survey by foreign-exchange-as-a-service vendor MillTechFX found fund managers reacting to the 2023 bank failures by adding more FX counterparties to offset that risk.

Wiemer said he advises companies to take measures to protect themselves from a potential bank failure. That requires working with the company’s CFO and/or board to assess a risk appetite for each bank relationship.

Next, he suggested, strive for visibility into all of a company’s bank accounts – which can be numerous and in some cases global – to calculate the default exposure to each bank. Then multiply each exposure by the default-risk percentage calculated from the bank’s CDS spreads to determine the default risk.

“This should be smaller than the risk appetite,” Wiemer said.

“Connectivity is critical, to report from those banking partners into a single treasury system and dashboard,” said Deloitte principal Prashant Patri.

Safeguarding Payments

Also critical, Wiemer said, is control of the payment process. It is best practice to be able to stop outgoing payments at any time, he added, recalling how an automated payment from a German state-owned bank was transmitted to Lehman Brothers the day after the investment bank’s bankruptcy filing in 2008.

Companies should maintain alternative bank accounts to which they can transfer money immediately when any of its banks runs into trouble, and customers must be informed to avoid sending payments to that bank.

 Prashant Patri of Deloitte

Clients are questioning companies more often about the robustness of their treasury infrastructures, Patri said, including tightening of policies and procedures to better control cash management, payments and disbursements.

“One of the first things they’ve done is identify alternative banking partners to maintain the continuity of collections and disbursements operations,” Patri said, noting payroll’s critical importance to “keep the business running.”

Hedging Exposures

A way to minimize losses in the event of a bank failure is to offset assets held by each bank with a drawn-down loan or other bank liability. “So if the bank counterparty goes down, your company’s exposure is the net of those assets and liabilities,” Patri explained.

Dhargalkar said that Chatham Financial has discussed with its clients using CDS to hedge bank-counterparty risk but never facilitated a purchase, due to the cost and uncertainties around which banks to hedge and the swap’s actual risk coverage. In the absence of buying CDS, he said, most companies have sought to diversify their counterparties as much as reasonably possible.

“Companies doing a large derivative transaction or interest rate swap that will run for several years are more likely today than six months ago to split that up among several banking partners than sole-sourcing it to one institution,” Dhargalkar said, adding that recent bank downgrades have further justified diversification.

Midsize and smaller companies may not have that luxury if, for example, they borrow from only a few banks that may be less liquid and riskier amid market turbulence. Therefore, CRISIL’s Vora said, “there is the utmost need to conduct enhanced due diligence of the banks and ascertain their risk management framework as well as analyze their history in the syndicated lending space.”