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Bank Tying: Where Are We Now?


Almost a decade after bank tying made headlines, it seems like the practice is still prevalent, albeit done with discretion.

MINYANVILLE ORIGINAL In 1998, the Justice Department famously sued Microsoft (MSFT) for, among many things, the 'tying' together of its browser, Internet Explorer, to its Windows 98 system,

Microsoft is, of course, hardly the only company that has engaged in tying, which is the practice of making the sale of one good conditional on the purchase of another. And, of course, some cases of tying are perfectly legal, or at least start out that way. When first released, Apple's (AAPL) iPhone was notably tied exclusively to AT&T (T) (though a Californian challenged the legality of that with an antitrust suit against the Cupertino-based company that has yet to be resolved).

A McDonald's (MCD) Happy Meal, in which an entree, fries, drink, and a toy is bundled together, is another example of tying (in San Francisco, parents who want to get that McDonald's toy for their children have no choice but to get a Happy Meal, thanks to a legal quirk).

In banking, tying can mean something like providing a home loan on the condition that you buy another product, such as home insurance. This form of bundling is legal because both are naturally-related traditional banking services.

Tying, however, can also come in the form of forcing corporations to utilize a bank's investment banking services in exchange for loans, which is illegal under the Bank Holding Company Act Amendments of 1970. But some say it's still being practiced,and in fact has been fostered by changes in banking over the past decade.

Bank tying (of lending to investment banking business) has coincided with the rise of universal banks, itself a product of the dismantling of the Glass-Steagall Act, according to The Review of Finance. Banks like Goldman Sachs (GS), Morgan Stanley (MS), Citigroup (C), and Bank of America (BAC) combined the lending and payment services of commercial banks with other non-traditional banking services like securities underwriting.

A 2004 survey of 370 financial executives conducted by the Maryland-based Association of Financial Professionals, or AFP, found that 53% of respondents who worked at companies with annual revenues of over $1 billion said that their companies had loans denied or borrowing terms adjusted in the previous five years when they did not confer securities-underwriting services to banks.

This would appear to be confirmation that tying is known to happen across the industry.

However, according to a 2003 report by the General Accounting Office, not much documentary evidence of tying has been discovered, because "credit negotiations are conducted orally." The report also pointed out that companies are not keen to report tying, because they are afraid that would further harm their chances at securing loans, and also because they cannot be certain when it is illegal.

Also in 2003, the Federal Reserve Board fined German bank WestLB $3 million for requiring corporations to name the bank as co-manager on debt issues in exchange for loans.

Yet, a similar arrangement which occurred around the same time did not trigger official sanction. Motorola (MSI) requested for its commercial banks to waive covenants to get bridge financing from Goldman. The two Motorola bankers, JPMorgan (JPM) and Citi, agreed, but only on the conditions that Motorola bring them on board as co-lead arrangers and that the company grant them future investment banking business.

"It's pure, unadulterated coercion," one Goldman executive told Institutional Investor about the deal. "They are going to our clients and saying, 'If you want us to continue lending to you, you'll give us your securities business.' There are laws against that."

A decade after the WestLB and Motorola requests made headlines, it seems like tying is still prevalent in the industry, even if it's practiced discreetly.

"I've never been at a place where we would go to a lending client and say, 'We will pull our credit if you do not give us investment banking business,' an associate at a mid-sized investment bank, who requested to remain anonymous, told Minyanville. "However, I think it's understood that if a borrower takes his capital markets business outside the lending group, those lenders would feel somewhat shortchanged, given that they are directly putting their capital at risk by lending to the client.

"If they're not getting properly compensated with ancillary business, that'll certainly come into consideration at the bank the next time the borrower has to renew the credit facility."

Andrew Schrage, co-owner of the website Money Crashers Personal Finance and a former portfolio analyst at Discovery Group, also said that he has had an experience with bank tying before.

"I was once in need of credit, and the bank employee hinted at the fact that I could get a better rate if I purchased underwriting through their affiliate. When I questioned whether this was a requirement to qualify for the reduced credit rate, the employee backed off and said I could still gain that rate, but it wasn't preferred," offers Schrage.

The rationale behind anti-tying restrictions is that tying is anti-competitive behavior. In the landmark Standard Oil v. United States case, the Supreme Court affirmed that "tying arrangements serve hardly any purpose beyond the suppression of competition."

However, it can also be argued that in today's financial landscape, banks do not have the kind of market power to compel borrowers to buy bundled goods. In fact, in certain cases, it is the reverse: Instead of banks coercing firms to give them investment banking business in exchange for credit, it could perhaps be corporations who tell banks they will not hire them for their capital markets business unless they also lend them money.

The investment banker Minyanville spoke to also believes that tying is not so much anti-competitive behavior "as it is a simple business decision."

"If you're a bank lending to a client, you are putting your capital at risk. If you lend $50 million to client A and $50 million to client B, and client B is consistently giving you capital markets business and an extra $5 million in fees every year, and client A is taking his capital markets business to another investment bank, isn't it a no-brainer for the bank to focus its capital on client B?" he said.

"To me, it's no more tying than it is for an airline to reward its best customers with upgrades and priority privileges that it doesn't provide to its general customers."

According to a 2009 working paper by Northeastern University professor Karthik Krishnan, instead of restricting credit to firms that do not give them underwriting business, banks are actually much more likely to engage in relationship-building and offer more generous lending terms in order to receive underwriting business:

First, I find that banks are 19.97% more likely to lend again to firms (particularly to investment grade firms) if they have underwriting ability, regardless of whether or not they actually underwrite the firm's prior debt issue. Second, banks offer yield discounts to investment grade firms if they have underwriting ability, regardless of whether or not they actually underwrite the firm's prior debt issue. Finally, banks that continue relationships with investment grade firms (by lending again on the ex-post loan) are more likely to get underwriting business on the next debt issue by the firm. Thus, banks' strategy of continuing relationships by lending more and giving yield discounts does help them obtain the firm's underwriting business.

Schrage agrees that companies seeking loans have plenty of options. "If a company feels that it is being subjected to illegal bank tying, it always has the option to go elsewhere," he says.

Which option to pursue, the anonymous banker told Minyanville, would depend on the type of loan. "Unless it's a leveraged loan, it can generally be syndicated among banks of all sizes." He suggests that borrowers could turn to banks with significant balance sheets that do not have a large capital markets presence in the US.

"Many banks, like US Bancorp (USB), KeyBank (KEY), or Comerica (CMA), aren't capital markets heavy. They wouldn't rely on the cross-sell as much since they don't really have the capital markets scale. Their lending syndicate may be a bit weaker though. That's the tradeoff."

Twitter: @sterlingwong
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