The lending debacle shows that anything that looks like a corporate banking business should probably stay a corporate banking business.
About a decade back, the Lombard lending business at a small but known private bank could sometimes feel like a game of whack-a-mole.
The usual solution to deal with chronic problems at the far-flung outpost in Asia, the weekly sub-committee meeting, had been once again trotted out to deal with increasingly rampant exceptions, or internal breaches exceeding predetermined levels.
Compensate for Movement
It was the gap between the collateral the bank held against a client’s ever-fluctuating securities positions, and it had to be set high enough to compensate for – reasonable – daily market movements yet still low enough so that the bank wouldn’t be left in a lurch should the merry go round suddenly stop for some reason.
The key offenders, private bankers, would get called in one by one to review their specific exceptions on a spreadsheet cobbled up by a management staff function together with the operations teams. The chair set deadlines and action points and the secretary noted them down for the minutes and the log.
Hard and Fast
In the weeks after, the excuses would roll in as hard and fast as an elementary school playground at the end of recess. The banker couldn’t possibly tell their client– they might go somewhere else. The client was traveling on business for the next one, two, three, or even four months and couldn’t be reached. The secretary wouldn’t let the banker speak directly to the client as he or she was very busy with far more important matters.
In hindsight, it all highlighted the fundamental problem in lending in the wealth management sector. The banker is at the whims of a person who believes they are on the advantageous side of the equation, and that makes them loath to do anything that might rock the boat, particularly when the situation calls for it.
Not a Soft Drink
The problem with all this is that private banking isn’t the innocent marketing of your average consumer goods item, an inoffensive soft drink sold at a convenience store – it can quickly go societal – and viral to boot - as we saw last year with Credit Suisse.
And from what we can piece together of the public details of Julius Baer’s disclosure on Thursday, their private debt business, which is now being exited, went pretty far off track.
Mission Creep
It kind of looked like Lombard-lending-mission-creep. The way they describe the business in their media release is that it provides financing against future cash flows and non-listed securities for ultra-high-net-worth clients.
On the surface, it sounds reasonable, but when thinking about it in any depth, it ultimately sounds better suited for a corporate banking business.
If that is true, and we can’t know for sure, the devil would be in the details, some of which we already know. Three loans were made to different entities in that so-called European conglomerate which in all likelihood is Signa. They were in in commercial real estate and luxury retail and, all together, they triggered the single loss allowance of 586 million francs.
Mass Business
The problem with all this is that corporate banking, and retail, are entirely different from private banking and wealth management. The former are wait-your-turn businesses. Volumes and demand in many regions of the world are inescapably high when it comes to prosaic daily matters. Wealth management, however, is entirely different. The latter sends bankers scavenging into the urban wilds of the world looking for clients and their portfolios, which are then relatively static once onboarded, wrestling with Lombard lending exceptions regardless.
But a corporate banker is also in the business of knowing their clients, mostly entities, in the way surgeons know their patients. Involved exchanges with credit risk are a near constant. Unsecured lines are regularly extended and cash management can involve hundreds, sometimes thousands of accounts - from master accounts on down.
They see payments to and from all clients, not just the most important, and compare the numbers they see against internal client forecasts as they can request as much internal documentation as they see fit. If it is a business selling in retail spaces, they see the gross figures from each outlet and know what roughly is cash and what is a card. In trade finance, they reconcile invoices, sometimes against actual contents, and regularly make personal visits to key production and sales sites of the businesses they are responsible for.
Private bankers have a view of a client's portfolio and their personal assets, but apart from the information in the KYC, they are not usually as close to the daily business activities if they are dealing, for example, with wealthy entrepreneurs.
No Shortcuts
The question here is whether Julius Baer was taking those unlisted securities and future cash flows purely at face value without that kind of knowledge when it made the three loans. Normal due diligence, even from an independent third party, is not going to make up for the first-hand knowledge the average corporate banker has.
The evidence is that they didn’t. Given this business is now being consigned to the dustbin of history, we won’t likely ever find out for sure. The wind-down, which will take until the end of 2026 given the needed client consent, does seem to have at least some of the characteristics of a typical corporate banking business.
Diversified Exposures
The remaining exposures seem diversified, led by a 209-million-franc exposure to media and technology, followed by 135 million francs to the food industry, 81 million to logistics, and on down through private equity, insurance, telecommunications, property management, and e-commerce.
Geographically, it also looks well spread out, with 64 percent of the debt coming from Western Europe, Switzerland making up 19 percent, Central and Eastern Europe 8 percent, and 9 percent from the evergreen «other».
Clear Traces
It certainly bears the hallmark of a framework and a functioning credit risk department. But the resignation of CEO Philipp Rickenbacher and board member David Nicol, who was chairman of the governance and risk committee, also points out something was amiss, something that chairman Romeo Lacher subsequently hinted (finews.ch) later on Thursday.
The fact that three loans to one client could end up making up more than 40 percent of the entire private debt portfolio suggests something above and beyond what any normal credit risk function and board sub-committee would institutionally allow as a matter of course in any kind of eventuality, regardless of the quality of data and information related to a single incident.
Back at the Start
Which brings me back to my story about Lombard lending. This new era of collateralized lending first introduced by the major Swiss banks, UBS, and Credit Suisse, in the early noughties, has indeed been a successful one for private banking and wealth management.
At first, the collateral pledged was to help the ultra-high net worth ostensibly have an easier time purchasing weighty, expensive trinkets such as yachts while leaving their portfolios untouched. Often, private jets were explicitly excluded as they were often so easy to fly away at a moment’s notice.
Not Making It
Most of the time it helped to keep tight bonds between clients and their banks. At the outset, however, there were relatively strict limits on collateral, and it is unlikely that Benko’s companies, and his pledged, unlisted securities, would have made the grade back then.
Julius Baer now wants to refocus its lending activities on Lombard lending and Swiss mortgages, where it has been traditionally strong, and which make up for more than 98 percent of its total net loan book.
Not Keeping Up
As part of that, it also intends to strengthen its credit risk framework. But that is the expected thing to say in these situations.
As chairman Lacher subsequently indicated, the bank couldn’t keep up with the constant revaluation of the risks and the way the positions grew. That statement by itself bears some parallels with that small private bank's Lombard business a decade back - and it brings us back to that first story at the start.
More, Not Less
A better idea to solve this all for good in wealth management might be to finally get the private bankers involved to be responsible for their actions – and not just pay them handsomely for the business they bring in – while all too frequently laying the blame on risk management and frameworks.
On the positive side, at least the senior leadership of the bank and a relevant member of the board took the fall this time at Julius Baer, even if it came late.
