Leveraged on European 'junk'
Daiwa Europe took the greenfield approach to the credit business. It recruited 40 staff with varied backgrounds from different firms and built from scratch a kind of credit-processing station. In one end goes a range of assets that are then repackaged and sent out in different forms.
"Whatever asset comes into the Daiwa structured finance group, we always recharacterize the risk, whether through swapping, tranching, enhancing, repackaging. It never leaves in the same shape it came in," says managing director Robin Nydes, who has built the group up since he joined Daiwa from Bankers Trust a year ago.
Using this approach, the bank was able to sell high-risk Russian treasury bills to cautious Japanese investors and repackage Turkey's samurai bonds as Deutschmark Eurobonds taking advantage of different perceptions of Turkish debt in Tokyo and Frankfurt. In a different kind of deal, Daiwa outbid rivals for a UK office complex because it was able to see how securitization - and the role of credit - could release value hidden to equity investors.
None of these deals is exactly rocket science and there are those who feel that the significant characteristic of the new role of credit is hype. But what is undeniably different is the speed and volume of such deals and the way banks are mass-producing them. Daiwa's Turkish debt transaction was turned round overnight, for example, and the UK property deal took just two weeks to complete, including the securitization.
All day long the Daiwa group's traders are active in emerging and other high-yield markets, sometimes isolating and retaining the convertibility risk in local-currency markets and passing on the pure credit risk to investors; sometimes changing maturity or duration to create credit-yield curves where none yet exists selling two-year synthetic securities where there are only six-month treasury bills. The scale and dynamism of the operation may be a model for other firms thinking of building similar credit departments that combine trading, investment banking and a lot of marketing.
The bringing together in one department of a large number of hitherto disparate functions is different, too. The Daiwa group does a range of things including credit product trading, covering developed and emerging markets and including credit derivatives; repackaging and tax-structured deals, as well as more investment banking-type activities such as principal finance, real estate and securitization. The common thread is that new economic conditions - chiefly the improving fundamentals of many emerging countries - and abundant liquidity at banks and investors all desperate for yield, has made taking a view on credit the driver of deals.
Daiwa's approach puts it at the forefront of banks' attempts to respond and exploit the new role of credit. But it is not alone. Other leading banks such as Merrill Lynch, Bankers Trust, Lehman Brothers, CSFB and Nomura have their own strategies. Merrill Lynch has combined most of its debt businesses into a huge global credit group. More cautiously, CSFB has merged its asset swappers and credit derivatives teams to produce a credit clearing house for the rest of the group. Bankers Trust has long played in the more credit intense businesses, which it calls credit laboratories. Now it is putting all its efforts into building a European junk bond market and creating high-yield funds. Lehman Brothers exemplifies the less excitable typical American approach, dealing in credit but only in large, liquid dollar bond issues: stuff you can put in an index. It has set up a global credit index especially for the purpose. But it is the Japanese houses Daiwa and Nomura that have excited the most comment often because of their gung-ho approach to trading and their use of principal to back up deals. Nomura's credit traders, for example, bet large amounts on tiny price anomalies.
Do any of these firms live up to the billing "The New Masters of Credit?" Are they artists with a unique vision? Or are they involved, perhaps unwittingly, in a huge confidence trick - a market built on froth and speculation in which traders have used a new lexicon of terms to justify high-risk strategies. If so, how long will it be before the market makes a dramatic correction? What will survive of the banks' new credit strategies after it does? Even Daiwa's Nydes cautions that "sometime in the next year there will be a major linked-equity and credit-negative event. Things have been rosy for too long".
Excess aplenty
Signs of excess in credit markets are abundant for anyone prepared to look for them. At Euromoney's recent borrowers and investors conference, Miguel Siliceo Valdespino, managing director of international finance responsible for borrowing at Bancomext, told of his confusion in preparing new bond issues at how some potential underwriters would bid to lead new issues at terms much tighter than other firms. He eventually realized that these firms were happy to own entire new issues at tight levels, taking a bought-deal view in the expectation that ever-tightening credit spreads for Mexico would produce a capital gain in a few months.
At a recent conference on European corporate high-yield bonds, a salesman talked enthusiastically about how European investors were growing judicious at understanding the returns available for taking junior positions in issuers' capital structures. The salesman admitted that the same investors were showing no enthusiasm for researching the practicalities of bankruptcy and work-out procedures in the home markets of these new issuers.
Guy Hands, who built Nomura's trend-setting principal finance business in the last two years, using securitization to outbid others on assets from pubs to rolling-stock companies, leasing companies and the homes of military personnel, has found himself regularly outbid in recent months. "Last September we bid on an asset just 75% of what it eventually sold for. There seems to be a feeling in the market that missing out on a deal is the worst thing that can happen to you." Systems technology allows bidders to run hundreds of different simulations to test how assets will fare under different interest rate, inflation and other variables. But, rubbish in, rubbish out. Hands says: "It seems to me that some bidders are deciding what number they should bid to win and then fitting in their underlying assumptions backwards from there. There is an element of over-confidence among some individuals in the market, many of whom have only ever been investment bankers and have never traded. In consequence, they have never known that sick feeling in the pit of stomach you get when something goes wrong." He adds: "Nomura has no intention of being dragged into a bidding war."