You don’t have to be big to be good at risk management, but it helps. So Deutsche Bank is well placed. “There’s a lot of business we would find it harder to do without being a big plain-vanilla interest-rate and credit derivatives player,” says Charles von Arentschildt, head of global markets North America at Deutsche Bank.
His colleague Jon Kinol, who is in charge of interest-rate derivatives, says: “It means that clients come to us with the knowledge that we can handle it.”
Deutsche is a big player in the plain-vanilla markets and has got bigger over the past year. That, in the US at least, could perhaps be a response by clients to issues that have affected some of the more established players in their market, such as concentration risk, merger hangovers, downgrades and perceived reputational hits.
According to a mix of the bank’s own data and that from the Bank for International Settlements and the British Bankers’ Association, Deutsche has outpaced the growth of all the major derivatives markets in 2002. Overall credit derivatives volume grew 119%, for example, whereas Deutsche’s increased by 170%. Its interest-rate derivatives volume grew 70%, as opposed to 40% in the market overall, and its equity derivatives volume jumped 106% while the overall market expanded by just 17%.
It’s using that volume, along with its balance sheet, to offer risk management solutions to clients of all varieties, be they investors, hedge funds, corporates or governments.
In the public markets, for example, Deutsche has done several innovative deals in the asset-backed securities market. In May this year it structured a e100 million deal for the Greek government enabling it to monetize its venture capital investments in telecoms start-ups, while in the US the bank used securitization to raise debtor-in-possession financing for bankrupt car rental company ANC Rentals.
Deutsche views these and even simpler transactions as part of risk management. Anand Parekh, head of North American structuring , says: “Our structuring business is organized to deliver efficient client solutions, not to sell structured products. If the optimal solution to a client’s risk management problem is simply to trade treasuries, that is what we recommend.”
But everyone knows that it’s in the private arena where banks compete. And because it’s private few want to discuss details. Perhaps it’s a corporate taking advantage – legally, of course – of a tax loophole, or a hedge fund looking for capital structure arbitrage opportunities.
Or it might be a pension fund wanting to change its fund managers. Transition management has become a buzz-word in the equities trading world during the past two years. Deutsche has one of the best teams on the street, as part of its overall equity prime services division, which reports to Rick Goldsmith and Ralph Reynolds, global heads of equity sales and trading respectively. They were instrumental in building Morgan Stanley’s prime brokerage business, and came to Deutsche Bank in 1998 after a stint at NatWest Markets. Deutsche has since become one of the leaders in equity derivatives, programme trading and transition management.
Deutsche is one of the key players in capital structure arbitrage. In December 2002 we wrote about how Deutsche was mainly a prop trader in capital structure arbitrage. That has changed since, says Boaz Weinstein, head of credit derivatives trading for the Americas. He and his team are still in the prop trading business but “funds have started to play in this space a lot more this year, and are coming to us for advice and ideas”. One trade he mentions where clients got involved was arbing Philip Morris’s capital structure. “The credit markets seemed unconcerned about the tobacco bond suit,” he says. “They’d seen it and the huge numbers associated with it before, and the bonds traded in a relatively tight range of Libor+130 to L+160.”
The equity markets took a much more negative view as evidenced by the steep price decline and an outsized dividend yield. “If you backed out the Kraft piece, which is 84% owned by Philip Morris, the numbers were even more striking, with the tobacco stub dividend topping 17%. We came up with the idea for credit investors to hedge given the equity market signal.” The bonds subsequently gapped out as wide as 600bp.
Weinstein’s other area of responsibility is CDOs, which have been hit with most downgrades affecting the whole ABS sector. “So many of these deals need reworking for investors,” says Weinstein. “We’ve done a large number of trades for investors who’d done baskets with a small number of reference notes where one has gone under water. Often the dealers who did the trades couldn’t get them out of it, which opened an opportunity for us.”
There’s also been a good market for using credit derivatives in advising commercial banks on their own portfolios of loans and bonds. “We, for example, can help banks which have too much exposure to one region of the US, or have a portfolio skewed towards a certain sector,” says Parekh.
One of the most active areas of risk management in the past year was mortgage risk. Long-term low interest rates have continued to fall, prompting residential home owners to continue refinancing their mortgages. That’s led to an increasing supply of whole loans and of mortgage-backed securities being bought by banks as they take the positive carry. “For the past 10 months the mortgage tail has been wagging the rate dog,” says Kinol. Trying to hedge the prepayment and extension risks has become an obsession for some banks. Last year Deutsche ranked seventeenth in mortgages in the US, but then decided to invest in the sector. It also created a cross-rates desk pairing up its mortgage TBA trading desk with its OTC derivatives traders. A year later, it is seventh in the rankings.
