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They were undervalued, underpaid and covered an illiquid market. Credit analysts in Europe used to feel inferior to their glamorous cousins in equities and US bonds. Now they're big enough to be taken seriously. See our poll on who investors think are best sector by sector. Michael Peterson reports, research by Andrew Newby
Credit research is harder to do well in Europe than in the US. That's not just because of the number of languages and legal jurisdictions in Europe, it's also because credit is a novel concept for many investors. "This is a brand new business in Europe," says Varki Chacko, European head of credit research at Goldman Sachs in London. "There are a lot of demands on sell-side analysts both in terms of analyzing credits which have never been analyzed before and in reaching out to clients who are new to the credit markets. What could be done in 30 minutes in the US often takes an hour and a half in Europe."
But European investors are rapidly learning the language of credit. Many piled out of government bonds into the higher yields of corporate debt following the launch of Europe's single currency. A few then got their Fingers burnt in late 1999 when the price of some corporate bonds took a sudden tumble.
Most notoriously, Mannesmann's plan to stretch its balance sheet in order to buy Orange proved a timely reminder of the complexities of credit risk. "Across Europe, interest in credit and awareness of event risk has increased dramatically," says Geraint Thomas, head of Fixed-income credit research at Commerzbank in London. "Investors have gone through a steep learning curve recently."
That has boosted the importance of banks' credit research teams. A number of large Firms had cut staff following the Russian default crisis of 1998. In 1999 they raced to build up again and staffing levels are now higher than ever before.
Merrill Lynch, for example, has nearly doubled its credit research headcount in London in the past year. It now has 14 analysts, eight covering investment-grade credits and six looking at high-yield bonds. Morgan Stanley had only Five high-grade credit analysts in London at the beginning of 1999. By last month the team had grown to 14 investment-grade analysts, with a further Five looking at high yield. Both Merrill Lynch and Morgan Stanley expect to increase their numbers further in coming weeks.
Goldman Sachs was a late starter. Until late 1998, it did not have a European credit research department. Now the Firm has 15 credit analysts in London and our poll indicates that the team has made an impact with investors in the short time it has existed. Goldman Sachs tops our poll for the quality of its research in a number of key sectors such as telecoms.
Some European houses also have sizeable numbers of credit analysts and have also increased their headcount in the past year.
Deutsche Bank and ABN Amro have two of the largest teams. BNP Paribas now has some 11 analysts in Europe following the merger of two French banks which both had credit research departments of a reasonable size.
Mergers between investment banks are adding to the number of analysts on the move. Joe Biernat, head of credit research at Paribas, has been the latest high-profile credit analyst to move jobs. He is rumoured to be leaving BNP Paribas for a buy-side start-up.
All eyes are now on Dresdner Kleinwort Benson's credit research team to see how many of them will survive the merger with Deutsche Bank.
Our poll suggests that those Firms, both US and European, which have invested in building large teams with a pan-European focus are the ones whose research is most prized by their clients. When asked which credit research they used most frequently, investors picked out two of the bulge-bracket US houses, Goldman Sachs and Morgan Stanley, followed by two of the largest European banks, Deutsche Bank and BNP Paribas.
This frenzy to build large, pan-European teams is continuing to push up the salaries of credit analysts. So much so that many established credit researchers in London can expect to earn more than their US counterparts. "The market for credit analysts is as tight as it's ever been," says Steve Penwell, Morgan Stanley's London-based global head of investment-grade credit research. "For much of the 1990s it used to be that the US led the way in compensation terms. But now, especially at the medium level, analysts tend to be better paid in Europe."
According to Ron Bradley, a recruitment consultant at Jonathan Wren who specializes in the Fixed-income credit research business, a professional with at least three years' experience and a sector specialism could expect to earn a base salary of least £80,000 to £100,000. To lure such an analyst away from a rival, a Firm would typically have to oVer a guaranteed bonus of at least 100% of salary in the analyst's First year and maybe throw in £25,000 to £50,000 of share options as well. "There is more movement now than ever before," says Bradley. "I think that's partly because this business is now eight or nine years old and there is a generation of analysts who are ready for a change."
It is also because all the big Firms are trying to hire the narrow group of people with a combination of analytic skills, commercial nous and a knowledge of European countries and languages. "It is difficult to Find people with the exact skill set we are looking for," says Marc Pinto, head of high-grade credit research at Merrill Lynch. "The market is tight for good people."
Firms are Finding those people in a number of different places. Some, though not as many as was once the case, are moving from credit rating agencies to banks. Quite a few have moved within Firms from New York to London.
And a good few have been poached from other departments of the same organization. Some have made the move from analyzing counterparty credit or lending clients to the more glamorous Fixed-income credit research department. Others, displaying a rare combination of trading and communication skills, have left the trading Floor to become credit analysts.
It is not just banks which are recruiting credit analysts in large numbers. The rating agencies are continuing to take on staff as more European borrowers seek ratings. And investors too are beefing up their own credit research departments. Typically, however, buy-side analysts continue to earn less than their sell-side counterparts whose pay is racing away from that of other types of credit researcher.
Bradley believes there is now a large gulf between Fixed-income credit analysts and those who work in the commercial lending business. "I think we have to Find a new term for this job," he says. "What Fixed-income credit analysts do is now so different from the work of a credit analyst in the old sense.
It requires much greater commercial Flair."
There is also a divide between those Fixed-income analysts who cover investment-grade credits and high-yield specialists. "In terms of pay, high-yield analysts are on a different level to investment-grade analysts now," says one credit research head. "And within high-yield, telecoms specialists can command a particularly high salary. Telecoms is a growth area with a lot of issuance. Investors are becoming very demanding of telecoms analysts."
It is among this elite of high-yield telecoms analysts that we can expect to Find the much heralded million-dollar analyst. According to Bradley, there are already a select few analysts in Europe who can command seven Figures. And as Fixed-income credit analysis gains the stature of equity research, we can expect their numbers to swell.
Credit research departments are increasingly being organized along industry-sector lines.
This growing tendency is reflected in the methodology for our poll, which asks investors to nominate their preferred houses for credit research for each of the most important industry sectors present in the European credit markets, rather than ranking banks on an overall basis.
The rise of sector teams reflects the trend for investors to look at individual sectors on a pan-European or global basis. "Sector specialization has increased as the market has grown and as more and more sectors are Filled out," says Penwell at Morgan Stanley. "As credit groups on the buy-side are growing and investors are adding analysts to look at different sectors, so we on the sell-side are working to stay ahead."
The two sectors which dominate international bond issuance, banks and telecoms, have dedicated analysts at most large banks. Other industries tend to be grouped together. Morgan Stanley, which has one of the biggest teams in London, divides industrial companies into the broad categories of utilities/energy, telecoms/capital goods and consumer/retail/auto/media. Each of these agglomerations is covered by a single senior investment-grade analyst.
European credit researchers hope this year to progress from simply introducing new issuers to providing opinions about which bonds are likely to be upgraded or downgraded and which bonds look cheap compared to others. "US colleagues used to call me and ask: 'When are you going to put out your relative value picks?'," recalls one senior credit analyst in London. "I'd have to tell them the market wasn't liquid enough for us to make sound relative-value judgements."
Credit analysts in London have long talked about carrying out relative value analysis.
But until last year, there simply weren't enough actively traded bonds for banks to be able to provide much advice on individual credits. "As recently as a year ago a lot of European credit research was about providing basic information on companies," says Pinto. "We were describing a company and the risks it faces. And, in a lot of cases we were giving our rating assessment, because many issuers were unrated. As investors have become more sophisticated we can move on to providing higher value added services. Now that there are some large issues that are actively traded we can comment on particular bonds with more confidence."
What investors want above all, is to know which companies are likely to be the next to leverage up, thus hurting existing bondholders, and which are likely to be upgraded. "There is much greater understanding of the nuances of credit risk than there was a year ago," says Penwell at Morgan Stanley. "Event risk is now better understood, and there is more awareness of ratings transition risk. The investor base has become much more forward-looking about credit. They are thinking not just about what the rating is now, but about where it will be in future."
As analysts focus more on the trading dynamics of individual bond issues, the big picture has become, if anything, even more important. Many banks are now keen to hire credit strategists. "Top-down credit strategy has grown in importance," says Philip Crate, head of investment-grade credit research at BNP. "An investor looking at portfolio allocation needs to know what impact swap spreads will have on credit spreads, for example."
Morgan Stanley has recently appointed a dedicated credit strategist. "Macro strategy is still very important," says Clive Parry, Fixed-income strategist at Morgan Stanley. "But we have also added resources to be able to provide more strategy from a sector perspective, why we like one sector versus another, for example."
Meanwhile, Merrill Lynch will shortly be taking on its second investment-grade strategist, Alok Basu, who is joining the Firm from HSBC, and the Firm already has a dedicated high-yield credit strategist.
European credit research has not only been growing in quality and breadth, it is also becoming ever more professional in terms of presentation. After quality of analysis, our survey found that presentation or access to analysts was the biggest factor in investors' choice of research house. "Big institutions are no longer happy to receive amateurish research," says Crate at BNP Paribas. "They are demanding a product that is as good as US research. And research in Europe is starting to get up to that standard."
The way investors access research has changed a lot in a short space of time and most credit research heads expect they will continue to have to work hard to stay ahead of the game in terms of distribution. According to our survey, 57% of investors now prefer to receive research electronically. "Electronic distribution is the key," says Thomas at Commerzbank. "Already, much research is distributed by e-mail and over the internet.
And in future we will see greater interactivity in the way we provide research to clients."
In this, as in many areas, equity research is leading the way. But credit analysts are also determined to remain a little different from their colleagues in the equity research department. "Credit analysts have never had the ivory tower mentality of a lot of equity analysts," says one credit researcher. "We are much closer to the trading Floor. And I hope that never changes."
What the top investors say
Euromoney polled 80 big investors on which firms they rated for credit analysis, and for which sector. The poll showed that credit investors rely extensively on banks' research. They want high quality, timely and independent analysis and access to the analysts. Euromoney's poll shows which firms investors rank highest across various sectors
|Profile of investors polled|
|Value of total fixed-income funds||($bn)|
|In-house team of credit analysts?||%|
|Setting one up||10.5|
|Reliance on sell-side research||%|
|Not at all||7.9|
|Do you buy unrated paper?||%|
|If so, own or banks' shadow rating?||%|
|Top six criteria for research used||Score|
|1||Quality of analysis||160|
|2||Presentation/access to analysts||159|
|4||Speed of response to events||77|
|5||Relative value and trade recommendations||64|
|How do you like to receive research||%|
|Use of rating agency research?||%|
|If yes, preferred agency||Score|
|4||Duff & Phelps||4|
|Who they think is best, sector by sector|
|Research services used most frequently|
|5||Salomon Smith Barney||25|
|Use corporate/high-yield benchmarks?|
|If yes, which benchmarks used?|
|2||Lehman/Euro/ Euro 500/Global||109|
|3||Salomon Smith Barney Eurobig||46|
|4||Merrill Lynch High Yield Master||18|
|5||Merrill Lynch Eurosterling Index||16|
|Investment grade (best broker research by sector)|
|3||Salomon Smith Barney||39|
|1||Morgan Stanley Dean Witter||34|
|2||Morgan Stanley Dean Witter||25|
|5||Morgan Stanley Dean Witter||21|
|1=||Salomon Smith Barney||18|
|4||Morgan Stanley Dean Witter||15|
|5=||Dresdner Kleinwort Benson||12|
|2||Warburg Dillon Read||12|
|Investment grade (best broker by information category)|
|Relative value analysis|
|4||Morgan Stanley Dean Witter||37|
|Daily trading ideas|
|2||Morgan Stanley Dean Witter||28|
|Calls on ratings moves|
|1||Morgan Stanley Dean Witter||33|
|3||Salomon Smith Barney||24|
|2||Morgan Stanley Dean Witter||35|
|Credit risk management|
|Sub-investment grade (best broker research by sector)|
|3||Donaldson, Lufkin & Jenrette||36|
|4||Salomon Smith Barney||23|
|2||Donaldson, Lufkin & Jenrette||32|
|4||Donaldson, Lufkin & Jenrette||19|
|5||Salomon Smith Barney||17|
|3||Donaldson, Lufkin & Jenrette||15|
|4||Morgan Stanley Dean Witter||14|
|5||Salomon Smith Barney||12|
|3=||Donaldson, Lufkin & Jenrette||15|
|5||Salomon Smith Barney||14|
|6||Dresdner Kleinwort Benson||13|
|2||Dresdner Kleinwort Benson||7|
|2||Salomon Smith Barney||30|
|3||Morgan Stanley Dean Witter||23|
|4||Salomon Smith Barney||9|
|5||Credit Suisse First Boston||8|
|2=||Salomon Smith Barney||10|
|5||Dresdner Kleinwort Benson||5|
|Sub-investment grade (best broker by information category)|
|Relative value analysis|
|3=||Donaldson, Lufkin & Jenrette||19|
|5||Morgan Stanley Dean Witter||15|
|Daily trading ideas|
|3||Donaldson, Lufkin & Jenrette||15|
|4=||Morgan Stanley Dean Witter||14|
|Calls on ratings moves|
|1||Donaldson, Lufkin & Jenrette||14|
|5||Morgan Stanley Dean Witter||6|
|2=||Morgan Stanley Dean Witter||15|
|2=||Donaldson, Lufkin & Jenrette||15|
|5||Salomon Smith Barney||7|
|Credit risk management|
|2||Donaldson, Lufkin & Jenrette||13|
|3||Morgan Stanley Dean Witter||9|
|4||Dresdner Kleinwort Benson||6|
|Asset-backed investment grade (best broker research)|
|4||Morgan Stanley Dean Witter||13|
|2||Dresdner Kleinwort Benson||26|
|1||Morgan Stanley Dean Witter||27|
|4||Morgan Stanley Dean Witter||5|
|5=||Credit Suisse First Boston||4|
|Asset-backed high-yield tranches (best broker research)|
|Junior tranches rated BBB- & above|
|3=||Morgan Stanley Dean Witter||5|
|5=||Salomon Smith Barney||4|
|Junior/sub-tranches BB+ and below|
Euromoney's third survey of credit research has been extended to seek investors' views on investment-grade and high-yield research, overall credit research services and the work of the rating agencies. We received 80 responses, most of which came from investors within Europe. Respondents nominated up to three banks for best broker, analyst or salesperson as shown in the tables.
Scores were given in the ratio 4:3:2. Scores were not weighted to take into account the size of institutions or volume of secondary turnover. Answers to the sections on best broker, analyst or salesperson were too diverse to allow for ranking by individuals.
If you have any questions about the survey, please contact Andrew Newby, head of research, on +44-207-779 8694 or E-mail him at firstname.lastname@example.org.