|Credit research poll 2005|
|Winners and losers in 2005|
|HIGH GRADE results tables||HIGH YIELD results tables|
|OTHER CREDIT results tables||Methodology|
WHY DO BANKS still churn out daily sector updates chronicling company results, rating changes and the like? Maybe it's a matter of inertia. "Banks do maintenance research because at a party you expect peanuts, even though you don't go to the party in the first place to get them," remarks one head of research.
For a long time the philosophy in bank research departments, which has also pervaded credit research teams, has been that providing a full range of research products and services and exhaustive coverage on every name, asset class and sector to external clients is something banks should be doing because it was expected of them.
If you did trading and underwriting, you weren't much of an institution if you didn't have a first-class research team as well. But that harks back to the period before New York state attorney-general Eliot Spitzer threw a spanner in the works. In those days, having an award-winning team of analysts meant a lot.
Now, it doesn't. The kudos banks get for this is disproportionately low compared with the amount of flak they can be exposed to from regulators.
There's also the inescapable fact that research teams cost a lot, and if underwriting P&Ls are not going to be able to sustain this any more, some other part of the bank is going to have to, or the research department will have to become like the one at Smith Barney, whose clients themselves foot the bill.
It's doubly painful forking out for expensive in-house research teams if as a bank you are in cost-cutting mode and are providing a bunch of services that clients have come to expect but they don't actually want.
Across the board, this has led to a big move of analysts internally to support trading desks, yet that has been going on for a while. Banks have now set about radical reorganizations of the type of external credit research they offer to clients in a bid to make it more profitable and relevant.
Given that pretty well all of them profess to have talked to their customers about what they do want, banks are going in very different directions. HSBC announced in February that it would no longer produce buy/sell recommendations. Bank of America will keep doing so, but not for high-yield paper. Deutsche Bank is following others and merging debt and equity research; in Europe, JPMorgan is uniting debt and equity under one manager.
Pretty well all the banks want to focus on strategic research and lucrative sectors or asset classes but some of them are keeping maintenance research, others are outsourcing it and some are dumping it altogether. In Europe, Goldman Sachs has taken the radical step of ditching published research completely.
"There's been a big upheaval in credit analysis," says Christian Dinesen, head of European credit research at Merrill Lynch. "A number of banks are adopting changed business models, either merging equity and credit research desks or moving away from traditional, published analysis and moving people to be desk analysts. Or, they are remaining entirely independent from the bank, not offering buy or sell recommendations at all."
There's not necessarily one recipe for success and you can keep spending a lot of money on your client-facing research and still be profitable. Lehman Brothers is consistently ranked as the top credit research team in the US, and it has not backed away from either sector or maintenance research coverage.
It's an area where it ploughs in more resources than most. Yet it also has one of the most profitable fixed-income businesses on Wall Street, as its first-quarter results published in March attest. It is surprising to see banks now going in completely different directions in their approach to research, following the "me too" years when every bank worth its salt had to have a prestigious group of client-facing, publishing analysts to prove they were good at research and a force to be reckoned with.
It's pretty obvious why many banks want to focus more on fast-growing, sophisticated products within their research output such as structured credit. As Goldman of Bank of America Securities says, good research is about giving clients an understanding of new asset classes and products and reducing their margin of error when they trade in them. "We're focusing on particular areas such as structured credit and we're committing a great deal of resources to becoming the market leader here," he says. "The idea is to provide innovative research that's not universally available."
These approaches are expanding parts of the fixed-income market and of banks' debt capital markets revenue. "Structured credit and particularly synthetic structured credit are the fastest-growing part of the fixed-income market and they are certainly among the most profitable," Goldman says.
It's easy to see why banks would want to spend their valuable research dollars where they make most money, such as in structured finance and distressed credit. "There's no money to be made any more in looking at the commoditized parts of the fixed-income business, such as covering 100 triple-B names," one market participant says.
Producing research across asset classes is now clearly a winner with investors. Most sell-side research houses are trying to incorporate this to some extent, but whether you merge equity and debt research altogether is more contentious. This is the model that was adopted by Deutsche Bank last December. Its global company research group has been formed out of the firm's old equity, high-yield and high-grade credit research groups. "We're not saying that all our products are going to be combined there will still be credit research for credit investors, but we will provide joint research where it makes sense. The real drive is to improve quality and allow credit analysts and equity analysts to tap into the expertise of both parties," says Guy Ashton, head of European company research at Deutsche Bank. Ashton has held this post since December, following the departure of Nimrod Schwarzman, the former head of European equity research at the bank.
Integration not a merger
Deutsche employs 112 equity analysts in Europe and 14 credit analysts, roughly the same ratio as before the reorganization, but Ashton points to compelling cost savings. "There are lots of cost synergies in having the same technical and editing platform," he says. "Given pressure on margins in debt and equity, it means we can pass those savings on in other parts of the business."
In March, JPMorgan in Europe also took a step towards uniting debt and equity research, putting the group under the management of Katherine McCormick, the former head of European credit research, now director of all EMEA corporate research, after the former head of European equity research, Peter Redhead, left the bank. "This is an integration, not a merger," she says. "We want to offer a differentiated product and we've got no plans to collate the two teams. But by putting everything under a common management, there will be a greater sharing of information between analysts.'"
Merrill Lynch is content to retain its traditional sector-based analyst approach to publishing for external clients and Dinesen agrees that while dialogue with equity colleagues is important, you don't need to merge the two functions to achieve that. "We work closely with our equity colleagues, but that's more fruitful when it's facilitated, rather than forced. Instead, what we have here is a strong commitment to analysts actually owning their sector this is what investors are looking for."
It's not just an issue of organization, banks are certainly diverging on how much they publish and what the priorities are. At one end of the scale are the banks that are going to carry on producing their own daily maintenance research as well as all their more in-depth sector coverage, such as Lehman Brothers; at the other end is Goldman Sachs, which stopped publishing any research in Europe approximately nine months ago.
In its place in Europe, Goldman Sachs has set up what it has called the fundamental strategies group, which will cover all asset classes. The new group is headed up my Sandy Rattray, a managing director at the firm. This new organisation was work in progress when Euromoney went to press, but its remit will be to provide one-on-one, tailor-made strategic ideas to investors, rather than reams of published material.
The two ends of the scale represent the difference between being a full-scale credit research publishing house, a model that Lehman Brothers has pursued so successfully in the US, and the new Goldman Sachs approach in Europe, offering investors more of an in-house consultancy.
Perhaps the most important area of debate is whether banks should continue to offer trading recommendations to clients. As plenty of firms have done before it, HSBC is expanding and wants to add 50 analysts as it bids to build its fixed-income business, especially in the US.
Its approach, however, is markedly different and potentially risky. It has decided not to publish any buy or sell recommendations on individual securities or even the fixed-income market in general, despite the fact that the research group will be paid for out of the trading budget.
Instead, it wants to create an independent business producing medium-term or long-term strategic pieces intended as an introduction to more one-on-one dialogues with clients and research packages tailored to suit them.
On the other side of the fence, McCormick at JPMorgan says that innovative market trading ideas are as important as fundamental analysis in what her team passes on to investors, even if individual credit recommendations aren't.
"Right now technicals are an extremely important issue for clients, not just fundamentals. This year will be like 2004, where you had to be inventive in looking for ways to optimise returns for clients trading that would make them money in a tight spread environment."
Clearly, if a bank's publishing analysts are to give out trading ideas to clients, they need regular dialogue with their trading desks, and this mean publishing analysts have to tread very carefully to disseminate information internally and externally at the same time, a reason why some firms have decided to dispense with issuing trading recommendations to clients altogether.
Although Bank of America is not producing buy-and-sell recommendations for high-yield bonds any more, David Goldman says that high-grade investors like having recommendations. "You just do it the right way. Publishing analysts can talk to the desk and to customers all day, as long as they tell the whole world at the same time about any change in recommendation."
Banks are walking a regulatory tightrope in this area and providing trading ideas at all becomes increasingly difficult as more complex credit and structured products come to the market, catering, for the large part, to growing hedge fund needs. "We want credit analysts to feel comfortable expressing trade ideas through a variety of different instruments, but there are always new credits and new products coming out so it's always a challenge to incorporate all that," says JPMorgan's McCormick.
At the same time, the investor community is becoming more disparate, particularly with hedge funds opening up all the time. The sorts of trading ideas that are both interesting and applicable to a hedge fund are very different to a long-only fund, for example. "What investors don't like is a lot of maintenance research; what they do like to know are the top five things that drive the price of a security. But it's impossible to narrow down exactly what investors want because there is not just one type of investor," says McCormick.
"It means that research has to be modular. However, even if as an investor you can't use some of the instruments our research covers, knowing that a particular credit curve is steep between two and five years can still tell you something useful about the profile of the company."
When writing about an increasing number of products for an ever-growing range of constituents makes the job of writing something for everyone more and more difficult, it's no wonder many banks are, ditching full-scale credit research publishing and narrowing their focus to give themselves a competitive advantage.
These difficulties, while challenging, mean that the best analysts in the market can distinguish themselves. "With such a concentration of assets to look at and such scrutiny of regulators, only good analysts will survive," points out BofA's Goldman.
Those industry leading analysts are certainly getting paid a lot more these days. Yet if banks are not prepared to get their wallets out, retaining talent is a challenge at a time when many banks are frantically trying to cut costs from their research budgets.
Many analysts that used to be publishing analysts have moved internally to lucrative jobs on bank proprietary trading desks, funded by the trading P&L and solely supporting the desk traders. "There is a big flow of sell-side analysts quietly disappearing off to the prop desks within banks," says Glenn Reynolds, CEO at independent research firm CreditSights. "Actually those types of guys often end up being great clients of ours."
The other danger is that if client-facing analysts provide more strategic, tailor-made advice to individual clients, as, for example, Goldman Sachs wants to do, it will be even easier and yet more tempting for analysts to jump ship and command much more money by moving to one of their hedge funds clients or another part of the buy side, a route that many sell-side analysts have taken already.
As Reynolds puts it: "Do I become a star in the annual polls working with investors or move in house or do I go to a hedge fund, where I can probably get paid better for my services?"
Banks are radically rethinking not just what credit research they offer but also their research models in general. There's no doubt that research will continue to have an important role to play at some houses.
"Simply having a view of the world to share with your customers and extending them the courtesy of bringing them into your house is still a valuable thing," says Bank of America's Goldman.
Overall, though, banks seem to have finally dispensed with the notion that published research and information provision is as important as underwriting and trading to their institutions.
There's going to be a lot more change on the way as banks figure out whether these new models actually work for their businesses.