Credit chief continues Credit Suisse revamp

David Miller

As the period of near-zero interest rates and central bank liquidity draws to an end, the credit market has started the long journey towards standing on its own two feet once again. This has led to a guessing game among the pundits: when will the three-decade bull run in bonds turn? Have the years of record low volatility come to an end? Has the booming leveraged finance market reached its peak?

Few are better placed to cut through the speculation than David Miller. In 2016, after more than 20 years working across the full spectrum of debt businesses at Credit Suisse and Donaldson Lufkin & Jenrette (the brokerage it acquired in 2000), Mr Miller was named head of credit products at the Swiss bank. It is a role that involves overseeing trading as well as origination, giving him an optimal vantage point of a market subject to much speculation.

Dispelling myths

After a prolonged lull, the VIX benchmark, which measures the implied volatility of the US stock market, hit a six-and-a-half-year high earlier in 2018. The rise of the so-called ‘fear gauge’ around the beginning of February caused bond spreads to widen, but Mr Miller does not see the market entering a new period of volatility.

“We expect volatility to be higher than in 2017 and January 2018, but we aren’t expecting the kind of volatility we saw in February on a continual basis,” he says. “We are hoping for something that’s not single-digit VIX, but also not the 25% to 50% levels we saw in the first two weeks of February.” 

While many hedge funds and sell-side trading businesses have blamed, inter alia, low volatility for their dwindling returns, overall trading activity slowed during February as clients stepped back to figure out the market’s next move. In addition, too much volatility jeopardises primary issuance, as treasurers are often willing to wait for stable conditions.

Mr Miller also shrugs off the impact of the Federal Reserve entering a new monetary cycle. The market has proved resilient to its gradual lifting of interest rates and the Fed’s announcement in late 2017 that it would wind down its balance sheet. While this normalisation has caused 10-year treasury yields to creep towards 3% – which many view as the tipping point for a bear market – Mr Miller does not view the Fed’s direction of travel as a major threat to the thriving bond market. 

“We don’t think it will impact primary offerings, and it won’t impact trading unless the changes are more rapid than what you see in the forward curve,” he says. “If there is a continual gradual increase over time to 3%, 3.25%, 3.5%, we don’t think that will, in a material way, hurt the credit market.”

Room to run

US bond and equity houses faced signs of a cooling market during first months of 2018. February’s stock market correction delayed several initial public offerings, and analysts expect further drops are in the pipeline. Meanwhile, first-quarter bond sales were down on recent years, which is partly attributable to corporate taxes being reduced from 35% to 21%, which means firms are repatriating cash rather than raising new funds.

In both of these developments, Mr Miller sees potential silver linings for leveraged finance, which is a pillar of Credit Suisse’s investment banking business. Stock corrections lower company valuations, which have hit record highs of late. “That will spur more merger and acquisition activity by private equity firms, which we of course finance,” he says. “So for us, that acts as a hedge against any equity correction.”

Under the new tax regime, private equity is a rare example of an industry that stands to lose thanks to restrictions on the tax deductibility of debt interest payments. However, Mr Miller stresses that this is outweighed by the overall rate drop. “That’s true until you get to the very highly levered entities. Mathematically, you must be levered 6.5 times Ebitda [earnings before interest, taxes, depreciation, and amortisation] for the loss of interest deductibility to not be offset by the tax reduction,” he says, adding that entities with such elevated ratios account for a very small part of Credit Suisse’s business.

As a floating-rate product, leveraged finance is less susceptible to interest rate changes than fixed-rate instruments. It does not escape the effects of volatility, but Credit Suisse has navigated this year’s VIX fluctuations better than most. It was the most active mandated lead arranger in US institutional loans over the first quarter of 2018, and in February priced financial services software firm SS&C’s term loan B tighter than anticipated during the underwriting stage. 

“It’s the largest non-investment-grade term loan placed in the market today. We priced it tight and it continues to trade well,” says Mr Miller. “That gives you a flavour of just how strong the market is for floating-rate products, even in this volatile environment.”

A new direction

Deals such as this suggest that Credit Suisse’s unwavering commitment to its leveraged finance business – even throughout its group-wide restructure – is paying off. Furthermore, private equity firms collectively have nearly $1000bn of ‘dry powder’ that must be invested over the next five years or so, all of which requires debt financing. 

“That is our core competency – originating, syndicating, distributing and eventually trading that paper,” says Mr Miller. “We think this business has an extremely high growth profile and we want to make sure we have the people in place to capitalise on our number one market share.”

Indeed, this business is in Credit Suisse’s DNA. Jim Amine and Mathew Cestar made their name in leveraged finance before becoming, respectively, global head and European co-head of its investment banking and capital markets division. The bank is now leveraging its historical strength in this area to build out its investment-grade platform. Jason Safriet has been promoted from head of high-yield sales to head of securities sales, while leveraged finance trading chief Daniel McCarthy now covers investment grade, too. “We are continuing to meld the two groups together, especially in the crossover space,” says Mr Miller.

It is also bringing in new talent. In February, Credit Suisse recruited Morgan Stanley’s Brian Connors and Dan Driscoll to co-manage US investment-grade bond trading. That same month it hired Goldman Sachs’ Philip Hartman and Max Quinzani for its investment-grade sales desk. Based on the feedback received by Mr Miller, bringing them on board was a smart move. “A number of clients that know these four individuals have since called me up,” he says. “I’ve also received e-mails from people in the industry saying: ‘You don’t know who I am, but I know these people and they are great hires for you,’” he says.

Investment-grade is also leading the credit division’s fintech advancements via an algorithm called CSLiveEx. Created by Julian Pomfret-Pudelsky, one of the bank’s fixed-income algorithmic traders, this tool autonomously handles enquiries capped at $1m for corporate investment-grade bonds. The algorithm decides the best price and responds to the request for quotation; if it wins the trade, it decides what to do with the risk. CSLiveEx has enabled the bank to offer a price on 10 times as many qualifying trades than in the past, while the number of trades it wins has trebled. It is now looking at rolling out the tool to larger ticket sizes (especially in very liquid bonds) and other categories of debt.

Restructuring results

Like other banks’ credit divisions, Credit Suisse’s has had its problems over the years. It is still fighting lawsuits stemming from pre-crisis leveraged financings, and the credit business (alongside securitised products) was a big contributor to the global markets division’s $979m write-downs in 2015 and the first quarter of 2016.

Credit was not the main target of the market division’s overhaul, which was announced as part of a group-wide restructuring in October 2015 and intensified five months later, but has since undergone a raft of changes. 

“We reduced our headcount significantly over the first six months of 2016,” says Mr Miller. “As part of that restructuring we exited our distressed trading businesses, significantly reduced our value-at-risk and moved more towards a model based on customer flow and trading activity versus holding positions.”

The credit business’s positioning into more of an originate-to-distribute model has paid off handsomely. Revenues in fixed income (which post-restructuring is dominated by credit) hit SFr2.92bn ($3.06bn) last year, up from SFr2.6bn in 2016. Credit Suisse is a rare example of an investment bank that managed to increase fixed-income revenues in 2017. According to data firm Coalition, this puts it among the year’s two fastest growing revenue generators in fixed income, currencies and commodities throughout the Americas.