Junk-Debt Teams Gutted in Crisis Grow Again as RBS Hires

Royal Bank of Scotland
A pedestrian passes a branch of Royal Bank of Scotland Group Plc (RBS) in London. Photographer: Chris Ratcliffe/Bloomberg

Dealers from Royal Bank of Scotland Group Plc to UBS AG that gutted their credit units after the 2008 financial crisis are now hiring to trade junk debt, seeking to tap into the biggest fixed-income gains during the past year.

RBS, owned by the British government after the biggest-ever bank bailout, is adding to its U.S. high-yield debt team by the most since 2006 with five senior hires since July to its trading and sales team in Stamford, Connecticut, said Dick Smith, the head of the group. Zurich-based UBS expanded a trading group created in August with three additions since November, said Tom Einhorn, the head of that team.

While new capital rules make it costlier for the biggest banks to hold speculative-grade assets, lenders are vying to profit from trading in the debt as the least creditworthy borrowers benefit from a strengthening U.S. economy. Bond buyers are finding a haven in junk after the Federal Reserve’s move to start tapering its unprecedented stimulus left the broader fixed-income market with its first annual loss in more than a decade.

“It’s typical of Wall Street, of over-cutting and then hiring people back,” said Michael Maloney, president of New York-based headhunter Maloney Inc. “There’s still money to be made in this market.”

Making Hires

Since July, RBS has hired credit salesman Michael Miller, strategist Vivek Khanna, and traders Kevin Dooley, Paul Stokes and Jack Oestreicher, said Smith, RBS’s head of loan and high-yield capital markets in the Americas. Stephen Chronert joined in March as head of U.S. high-yield bond and loan sales. Michael Sanzone moved to the Stamford office from London to run the firm’s sponsor coverage unit, which caters to financing needs of private-equity and hedge-fund firms in the U.S.

“From both a client and return-on-equity perspective, our high-yield business remains attractive for our global institution,” Smith said.

UBS, which has been selling assets accumulated before the crisis, formed a global team that focuses on debt ranging from the credit of Greece, Portugal and Cyprus to bonds of Caesars Entertainment Corp. and Eastman Kodak Co.

Investors are “going to look for the highest risk-adjusted returns,” Einhorn, who joined UBS after leaving Goldman Sachs Group Inc. in 2009, said in a telephone interview from New York.

Plunging Further

The team hired analysts Chris Ellis, formerly of Mizuho Securities USA Inc., and James Finneran of Developing World Markets this month. Tharsh Thavagnanam, a London-based corporate-bond trader, joined from RBS in November.

Investors are plunging further into riskier securities five years after the Fed embarked on an unprecedented program of keeping benchmark rates at about zero and buying bonds to suppress borrowing costs. While corporate and sovereign bonds lost 0.3 percent globally last year, junk-rated debt gained 7.1 percent, according to Bank of America Merrill Lynch index data.

Junk-debt offerings typically pay underwriters fees that are about three times those on investment-grade issuances, Bloomberg data show. The difference in what dealers charge to buy and sell the debt in the U.S. has averaged 55 basis points, or 0.55 percentage point, since the end of 2006, almost three times as much as the 19 basis-point spread for investment-grade securities, according to Barclays Plc data.

Junk Fees

Distressed-credit hedge funds delivered 16.8 percent returns in 2013, the most among all strategies, according to data-provider Eurekahedge. U.S. Treasuries lost 3.4 percent, Bank of America Merrill Lynch index data show.

Speculative-grade companies have raced to lock in yields that plunged to an all-time low last year, selling an unprecedented $379.77 billion of dollar-denominated high-yield debt in 2013, Bloomberg data show. Yields on the notes have risen 28 basis points from the low to 6.26 percent on Jan. 14.

Speculative-grade, or junk, debt is rated below Baa3 by Moody’s Investors Service and lower than BBB- at Standard & Poor’s.

Banks “need to support new issues,” Maloney said. “What they should do is hire one sales force to cater to firms globally.”

RBS shrank its investment bank after coming under pressure from lawmakers and regulators to bolster capital. The firm cut at least 20 jobs in corporate debt in November 2011. Oestreicher departed at that time, going to Cantor Fitzgerald & Co. before RBS hired him back in October, according to records maintained by the Financial Industry Regulatory Authority.

RBS’s Goal

After thousands of staff reductions in the Edinburgh-based firm’s investment bank, RBS began cutting 2,000 additional jobs as Chief Executive Officer Stephen Hester resigned in June. The firm fell to 12th on the list of most-active underwriters of dollar-denominated junk-debt sales last year from 10th place in 2011, according to data compiled by Bloomberg that excludes deals in which banks manage their own offerings.

“Our goal is to return to the top 10 in the league tables,” Smith said. “We’re looking to add, in a very strategic and select manner, senior people with strong relationships.”

Bond dealers jettisoned assets and shrank credit teams to comply with rules issued in 2010 by the Basel Committee on Banking Supervision and the Dodd-Frank Act passed by Congress the same year.

Capital Rules

Under the Basel standards, lenders need to reduce assets -- tallied according to the level of risk each carries -- by at least 25 percent, according to estimates by Sanford C. Bernstein & Co.

“The industry is trying to come up with the optimal mix of business in this changing world of regulation,” said Brad Hintz, a New York-based analyst at Sanford C. Bernstein & Co. “At some point, they’ll find that new optimality.”

UBS sold $500 million of distressed debt in November to Sound Point Capital Management LP and KKR & Co.’s Special Situations Fund, people familiar with the matter said at the time. Sound Point hired a UBS team managing the securities, led by Jeff Teach.

The bank, which is cutting 10,000 jobs and exiting most debt-trading businesses to concentrate on money management, is still committed to maintaining its investment bank, Chief Executive Officer Sergio Ermotti said in a Jan. 13 Bloomberg Television interview.

‘Defined Assets’

“We have very defined assets and capital that we want to put at work in the investment bank, and the business model works,” he said. “To imply necessarily that a higher leverage ratio means that the investment bank is the one most affected is too much of a simple conclusion.”

Elsewhere in credit markets, corporate defaults are expected to decrease as the global economy gathers pace, according to a survey by the International Association of Credit Portfolio Managers. The market for corporate borrowing through short-term IOUs contracted to the lowest level in three months as offerings from financial institutions declined.

The cost to protect against losses on U.S. corporate bonds rose, snapping a two-day decline. The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark used to hedge against losses or to speculate on creditworthiness, climbed 1.2 basis points to a mid-price of 64.8 basis points as of 11:18 a.m. in New York, according to prices compiled by Bloomberg. The index reached a six-year low of 62 on Dec. 26.

European Benchmark

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings increased 0.7 to 70.3.

The indexes typically rise as investor confidence deteriorates and fall as it improves. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

The U.S. two-year interest-rate swap spread, a measure of debt-market stress, fell 0.24 basis point to 12.51 basis points, declining from the highest since Oct. 28. The gauge typically narrows when investors favor assets such as corporate debt and widens when they seek the perceived safety of government securities.

The IACPM’s credit default outlook index, in which positive numbers indicate an expectation of fewer defaults and improved credit conditions during the next 12 months, rose to 4.5 from negative 6.9 in September and minus 35.6 last June, according to the survey, which was released today and conducted during the first week of January. IACPM’s 89 members include banks, insurance companies and asset managers in 17 countries.

Commercial Paper

Respondents forecast better conditions in Europe, Asia, North America and Australia, according to the IACPM. The Washington-based World Bank forecasts the global economy will expand 3.2 percent this year, compared with a June projection of 3 percent and up from 2.4 percent in 2013.

The seasonally adjusted amount of U.S. commercial paper fell $23.7 billion to $1.036 trillion outstanding in the week ended yesterday, the Fed said today on its website. That’s the least since the market touched $1.034 trillion for the period ended Oct. 16.

Demand from money-market funds, among the biggest buyers of the debt, declined earlier this month amid a shift into riskier investments. Total assets in the funds fell from the highest level since June 2011, decreasing $4.2 billion to $2.715 trillion in the week ended Jan. 8, according to the Investment Company Institute.

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