Telling it as it is

Credit research

juliapeach-feb02-gif

The fixed income markets have attracted nowhere near the amount of criticism that the equity markets have over the impartiality of sell-side research. Nonetheless, credit investors complain that some investment banks are far more sell-side driven in their research than others. Hardeep Dhillon reports.

It is not only in the equity markets that the impartiality of sell-side research has been under scrutiny. In the fixed income markets, too, the conflict of interest between selling the bond issues that banks have on their books and what they say in their research pieces has led investors to keep a watchful eye on the quality of sell-side credit research. Nowhere near the same amount of criticism has been levelled at fixed income research as equity research, and rightly so. But there is no doubt that there has been room for improvement. Bankers confess privately that standards have been raised as European fund managers have become more experienced investors in credit, and investors, too, say that the quality of the coverage has improved. The jury is still out, though, on the total impartiality of analysis. Looking at some research pieces, investors could be forgiven for wondering who, exactly, is pulling the strings - the analyst, or the sales or investment banking departments?

An impartial view should form the basis of any good analysis, but investors and bankers alike freely recount circumstances where this has not been the case. Take the investor who phoned up requesting information on a company and was told that the bank could not send it out because the analyst was awaiting the company's authorisation. Or take the situation where analysts have been made to edit analysis because, in their own words, "it was written objectively", and did not match up to the syndicate department's expectations, or even situations where research pieces have been stopped because they do not toe the company's line.

The development of multibank sites, such as Bond.Hub, provide a convenient way for investors to compare and contrast a wide range of research publications from competing banks, and another option is for investors to obtain analysis from independent publishing houses, such as First Call.

"You can get information from other sources and these can be more beneficial than bank research," says one investor. "It is an additional information source."

Much has been said about the conflict of interest between the research and origination or syndication departments, and question marks over the independence at all times of the research are inevitably hard to dispel.

"I am not saying it is inaccurate in any way, shape or form," says Tim Webb, credit fund manager at Barclays Global Investor (BGI), "but new issue research is there for a purpose. There is always a slant on something, whether that is a way of avoiding focusing too much on the negative, rather than giving a balanced delivery."

Investors say that some investment banks are still putting an angle on research and using it more as a marketing exercise. "You can just open up a copy of research from some houses," says Karl Bergqwist, fund manager at BGI, "and it is blatant that they are presenting it in a sales manner. Receiving analysis is a sure way of finding out that an investment bank is about to launch an issue on the company covered."

The fact that the larger banks can feel duty bound to send out analysis on companies whose bonds they are about to underwrite can present opportunities to banks that are less active in the new issue market.

"Research can be too new-issue oriented," says one high-yield investor. "That is where the second tier of banks can offer independence and add value."

Banks such as Bear Stearns, BNP Paribas, HSBC (in sterling), Royal Bank of Scotland (particularly for ABS and sterling credits), Lehman Brothers, Deutsche Bank and Merrill Lynch are some of the banks mentioned most regularly by fund managers as being a cut above the rest in terms of the impartiality of their advice. Although some of these banks are active in various niches in the new issue market, only Deutsche Bank and Merrill Lynch can genuinely claim to belong to the top-tier of underwriters.

Although Credit is not claiming that this list is exhaustive, the fact that investors are even willing to compare and contrast different houses is significant. And there is little doubt that some banks have worse reputations than others for being sell-side driven.

"At present we are not pulled from pillar to post by the relentless demands of a new issue business which enables us to take a more considered view of the secondary market and see the wood from the trees," says Philip Crate, head of credit research at Bear Stearns. "Although we are still developing our new issue business, our standards are high and we provide an independent and honest viewpoint."

Rick Deutsch, head of European credit research at BNP Paribas, believes progress has been made generally among banks in turning out objective research.

"Several years ago, it was often a mouthpiece for bond positions on the book," he says. "Now, it is much more independent than in the past, mainly as a function of the increased sophistication and growth of the client base and the market in general. Clients will know when you are expressing an independent and real view and when you are doing something for the house."

Deutsch provides as an example of candidness in a new issue note he wrote on Telefonica last year. "It says a lot about BNP Paribas, when I can write a research piece on a high profile new issue from Telefonica and say I believe that its A+ rating is likely to be downgraded to A. It was the same with the Alcatel bond we lead managed last December. I wrote in the analysis that I thought it was facing ratings pressure, but was likely to stay investment grade. This pretty clearly indicated that I thought that a move from the current triple-B to triple-B minus was very possible."

"We don't pull our punches," he adds. "We are very forthright about the problems we see – houses are not always that frank and open about issuers. We try to be market-oriented and tie credit opinions to performance in the bond markets, to make and hopefully prevent losing money for investors."

Julia Peach, global head of high-grade credit research at ABN Amro is equally forthright in suggesting that biased views need not necessarily creep into a bank's research, and says that her analysts have never had to submit to pressure from the bank's originators.

"The research team here is not told what they can or cannot write, in fact there is a very interactive relationship between traders and analysts about what risks are taken on the book. We believe that research has the capability to drive the business.

"What is the value added and where are you going as an analyst if all you are doing is providing positives? This does not differentiate you from the crowd and at the end of the day it is the analyst, the team and bank reputation that is at stake."

Peach says the research that the bank produced on Tesco and Railtrack are good examples of an honest and candid approach to analysis.” The more experienced an analyst is, the better the chance of impartiality," adds Bernard Hunter, head of investment grade research at Merrill Lynch Investment Managers. "On a positive note, recently I heard of one analyst that was downbeat on a credit who did not succumb to syndicate pressures to write something more neutral, and that is to be applauded."

One area where fund managers believe improvements can still be made is follow-up coverage. "It is a concern, when we are looking at a new issue and the banks are not in a position to research that deal on an ongoing basis," says Hunter at MLIM. "So we take that into account when we look at the level of business we do with a firm. We stress to firms that if they do this well, then they will make money."

Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.

To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe

You are currently unable to copy this content. Please contact info@risk.net to find out more.

You need to sign in to use this feature. If you don’t have a Risk.net account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an individual account here