Credit derivatives house of the year: Credit Suisse

Asia Risk Awards 2021

Jacqui Zhang and Soumitra Bhattacharya, Credit Suisse

It is getting harder and harder to compete in Asian credit markets, as smaller niche players offer increasingly attractive loan-to-value (LTV) ratios on deals that the more risk-conscious behemoths of the financing world are wary of touching. Keen not to head down the credit curve just to make a quick buck, Credit Suisse has needed to be creative in its thinking in order to succeed in what has become a very crowded market.

This trend has persisted for the past five or six years, but it is becoming more pronounced as central bank quantitative easing programmes – particularly from the Federal Reserve in the US – flood the markets with liquidity, which then gets pushed out into Asian credit financing.

Whereas before the Swiss bank would have been competing mainly with the other large US and European banks for a share of the credit market, they are now bumping shoulders with providers from elsewhere in Asia – Singapore, Australia, Japan and increasingly China – and some smaller European players that previously would not have been looking at Asian credit.

Increasing competition has seen some banks aggressively compete for financing business, accepting lower-quality collateral and higher LTV ratios while drastically compressing financing spreads, for both recourse and non-recourse financing. 

So, what does this mean for Credit Suisse’s credit strategy?

“At Credit Suisse, we remain vigilant and disciplined in our approach to the credit financing business, and have made a conscious decision not to compete in a crowded market where the financing terms no longer make sense to us,” says Jacqui Zhang, Credit Suisse’s head of financing and solutions structuring for Asia Pacific.

Adding value

Credit Suisse’s approach has been to focus on those areas the bank is particularly competitive in – chiefly private credit – and create value through structural innovation. To an extent this approach is a continuation of what the bank has done in previous years, but it has become more central to Credit Suisse’s long-term survival in the marketplace, as credit quality has deteriorated and defaults have risen. The Covid-19 pandemic has had a hand in this, too.

Min Park, Credit Suisse

“There is a lot of opportunity in the private credit space, where Credit Suisse can structure [private credit issuance] into a format in which capital market investors can invest, potentially provide leverage on this and risk distribute into the capital market investor base,” says Zhang. “Our strategy is to essentially bridge the gap between private credit supply and the depth of capital market investor demand.”

The vast majority of private credit transactions Credit Suisse has focused on are those that are relatively easy to structure, such as corporate loans, private corporate bonds and private placements.

But Zhang says the bank is increasingly pushing into other areas that are often untapped by capital market investors, but where future cashflows can be securitised. These are things such as commodities financing, bank deposits, letters of credit, patent rights, infrastructure and real asset financing.

An example would be an infrastructure loan for a power company. In Asia, many of these power companies are state-owned enterprises, and the loan would usually include an offtake agreement, whereby the government agrees to purchase a certain amount of power produced for the national grid. This offtake agreement can then be securitised into a credit instrument that is sold on the market. This model also applies to many other scenarios, such as financing charter ships or investing in technology that would subsequently be patented.

However, such financing agreements usually come with a variety of risks that extend beyond financial risk. This could include legal risk, regulatory cross-border enforcement risk, performance and operational risk and, when it comes to infrastructure loans, the risk that unforeseen natural catastrophe disrupts production.

It is the persistence of these risks that explains why providers of credit finance prefer to deal mostly with corporate loans or bonds, which are easier to understand and to model, rather than tap into some of these other opportunities.

“Essentially, we have the expertise and capability to structure a marketable instrument out of various private credit situations and present it to the investors in a very friendly way,” says Zhang. “These opportunities typically come with collateral or tighter covenants and have historically higher recovery as well as lower volatility, which present far better risk-adjusted returns for both our investors and for the bank.”

Credit Suisse’s ‘expertise’ can be split into two parts: being able to find and capture that relative credit value embedded in financing transactions, and then having in a place a reliable risk management framework that allows the bank to get comfortable with the transaction.

Finding those deals

In order to strengthen its origination capabilities, Credit Suisse has been working hard to foster and deepen partnerships with smaller Asian players.

“We are already doing a lot of business where Credit Suisse is the originator,” says Soumitra Bhattacharya, head of Apac structured credit trading for the bank. “What we’ve tried to do over the past year is to see if we can extend this to include third-party originated deals, where the structuring, financing and distribution is done by Credit Suisse.”

This obviously increases the spectrum of opportunities that Credit Suisse has access to, but at the same time comes with its own set of challenges.

“When Credit Suisse is the originator, we need to follow a set of processes and obtain approvals from various committees. As a result, when the product comes to us to be packaged and financed, we’re confident that it is in fairly good shape. But when it comes to a third-party originated deal, we need to make sure that the underlying deal meets a similar high standard,” says Bhattacharya.

Even if only a few of these deals were to go wrong, Bhattacharya says the bank is not comfortable exposing its clients to that risk. The upshot of this has been the introduction of a parallel due diligence process to try and wheedle out those few transactions that are not structured well and could suddenly blow up.

“We don’t only want to rely on the third-party originators – we also want to talk to the issuers,” says Min Park, head of solutions sales for markets at Credit Suisse. “Our team monitors all important issues themselves to make sure the collateral is of sufficient quality, the legal documents are well structured and that there is no weak link that could surprise us.”

In this way, Credit Suisse is able to generate attractive returns for investors, while keeping risk low. Bhattacharya says that some of the deals these third parties are originating can be 3–4% above the yield of comparable bonds from the same issuer.

“If one can be comfortable with the private placement nature of the underlying, then that relative value is quite attractive. Obviously with relative value comes relative risk. Nobody pays an additional 3–4% for no reason. Sometimes this is for a structural reason. Sometimes it might be that the originator has better relationships. Or sometimes it is because the inherent risk in the product is much higher than a comparable market instrument. So, we are trying to filter out those situations where the relative return does not justify the incremental risk,” says Bhattacharya.

Structuring capabilities

Beyond the origination part, there is also the structuring capability, which Credit Suisse excels at.

“There’s an old saying in computer science that, people who are really serious about software, should make their own hardware,” says Bhattacharya. “So, what has worked well for us in the private credit space is to design the underlying transaction itself to make it very financeable because many of these trades have features that make it challenging to provide financing. So if we can’t get comfortable with providing financing, then this limits the distribution potential to only those clients that don’t need leverage.”

A very simple example of how private credit can be made easier to finance is via a deposit-linked note. While most people have personal deposits they place with banks, the vast majority of these deposits are unable to get the type of funding that is available to a lot of commercial banks.

A deposit-linked note changes this balance, by creating a structure that pools investment customers together, in order to create a deposit size that is substantial enough for people to be able to get enhanced funding conditions. This allows Credit Suisse’s structuring team to turn investors’ money into something the firm is comfortable financing.

“We’re able to negotiate deposit-termination terms with the [deposit-taking] bank that allow us to early terminate this fixed deposit for a partial amount of size, and the bank guarantees the redemption value will not be below principal,” says Bhattacharya. “This floored-redemption makes the product easy to finance – because the financing provider knows they’ll be able to get back at least what was invested in the first place.”

Bhattacharya says that having good structuring capability in private credit matters a lot.

“In contrast, investors could choose to stick with the standard bank deposit terms, but typically it would be difficult to get financing for such products. Therefore, the yield for the investors may not be as attractive as in the case of the leveraged deposit products,” says Bhattacharya.

Growing with clients

The final plank of Credit Suisse’s Asian strategy is to always be there for clients – to capture them early on as they are just starting out, and then to be there for them as their investments grow.

“When some new credit funds are first set up, their capital is often limited so we provide non-recourse financing solutions, which looks to the value of the assets being financed. But as they grow and start to invest in more assets, then we can introduce solutions such as recourse financing or financing based on the net asset value of the fund,” says Zhang.

Bhattacharya adds: “This allows us to grow with these funds, and we hope that, as these funds grow and make investments, a number of them will also be potential investors for the distribution of our products. As an overall synergy that works well, and allows us to stay relevant in the market.”