SC Lowy, independent fixed income specialist, goes head-to-head with the bulge bracket sans the multiple layers and strict regulation as experienced by large investment banks. Michel Löwy, cofounder and CEO, describes how they went into markets such as the Middle East, trading billions of dollars while their counterparts had no Middle East presence and looked the other way.
Here is the transcript of the video.
Emmanuel Daniel (ED): I want to talk with you about the transition that you see taking place in investment banking today—from the big wholesale corporate banks to very successful independent players like yourself. You started SC Lowy together with your Korean partner Su Chen in 2009, coming right out of Deutsche Bank where you were the head of the distressed assets business. Where is the industry headed today?
Michel Löwy (ML): Yes, we had two names at Deutsche. Distressed assets business was one; strategic investment group was the other.
ED: At which point did you think you could actually step outside traditional banks to start what you started? Today, unlike many in your cohort who have left the large banks and have set up boutique shops, you’ve gone much further. You’ve got a very strong institutional client base. You offer your balance sheet when taking part in the programmes that you do, and you’re expanding your product base. In other words, you are beginning to look like the investment banks that you left. Did you actually see that when you were leaving Deutsche Bank?
ML: The goal for us was to be an investment bank, not exactly like the one I left, but one that certainly would have many of the skill sets and advantages that we had. If I look at us versus other boutiques or entrepreneurs, there are a number of large differences, which explains why our trajectory has been different. People who have left banking or investment banking in 2008–2010 to build their own businesses belong to either of three categories. One, those who built boutiques and have stayed as small boutiques, and who may be reasonably successful at a certain level. Two, those who tried boutique or left for boutiques and have gone back to bulge brackets. These comprise the majority, certainly over 50% of the people who have left banking to try to build entrepreneurial ventures, but have gone back to banking. And then there are the exceptions, like ourselves, who have been able to build that boutique, grow that boutique, and today compete in multiple products with the bulge bracket.
The reason why I believe we’ve been successful is because the business we were running at Deutsche Bank was already, by itself, a mini investment bank within the bank. Meaning we were not just traders, investors, or originators, we were doing it all. We were originating product, we were investing in product, we were selling product, we were settling product.
The team that I had at the time included sales people, traders, lawyers, settlement people—people from all the different areas. And when you do complex investments, you need to have a very wide set of skills. You need to know how to value an asset. You need to understand the legal process. You need to be able to transfer the assets that you purchase. And that’s what’s made us different.
ED: Did you build that environment? Did you see yourself actually building that within Deutsche, or was it something that was the nature of the business already?
ML: It was the nature of the business. So if you look back, I moved in the late 1990s to Singapore to start buying stressed and distressed assets, and then joined Deutsche in 1999. At the time, the distress specialist situation business was me in Asia, period, and a couple of people helping me out of London. Su Chen then joined me very quickly. So at the time, we grew our business organically from scratch.
ED: Just to pause, are the global corporate banks wrong in exiting some of these businesses today?
ML: That’s a difficult question. I’m obviously incentivised to tell you that they are not wrong. The least competition see, the better it is for us. I’d say it’s increasingly difficult for them to compete in this space.
ED: Because of capital costs?
ML: Multiple reasons. Capital costs is definitely one. We transact in liquid assets, distressed assets; that’s high capital costs for the banks. The second reason is people. You need to have highly qualified people to understand those assets, to value those assets, to transfer those assets, to sell those assets. And today, the banking world is not anymore the place of choice for the hardest working and most talented individuals. Why? Because of regulations. The banks like to offer extremely high salaries to their staff so that they can pay bonuses. Because as you know, the bonuses are capped at a multiple of their salary, depending on which jurisdiction. So what happens is that you create a top-heavy environment where people are incentivised to stick around for high salaries. They’re not necessarily incentivised to work hard, and they know that their performance is capped. So for young, ambitious people, it’s not anymore the environment where they want to operate. They would prefer to work for a hedge fund, which has been the choice of many.
At SC Löwy, we are one entity, not a hedge fund, but where you can work as in an investment bank. We are not regulated by banking authorities, with the exception of our Korean business because of the Korean Bank. And this absence of regulation allows us to pay people for performance.
ED: How, then, do you see the dynamics within a player like yourself, which can take on complex and traditional banks? Is there a change in role? Is there a certain kind of dynamics evolving?
ML: There is a changing world in those dynamics. The regulators have now decided to split banks into commercial banks and investment banks. We don’t have a Glass–Steagall Act and we don’t have a separation, yet. But to a certain extent, the degree of oversight and regulation has increased, and cost of capital has partially achieved that. Hence, banks with a very large balance sheet, which pose a systemic risk to the economy and have a large deposit-taking business, find it increasingly more difficult to run a proper investment bank.
ED: At the same time, what’s also interesting, I notice, is that as the global banks are retreating from this space, the regional and domestic banks are sweeping in because their corporate clients are asking for exactly this service. And they have less of the complexity issue, or maybe for their own domestic needs they have that talent pool that you’re talking about. Do you see that dynamic evolving, as well?
ML: Yes, absolutely. There is a vacuum and the vacuum is being taken over by people like us and by some of the regional banks that benefit from their network and local infrastructure, which have an advantage with some local clients, and which also see an opportunity to compete in the local market. We at SC Löwy want to be global so we’ve got offices in New York and London, and a lot of our business is across the globe, across geographies.
ED: Is there a specialisation or skill set that you have that shows up very clearly? In other words, do all of your other counterparts see you as a skills player rather than just as a deal maker?
ML: Yes. Our counterparts increasingly know that when you have something that is complex to value, complex to transfer, SC Löwy is the place of choice. It’s the place of choice because we can provide the skill set; also because we can do it in a very efficient and quick manner because we don’t have the bureaucracy, the different layers that you may have in an investment bank. When we met for the first time a few minutes ago, I was sitting in the middle of the trading floor. Whereas at Deutsche, I’d be somewhere in a corner office, removed from the trading floor, removed from the rest of the staff. The fact that we’ve been able to avoid those layers makes us a lot more efficient.
And then another aspect is how we communicate, how we transform information. Because we are highly specialised, we know exactly who’s the right buyer, who’s the right seller, who is the right advisor for a certain industry or business to help us out. That means we avoid what traditional bulge brackets do, which is to go on a speakerphone or on a massive email list to send information. And we can do things, in many ways, old school, by just picking up the phone and contacting the two or three investors who really fit that investment. What that achieves is speed and confidentiality, which today you can’t really expect from a large investment bank.
ED: Your 2014 volumes in the secondary loan and high-yield market were about $5 billion. And 2015 was…?
ML: I believe $6.5, if I’m not mistaken. So we were up a little bit over 20%.
ED: From the time you started, was it the high-yield market that drove your business and created the opportunities that you had? Were you eating the pie of a market that already existed? Were you plugging into it or were you growing into a growing market?
ML: Yes and no. There’s different products, right? You have the secondary loan and you have the high-yield bond market. In the last five years, Asia grew pretty much nonstop. 2014 was the peak of the market with regulations; 2015 was a little bit less. In 2016 we’ll probably see even less issuance. So we were sort of riding the tide of a fast-growing market and benefitting from that. We were gaining market share as well as benefitting from a developing market.
On the secondary loan side, it’s very different. It’s a heavily cyclical business. Until 2012–2013, it was a very active market primarily in Australia. In the last couple of years, it has been a very quiet market in Asia with commercial banks not selling assets. In the second half of 2015, we started seeing a turn in terms of secondary loan volumes. Despite that, we’ve been able to gain market share and grow because we started from a lower base. But the secondary loan market certainly has not followed the same trend as the high-yield bond market.
ED: Yet it’s got its own trajectory in that markets are slowing down now. And in various large countries in the region—China, Vietnam—there is a sizeable distressed assets business waiting to happen. How are you looking into this opportunity and how is it evolving? Who are the counterparts that are beginning to take shape right now?
ML: Yes, you are right. We have very optimistic expectations about the size of business and the growth expectations in the next couple of years. I think it’s going to be slow development. Banks in the region, whether local or international banks, do not at the moment have a lot of pressure to manage their balance sheets and offload some of their problem assets. And at the same time, conversations with borrowers that are in trouble are at very early stages. It’s going to be a slow development.
Where do we add value, how do we differentiate ourselves? It’s very simple. We’ve been doing it through the cycle. I’ve been doing this for 20 years. I’ve been talking to the same banks, helping them out, creating liquidity for the last 20 years. I’ve been talking to the same investment funds for the last 15–20 years about helping them to find investment opportunities and go into investments with them.
What we have done differently is we have geared ourselves and prepared ourselves for what’s coming by securing additional capital. So we have a much larger balance sheet today than we did even a couple of years ago and are ready for these changes.
ED: What do you mean when you offer your balance sheet? You’re not registered as an investment bank. From an advisory perspective, what does it mean when a boutique house like yours offers a balance sheet?
ML: What it means is that we are a trading counterpart of a bank that wants to sell assets, or a fund that wants to buy or sell assets. We don’t provide advisory services; we are not paid for advisory. The way this works is that somebody will contact us to share information. We do some due diligence. We explain to them where we think this will transact in the secondary market if they want to enter into a transaction. If they do, then we enter into more serious conversation with them and buy the asset. Later on, we work on offloading the asset or part of the asset to other investors.
ED: But more recently, you’ve had at least two primary issues of your own.
ML: That’s right. That’s a completely separate business; that’s a different equation. So you’ve got the secondary flows on the high yield on the loan side, and then we’ve added a debt capital market business where we are helping corporates raise primary financing. That’s a separate business that has separate licenses.
ED: You say that you want to be global. A lot of your contacts and your relationships are in this part of the world. How do you globalise that? I’m sure that in the main capital markets—London and New York—you would be well connected in that way. How are the opportunities coming for you that enable you to globalise what you’re doing?
ML: As you said, first of all, most of our transactions are global; over half of our clients are in London, New York, Geneva, Los Angeles, San Francisco, and those are people whom we’ve dealt with for a very, very long time. That’s why we’ve got over 20 people who are not in Asia but working in our offshore offices to either distribute or originate or analyse some of our products. The other reason why we can be global is (this may sound arrogant) I often find that we can be much more global than the large investment bank.
I’ll give you one example, the Middle East. The Middle East is a very big business for us, where we’ve been transacting billions of dollars of loans in Dubai and Kuwait. If you had asked me five years ago, do you know anything about the Middle East besides where it’s located on the map, I would have told you I don’t know a whole lot.
ED: It’s actually a highly leveraged part of the world.
ML: Yes, because everybody wanted exposure to Dubai—the European banks, the global banks, the Asian banks, the Chinese banks. Everybody wants the Dubai of 10 years ago. Everybody wanted to enter the region. And suddenly, five or six years ago, that changed. And we saw an opportunity because we had banks starting to call us saying, we’ve got this portfolio of loans here, we’ve got those assets there; can you help us value that? And we quickly built expertise trying to value that; we quickly got on top of the restructuring landscape in the region and we started trading. We started buying assets, selling assets. We started creating buyers. It was the same counterparts, just a different product.
In the meantime, our competitors (who will remain unnamed), were still fighting between New York and London, and London and Singapore or Hong Kong, as to whose mandate that should be. Because nobody has a Middle Eastern mandate. So it was sort of in between. And while people were fighting, we were trading billions of dollars. That’s how we could be more global and move much faster than some of our competitors.
ED: And at the same time, the relationships were all new because only in the last 10 years has the Middle East been coming into the market in that regard. So are you now domiciled in the Middle East, in Dubai?
ML: We are still not domiciled there. One of our senior colleagues is in Dubai today. We have people in and out of Dubai all the time but we don’t feel the need to have a physical presence there. We are still a small business. And as a small business, I think it’s important to sit in the same office. It’s important to have that physical interaction with the staff constantly. So for me, Australia is a very big business. The Middle East is a very big business. I would much prefer our people fly there on a very regular basis, but for them to spend over half their time in the office where they can interact with me. I find that’s really more powerful than having people based in satellite offices.
ED: In your sphere, in your wholesale sphere—and this is a question from a commercial banking perspective—do you ever worry about liquidity? With the availability of counterparties to trade and so on, is there any day that you have an issue on that front?
ML: Absolutely. As a matter of fact, one big risk that my industry is facing is counterparty risk. When you think about it, you trade loans, bankruptcy claims, trade claims. Settlement can be 2–3 weeks; it can be six months. In the meantime, you take the credit risk of the counterpart that you’ve entered into a contract with. That’s why we’ve got traders in our business, to expedite this as much as possible to limit the credit risk that we take. When there is less liquidity, there’s volatility. You sometimes see behaviour that should not take place. And we can be on the receiving end of that.
ED: I never thought that I’d meet a true, blue-blood investment banker in 2016 so it’s very interesting in that way. Some quick questions on the global economy as you see it, how it’s going to play out, and the nature of distress that is coming out of the market now. How do you think the market as it exists today is going to create some of these asset classes that maybe do not exist today?
ML: If we look beyond China, what you’re describing is not a new phenomenon, in the sense that distressed assets arise from massive changes in industries or massive changes in the macroeconomic landscape of a specific country. If you look at the cycle of distress in last few years, it was telecommunications in the US and Europe. In the early 1990s it was real estate in the US. Globally, it’s yellow pages, it’s shipping. Currently, it’s mining.
So we are used to seeing rapid changes in a specific industry or in a specific country, such as the Asian financial crisis of the late 1990s, and Argentina’s default and devaluation in 2002–2003. Those massive changes create opportunities. It doesn’t mean that something is worse; it means that something has a different value. It doesn’t mean that a business has no reason to exist anymore; it means that the business prospect as we saw it yesterday, and the assumptions we were making yesterday, aren’t valid anymore. And that’s where we jump in to try to rewrite the map and take a view on the future of an industry, or how restructuring is going to play out in a certain country.
So that’s what we do, what we’ve done the last 20 years. In the current cycle, with China slowing down and its impact on Indonesia, on Australia, and Brazil, in many ways those are not new to us. It’s something we do; it’s just a different equation that one has to try to solve: to provide liquidity to a market that suddenly has no liquidity. Now in terms of new asset class in a new country, and new opportunities in China, there are going to be massive opportunities in China for a business like ours, whether it’s on primary financing or secondary trading. However, we’re still very much at the very, very early stage in that cycle. If I look into my crystal ball, do I know what we’re going to be doing in China in the next 3–5 years? I have absolutely no idea. Do I believe that we’re going to be doing a lot there? Do I believe that we will probably need a strong, local partner to help us out? Absolutely.
ED: And likewise, other large countries like Vietnam, Indonesia, even the Philippines, which have not really come into the market yet, these countries are sitting on very large distressed assets in their banking systems. They do not have any of the legal infrastructures to trade them at the moment. And yet, the governments are interested but not really because of the politics of the country. Do you find yourself having to go in and do business development? Do you do some frontier work in some emerging markets?
ML: We do some frontier work. Part of it is simply that when you get involved in a specific situation that needs to be restructured, very often there’s a lot of publicity around it. And the experience that you go through, whether it’s specific or not for creditors or borrowers, very often entail significant ramifications as to what the regulator perceives the creditor or borrower needs to do. And so that’s where we would interact at a very early stage. You mentioned a number of countries. I would say that India, for example, is double duties for us; much more than a country like Vietnam or the Philippines. Why? It’s a much bigger economy, a much bigger problem.
The restructuring system has been tested. It’s been tested for the last 10 years. It’s a real system that’s painful but it works. So for us, India and China are sitting at the top of the list. Indonesia is right behind that. Why? Because they have US dollar debt. It’s much easier to assess that. And a lot of foreign lenders are involved. That’s our bread and butter. Local currency that is held by local institutions in a country that does not have creditors’ protection is very complex. So we’ll dip our toes in, but very cautiously.
ED: Almost all your work is in dollar debt. You don’t do much domestic currency?
ML: Ninety percent of what we do would be G3 currencies.
ED: And the ones that you do touch, which ones are they, the emerging market currencies?
ML: At this stage we’ve done quite a bit of Korean Won. We’ve done a little bit of Rupees and Renminbi and we expect those two to grow significantly. But to be a player in that space, you need to, again, overcome some regulatory hurdles. It’s very time-consuming. So while we’re very ambitious, we know that if we try to do everything at the same time, we’re going to fail. So there are ambitious plans but they are going to take us 3–5 years; they’re not immediate.
ED: In building your business in Korea, you were exposed to the distressed assets and then you bought one, which is the savings bank that you have. This is almost like the priest marrying the nun in the cathedral. Was that a temptation that you took on, or is it part of an overall strategic plan that you have for yourself?
ML: It’s more of a temptation that became a strategic plan.
ED: That’s an honest answer.
ML: We stumbled across an opportunity, and the more we looked at the opportunity, the more we realised that it was very attractive in that it could mix very well with many of the objectives we have.
ED: But there are ways that Korea bought banks and somehow didn’t learn the lesson that Korea is really not much, that what you see is what you get. Debt in Korean culture is very different from the way it operates in other parts of the world. I’m talking about commercial banks that have bought credit card portfolios and then found that they were actually plugged into the moneylender network, that kind of thing. So is that a risk that you’re taking? Are you happy with where you are at the moment on the savings bank side?
ML: I’m very happy with what we’ve done so far. We knew what we were getting into. Korea is a market we knew very well. My partner, Su Chen, is Korean. We’ve been doing business in Korea together since 1998 so we know the landscape really well. So there’s nothing there that came as a surprise. But you’re absolutely right, each market has its own intricacies.
ED: Michel Löwy, as a boss, in getting the people that you have, and in keeping the talent that you have, are you satisfied that you are able to attract the talent that you want and keep them in the face of competition from traditional players? I can see why some would want to be part of a boutique outlet because of the complexities that they can work on. But generally, salaries and seniority are also important How do you mobilize your staff? What is your operating philosophy?
ML: Our philosophy is very simple. People that are successful here would get paid more than they would anywhere else. And they do it in an environment that is a total meritocracy, a very flat environment. Nobody has a title, which works for some people but doesn’t for others. Generally, we’ve been very good at recruiting and assessing who are the right fit with what we are trying to achieve. So we’ve been pretty successful there. There has been some turnover but as far as I understand, the turnover for our staff is much smaller than it would be compared to any of our competitors.
And we’re starting an environment now where you can attract a lot of talent, and there’s a lot of talent that’s available. Taking a historical perspective, I have to say that in the first couple of years of our existence, it was hard to attract talent. Nowadays, we’ve got a very good reputation. People know in the market that the people who are successful are very well paid here, and that their upside is significantly greater than with any of our competitors. That too attracts a lot of talent. So it’s become a lot easier than it used to be.
ED: Finally, what do you do with the retained earnings that you build? You’ve got shareholder commitments but what are you tempted to use that for besides globalising your business?
ML: So far as a firm, we haven’t distributed any dividends because we just see very good opportunities for us to expand globally. Korea is one, so that’s been one way we’ve used our retained earnings. But so far, everything’s been reinvested in the firm because we want to continue to expand. We have the ambition to build similar local presence by building either a joint venture or buying infrastructure in markets like China or India and beyond that. In our European business, we are also looking at possibilities in markets like Italy, for example, where you have massive stock of nonperforming loans and you need regulated entities to buy those pools of assets. So at this stage, we just see so many opportunities so we plan to reinvest those earnings.
