Should We Measure Quality Over Quantity?

Stephen King has written round about 200 stories, including roughly 50 novels. That doesn’t necessarily make him the best writer around, just one of the most prolific.

But what about investment banks and their deals, specifically their high yield deals? Each quarter, data companies release the league tables, which rank investment banks according to how copious their volumes are. All that counts is the number of deals done.

But FridsonVision analysts have sought to rank debt underwriters in a different way—not by volume, but by the long-term quality of their deals as investments.

The firm’s analysts recently ranked high yield underwriters by the long-run default rate of the companies they completed deals for, taking a comprehensive list of high yield issues from 1997 to 2004 from Advantage Data and Merrill Lynch and adjusting figures for the quality of these issues (or their ratings). The analysts only included up to 2004 because they wanted to focus on three-year cumulative defaults, as analysis shows that the third year after issuance is generally when defaults peak.

So who topped the charts as the underwriter whose issuers had the best default rate? UBS took the No. 1 spot, with an unadjusted annual default rate of 2.62%; Lehman Brothers came in second, with a rate of 4.04%; and Deutsche Bank ranked third, with a rate of 5.08%. These three banks also came out on top when actual rates were compared with expected rates, which were adjusted for ratings. For example, a bank with 20% of its deals falling in the triple-C category should see more defaults than a bank with 6% of its deals in the same category. “It just means they’re selling Hyundais instead of Cadillacs,” said Martin Fridson, founder of FridsonVision. “I don’t expect a Hyundai to perform like a Cadillac. But if it doesn’t perform like a Hyundai, I’ve been swindled.”

On the other end of the scale, Morgan Stanley had the worst record, with an unadjusted annual default rate of 10.27% next to an expected rate of 6.67%—a difference of 3.51%.

Fridson, whose firm has released the rankings annually since 2003, said the purpose is really to help investors who might be looking at a deal, especially one that’s a close call, by giving them information on the underwriter’s record.

“Investment banks are compensated on volume,” he said. “There’s not really enough quality control. If it turns out to be a bad deal, they don’t make them give the money back.”


(c) 2008 High Yield Report and SourceMedia, Inc. All Rights Reserved.

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