Purgatory for the Sins of High Finance

Diwan, the Indian restaurant and kebab bar in New York’s midtown east, stands far away from the rubble of Wall Street. But for the Indian-origin professionals of high finance, it has always been worth the trudge given the restaurant’s sumptuous $11 buffet and unique dishes such as Juhu Pani Puri and Tandoori Vegetable Tower.

It was here that Maneesh Awasthi and Raparthi Viru, two investment bankers who migrated to the United States in the early 1990s, met at the peak of the financial crisis in September 2008 to ponder their future. Many a mighty bank was seeking government bail-out to survive. Dozens of small investment firms had downed shutters. Thousands were losing their jobs. Financial markets had turned into pools of poison, flooding every balance sheet. It hardly looked like the time anyone would talk of entrepreneurship.

But by the time dessert arrived on that evening at Diwan (now Bombay Bistro), that was exactly the conclusion the two friends had come to. Employed at Broadpoint, an investment bank, Viru and Awasthi figured they spent enough quality time at the sell side of structured financial products that they could make a living by helping the buy side — investors with portfolios of products that had gone sour — clean up the mess. After all, it should be easy to find them in the Big Apple.

Viru, 40, says they didn’t talk much to the other diners that day and rushed home to give shape to their spicy idea. By January 2009, he and Awasthi had quit Broadpoint and set up shop in an area often called the Hedge Fund Row in midtown Manhattan where about 500 boutique firms operate. Doubtless, there was no dearth of junk sellers. The big challenge was to find elusive buyers none of whom seemed to exist.

“Starting off was not difficult as we know our target clients. Also getting good people to work with us was easy as there are a lot of Indians in the structured product market,” says Awasthi, 39, who had earned a name intimately understanding some of the most complex derivatives based on subprime loans. The son of an Indian armed forces officer, he had perhaps learned to master complexity living in the several posts that his father was transferred to.

Viru, a quantitative finance professional who spent his childhood in Kolkata, took the plunge because of his belief that after the crisis, Wall Street will inevitably move towards the small firms model. The days of domination by the large investment banks were over, he thought. Managing complicated waste was second nature for Viru, as he had made his career as a specialist in mathematical modelling of oil spillage.

He once ran a firm: Risk Based Corrective Action that worked in this area, sold it for $6 million to a Mexican company, and moved on to do his MBA from Wharton. After stints at Merrill Lynch and Rabo Bank, Viru joined Secondpoint where he reconnected with old friend Awasthi. The two hit it off as a deal-making team.

Mission Clean-Up
“People like us basically restructure the balance sheets and try to value these assets and then find buyers for these assets,” says Viru. “There are many types of buyers for these distressed assets. But the biggest incentive for the asset managers or hedge funds is the simple fact that these products are trading at heavy discount.”

On one side, MARV (named after the initials of its founders) helps spooked investors identify which assets they must get rid of and at what value. And then, it works with pension funds, hedge funds and asset management companies interested in buying these assets at rock-bottom prices. The deal could be for a single asset or a set of assets. The ticket size is anywhere between $5 million and $150 million.

One of the biggest dealmakers for MARV is a structured financial product called Collateralized Loan Obligation. CLOs are securities that financial institutions issue against loan receivables. When banks issue such securities, they reduce capital adequacy requirements by transferring the risk to the investors. And CLOs come in tranches. So, the irrepressible genius of Wall Street traders takes them and builds CLO Squared (CLOs of CLOs) and CLO Cubed (CLOs of CLOs of CLOs).

MARV cuts through this jungle of jargon and helps the sellers and buyers deal in those mountains of junk. The seller could be a big bank or an insurance firm that finds toxic assets sitting on its books. It is better for it to sell them in the secondary market for whatever price it may get. The buyer could be anyone. A hedge fund might see value in the expected cash flows from the underlying assets and may offer a price accordingly. An opportunity fund that had gone short on a particular security could later buy it at a lower price.

Initially, there were no buyers for distressed assets, but with stock markets rising since March, some interest has reappeared. The real turnaround was in April, when Whistlejacket Capital, the defaulted structured investment vehicle of Standard Chartered, sold $2.5 billion of distressed assets at a 33 percent discount. Structured products started getting buyers after this. MARV claims to be one of the first boutique firms to have executed deals in it.

A real estate company that bought discounted assets through MARV says it pays to work with small firms. “Small firms give personal attention,” says its chief financial officer, on the condition that neither he nor his firm be named. “That is really important because these securities are complex to understand. We like to deal with firms like MARV because we know these guys personally. Big investment banks don’t like to deal with us because the size of our trade is small. Thus we prefer small boutique companies,” he adds.

An Evolving Market
Structured product professionals have earned a bad name after the crisis erupted. Neither then, nor now, does the wider world fully understand the risks associated with these products or can see through the labyrinth of abbreviations. This means, it must perforce be turn to the calculating boys who helped create these products, to find a market for them. So, the structured finance folks come under attack that they made money creating a bubble and are now making money bursting it. The critics say these professionals did not bother to look at the quality of the underlying loans or ensure transparency while slicing and packaging risk.

Viru defends the structured products industry vehemently. “People in our industry are blamed wrongly. Generally, we are the bankers on the transaction. We are not involved with the mortgage origination or selecting the collateral for the CDOs (Collateralized Debt Obligations). What is important is that we designed the transaction to behave in a certain fashion depending on the defaults in the underlying collateral. The CDOs are behaving the way they were designed to behave. We are not the ones that opine on the default rates. That is the job of the collateral manager — who is an independent entity.” The lack of a regulatory side of the picture to keep pace with financial innovation is an important reason that most structured professionals like to cite in their defence. But now regulation is slowly catching up with financial innovation.

While the debate continues, it is important to note that small firms like MARV help in creating a market for assets that nobody wanted to buy till yesterday. Now that buyers are returning, competition in MARV’s business is in fact becoming more intense. Viru asserts not everyone who has set up shop will survive. “There are only a handful of them who have a staying power. Those who have passion and penetration will survive. Those who will survive will essentially need to have product knowledge and relationships.” He believes the core eight-member team at MARV has the requisite knowledge in structured products to last beyond the time when the last of the toxic assets would have been sold.