When Julie Bouhuys, head of Wachovia Corp.'s credit capital markets group, took the helm of the newly reorganized group a little more than a year ago, credit deterioration was still on the rise. Bouhuys reflects on how Wachovia has changed both its mindset and approach to credit and how portfolio management is evolving in the industry.
LMW: How has Wachovia's approach to credit changed since you joined as the head of the Credit Capital Markets group?
We are taking a much more top down approach to portfolio construction that we are marrying with a traditional bottoms up process. Historically, banks have looked at individual credits and analyzed them, done traditional credit analysis and evaluated risk on a single name basis not giving much thought to how those loans come together in a diversified portfolio. Our new approach has allowed us to focus very heavily on portfolio strategy, defining very clearly what it is that we are working toward. A huge change for us has been the increased level of technology support in our analytics infrastructure. This is a very analytical business that's becoming more and more sophisticated. We've had to ramp up technology to allow us to accomplish our goals and realize our vision.
LMW: What kind of steps are you taking to more actively manage your portfolio of corporate loans?
First, we tried to build a new mindset around the value of capital. Banks have not historically understood how precious that capital resource is. Coming off the last credit cycle, we should appreciate the power of the loan portfolio to hurt our P&L and our shareholder value. So we really wanted to instill a true cultural mindset that appreciates capital. Second, we have developed a better understanding and placed more emphasis on reducing the risk of negative rating migration. Third, we've been very thoughtful and organized in our approach to portfolio diversification by creating industry specific portfolio action plans that give us a road map to accomplish our goals within particular sectors and sub-sectors. Another important step has been a much more active participation in the secondary loan market and the securities markets, in both defensive and offensive activities. We have also formed formal pricing committee functions that govern that activity and focus us on relative values. We are buying and selling loans and continuing to use the credit default swap (CDS) market for defensive hedging purposes. Finally, and equally important, we're managing toward a model portfolio, which is focusing us on active sector risk management in addition to single name management. It's what we call a model portfolio philosophy.
LMW: How is Wachovia participating more actively in the secondary loan market? Is the firm actively trading their exposures to par, stressed and distressed names?
Our volume is up twofold over 2002 across par and distressed loans, and CDS as well. We are involved across the credit spectrum. Our distressed activities are exclusively sales or defensive. But going forward, we've created a group that will focus on creating liquidity for many illiquid distressed loans and loans that would be appealing to investors. Our hope is that through providing more flow trading in distressed, we can actually create liquidity where there is not liquidity today, which obviously helps us in our defensive activities, but really looks more like an offensive activity.
LMW: Would the effort to provide liquidity be solely in loans led by Wachovia or in any distressed name that is relatively illiquid with limited dealer support?
We would certainly be focused on names that we have positions in. But we're a pretty big lender to the leveraged, non-investment grade loan market and a lot of those loans are illiquid. While we would limit it much to the names we're in, I think that gives us broad coverage.
LMW: What kind of results are you seeing from active portfolio management?
I think that it's too early to tell. We've had some clear successes where we've sold some loans and moved out of some positions that subsequently deteriorated. Through our active portfolio management efforts, we're trying to take risk out of our portfolio and better position ourselves for the next market downturn. We think we've done that. If we take a look at our portfolio today versus a year ago, it's dramatically improved in credit quality. The overall risk is down. We've taken problem assets down. We've taken our capital down. We've rationalized it. It's much more diversified. But a lot of that is due to the economy. What we are excited about is the mindset shift that we have been able to effect and how that's going to position us for the next credit cycle.
LMW: How do you achieve a balance between relationship building and portfolio management?
That is a challenging topic that we deal with. We can say that we are limiting ourselves to CDS activities or hedging, and sales of purely non-strategic loans, but that won't allow us to achieve our portfolio objectives. One thing that we are doing is heading toward more sector-based portfolio management. Traditionally, banks viewed portfolio management as a defensive hedging strategy that was fundamentally in conflict with client goals. Clients were obviously unhappy when we sold their exposures. But as we adopted a more offensive portfolio management approach, which involves more risk taking by purchasing different types of exposures through different types of instruments in pursuit of macro portfolio shaping, we found that allows us to be much more accommodating to our client coverage goals. So we can actually mold the portfolio in a way that accommodates our strategic activities.
LMW: Are there market dynamics that have strongly impacted the firm's strategy over the last six months?
The biggest trend in our market is a multi-year trend--there has been a general decline in loan demand. Companies are accessing the loan market less as a result of the appeal of the bond market. More recently, convergence trends have continued to intensify and that has created more opportunity for investors to take credit risk in different forms. As a holder of a lot of single B leveraged loan risk, which is typically illiquid, we are seeing a lot more financial engineering going on in our industry. This creates ways for us to effectively transfer risk without relying on single name trading. All the investors in the market are looking to diversify their portfolios. Given the limited number of actively traded names in the market, increased financial engineering has created more buyers of risk, which is good for us because we are natural sellers of risk. There's much more interest in our asset class and I think there's much more interest in portfolio management in general.
LMW: How has your experience as the head of Wachovia's Special Situations group helped to form your perspective on how credit is issued and managed?
A lot of people expected me to come into this job and basically ratchet down credit based on my mindset. But I don't think that's what I've done. I came in with an appreciation for capital and our institution is really focusing on that. The mindset that our capital is a precious resource is very important for me. But I've also brought the perspective that it's a competitive advantage if we use it skillfully, so we cannot be purely defensive. We have to use our resources in an offensive fashion in order to drive growth. One thing that I have done--clearly as a result of my workout experience having seen the lessons learned from the credit cycle that we've been through--is focus on training. Banks have really cut back on expenses in the last several years, and one of the areas that they've cut back on is training. One of the things I've done is to ramp up our continuing education program to ensure that we are building expertise. Our industry is becoming much more sophisticated. We need to train our teams to do those jobs and to take the business to the next level.