NEW YORK -- There is a revolution going on in corporate finance, and Bankers Trust New York Corp. is leading the charge.
Using complex financial instruments called derivatives, it is helping corporations like Shell Oil Co. and Johnson & Johnson dramatically change their financing methods while protecting against fluctuations in interest rates and currency values, or even in the values of products and investments.
Shell, for example, recently needed to finance a new oil field. Traditionally, it would have borrowed the money or issued bonds. But Bankers Trust advised Shell to raise funds by selling some of the oil before it was produced, by using prepaid forward contracts.
As a bonus, Shell was able to lock in a price for its major revenue source, a dramatic change from the usual crapshoot of selling oil on the open market.
The Door to Knock On
Transactions like that have made Bankers Trust one of the biggest dealers in swaps, options, and other derivatives. And many corporate treasurers regard the bank as the most innovative player in the market, the door to knock on when complex risk need to be hedged with novel products.
"I see Bankers Trust leading a revolution," said Eugene Barron, assistant treasurer at Johnson & Johnson.
The revolution is internal as well. In the past few years, Bankers Trust has abandoned lending as a major source of revenue, reshaping itself as a risk manager. In so doing, it has moved even further into investment banking and away from its roots as a commercial bank.
"We are derivative missionaries," said Brian E. Walsh, 39, co-head of Bankers Trust's derivatives business and joint manager of the global investment bank, the company's umbrella group for worldwide capital markets and finance.
Dependent on Derivatives
Some other banks, including J.P. Morgan and Citicorp, are also emphasizing risk management, lured by the $4 trillion derivatives market. But no other bank's capital and earnings are as tied to these products as Bankers Trust's. Indeed, nearly three-quarters of the company's before-taxes net income last year came from derivative dealing and related activities.
Bankers Trust's evolution into a derivatives powerhouse has not been seamless. Unlike some rivals, the bank does not have the top credit rating. It has suffered the body blows of defections. And even now, analysts worry about the amount of risk Bankers Trust assumes in supplying derivatives products.
Paying Off Big
So far, though, the bet on derivatives is paying off big.
Raphael Soifer, an analyst with Brown Brothers Harriman & Co., calculates that the net income from managing clients' risk has grown from a loss of $33 million in 1988 to a $228 million profit last year. During that same period, Bankers Trust's net income from lending moved in the opposite direction: from $344 million in profits to a $23 million loss, said Mr. Soifer.
Derivatives and related trading last year provided $431 million in net income before taxes, or 68% of total profits. The comparable figure for Morgan was 56%, according to Mr. Soifer.
15% of Capital at Risk
"Derivatives are more important to Bankers Trust than any other bank," said Mr. Soifer.
That dependence is evident in the amount of capital at risk from derivatives positions. Tanya Azarchs, an analyst at Standard & Poor's, estimates that in the first quarter of this year, $600 million of the bank's capital, or 15%, was at risk. At Morgan, the percentage of capital at risk is 11%, Ms. Azarchs said.
If anything, derivatives will become more critical to Bankers Trust. It has recently been pollinating other business lines with derivative experts.
|A Way of Life'
Lucy Rinaldi, an expert in foreign-exchange derivatives, is now in charge of the international private bank. Lisa Polsky, a former risk-management executive, will be creating investment funds that use derivatives. Richard Marin spent several years in derivatives and is now head of the bank's retirement services.
"They are focused on derivatives as a way of life," said Mr. Barron of Johnson & Johnson.
Aided by Bankers Trust, Johnson & Johnson has issued $50 million and $100 million of medium-term notes at lower-than-expected rates. The trick: include an option or forward that lets an investor place a bet on the direction of interest rates.
Switch Hasn't Been Easy
Bankers Trust hasn't always doted on derivatives. Nor has its strategic shift been a breeze.
Throughout the 1980s, risk management took a back seat to lending and foreign-exchange trading. Back then, Bankers Trust was the leading source of leverage buyout financing and was Kohlberg Kravis Roberts & Co.'s lead bank.
The emphasis on lending, combined with internal squabbling and turf battles, may have convinced some top executives to leave. Allen Wheat, the head of derivatives, and a dozen managing directors jumped to Credit Suisse to form Credit Suisse Financial Products. The mass exodus hurt Bankers Trust initially.
Since then, another top executive, Martin Loate, has moved to Merrill Lynch, and John Giannotti, London-based head of the global advisory products group, has resigned.
Bankers Trust has had other hurdles to overcome in building its business. In a business where relationships and balance sheet strength are critical ingredients, it lacks the loyal clients and the AAA credit rating of a Morgan. Bankers Trust is rated AA.
But in the words of rival, "They turn those into not very big weaknesses."
Innovations Spur Growth
What has kept Bankers Trust's derivative business growing despite setbacks and competition is the bank's ability to be innovative, to create new derivative products from the building blocks of options, forwards, and futures. Only Credit Suisse rivals Bankers Trust in inventiveness, said analysts and corporate treasurers.
Mr. Walsh said that 80% of the profits in the derivatives business comes from more customized products developed in the past three years, as opposed to interest-rate swaps.
These products can earn bigger spreads - needed to meet the banks profit hurdles and pay the huge contracts top derivatives people command.
"Bankers Trust has spearheaded the innovation in this business," said Ms. Azarchs.
The bank invented equity derivatives instruments linked to stock indexes or baskets of stocks. These allow a corporation, for example, to get the economic benefit of investment in foreign securities without taking the currency risk of actually owning them. Or, an investor can can bet that a stock index will rise.
The bank has either led the way or been among the leaders in derivative trading with companies and governments in Southeast Asia, Latin America, and Central Europe.
A Pioneer in Credit Hedges
And it was among the first to market the latest in derivatives, credit hedges. This type of instruments can be used as insurance against credit exposure.
Say a money manager buys $100 million of a corporation's bonds and the yield of those bonds is tied to junk-bond index. He can have a derivatives dealer structure a hedge that gives the manager some benefit if the index slips.
"If I mention to another company that we were thinking about doing some weird derivative, they'll say you must have been talking to Bankers Trust," said David Urbani, assistant treasurer at Air Products and Chemicals, Allentown, Pa.
Says Risk Decreasing
That concentration on novelty carries risk.
"These instruments are more risky, and more difficult to hedge," said Ms. Azarchs. "They may be tied to more volatile and less liquid markets."
Mr. Walsh said that in fact the risk in Bankers Trust's derivatives portfolio has decreased in the past year and the business requires less capital now than 12 months ago.
And that's the real proof of a risk manager - rising profits and lessening risk.
