Even in the financial world, where bigger is usually better, small can be beautiful. That’s what partners Alain Pelchat, Steve Marshall and Mathieu Lafleur-Ayotte discovered when they recently spun off Montreal-based Quanto Financial Corp. from National Bank Financial Inc.

“If we had worked at Citibank, for example,” says Pelchat, “it’s so big that we probably never would have met, even if we had worked on the same floor.”

But at NBF, each came to know the other two, and they were able to team up to launch a financial services firm that Pelchat considers “probably unique in the world.”

Quanto combines two services NBF previously provided through two internal divisions.
The first, OpenSky Capital, led by Marshall, has been designing principal-protected notes since early 2004. The second is the securitization division headed by Lafleur-Ayotte, which now carries the name Metcalfe & Mansfield Capital Corp. Pelchat headed the financial derivatives department at NBF that overlooked both Marshall’s and Lafleur-Ayotte’s groups.

The two divisions were melded into one and spun out of NBF on Oct. 14, with NBF retaining a minority interest in the new entity, along with Deutsche Bank. The three partners together hold the majority stake. Thirty-five employees from the two NBF divisions also moved over to the new firm.

Many independent boutiques are active in PPN design; many others specialize in securitization. “But,” says Pelchat, “we’ve spoken with lots of people in the U.S. and Europe, and no one could point to an equivalent firm that combined our areas of expertise.

“When you structure products such as ours,” he says, “you realize that the legal, fiscal, accounting and information-technology tool box is about the same on both sides. To deliver a PPN in the market, the background set-up is about the same as it is for issuing a securitized asset. So, we think it’s the combination of both areas that will fuel our growth.”

The three partners oversee all operations at Quanto, but OpenSky, which keeps the same name under the Quanto umbrella, remains the key responsibility of Marshall, who succeeded in less than 18 months in creating one of Canada’s foremost PPN design boutiques when he worked inside NBF.

“We’ve proven that a market exists for products such as ours,” says Marshall. “We’ve structured 40 products with total sales of $2 billion. In only a year and a half, we did what
we thought would take three.”

OpenSky’s foremost capital-protected product is the Index Optimizer. Investors have gobbled up the 12 series issued to date, paying a total of $700 million.

The name Metcalfe & Mansfield Capital refers to the street intersection in Montreal at which Quanto is housed. The securitization activities it now pursues outside NBF were so successful inside NBF that the new entity starts out with a $7.5-billion asset portfolio.
This portfolio is made up mostly of debt from mortgages, credit cards and bank loans, which is securitized and sold to institutional investors such as the Ontario Teachers’ Pension Plan Board, Caisse de dépôt et placement du Québec, mutual funds and municipalities. “Our job consists of structuring these transactions and managing them on a day-to-day basis,” says Lafleur-Ayotte, whose main responsibility remains Metcalfe & Mansfield Capital.

Investors’ appetite for such securitized assets is insatiable, Lafleur-Ayotte says. “The total stock of traditional debt, particularly government bonds, has been declining since 1995,” he points out. “In pension funds, thanks to aging boomers, there is more liquidity coming in than there are traditional fixed- income issues to absorb it. That is what explains the growth of our business.”

If investors are hungry for securitized assets, banks and other credit institutions are only too happy to feed them. For example, banks fill up their mortgage “warehouses” on an ongoing basis. “At the end of the month, we empty it for them,” says Pelchat. “Then the warehouse is ready to be filled up again, and we allow them to manage their pricing, their risk and their products better.”

But why would financial institutions do business with Quanto rather than NBF? “To finance these types of products, you need perfect transparency with your client,” Pelchat says. “This client would not want to hand out his information to a bank that could be in competition with him in other areas.”

Arm’s length

And this is one of the key reasons NBF agreed to spin off Quanto in exchange for only a minority stake. As long as the securitization division operated inside NBF, it essentially securitized NBF’s own assets. All along, NBF had wanted to offer its services to other financial players, but could hardly do so if it kept those services in-house. The Quanto spinoff was the answer.

@page_break@The same logic applied to OpenSky. “As time went by, it became increasingly difficult to present ourselves as an independent wholesaler to major clients such as CIBC World Markets,” says Marshall. “Why should they buy NBF’s product and help a competitor?
We couldn’t grow as much as we wanted.”

In time, Quanto hopes to become indispensable to clients, nationally and abroad, by achieving economies of scale as a result of its hybrid nature. Most financial institutions want to focus on their primary mission of extending credit. They don’t necessarily want to invest the time and money to develop expertise in securitization and PPN design. The fact that Quanto will be able to serve those institutions in this area at a low cost will make it even less attractive to develop their own products.

It turns out small is beautiful for everyone — Quanto’s three majority partners, Quanto’s clients and its backers, NBF and Deutsche Bank, as well. IE