TRADING TABLES

We meet the former derivatives trader who swapped the heat of Wall Street for his own restaurant on an island paradise in the Florida sun. Edward Russell-Walling reports.

TALKING BUSINESSMARKIT LIFE

39 Summer 2014

We saw an obvious opportunity to bring in a good chef, build the dinner business and double the revenues.

Ask former derivatives trader Bill Mertens when would be a good time to call, and he opts for late morning. “Being in the restaurant business, my day starts and ends a bit later now,” he explains. The

hospitality industry may have a different timetable to the trading floor but, as Bill has discovered, it is no less subject to the idiosyncrasy of market forces and human invention.

That said, it’s a long way by any measure from Wall Street to Amelia Island. Here, after a quarter century in the breakneck world of derivatives, Bill and his family invested their capital and their lives in the Gourmet Gourmet restaurant.

Amelia Island lies off northeast Florida, part of the busy fretwork of barrier islands that lines the southeastern US coast. Known for its beautiful soft, sandy beaches and its bird life, it boasts seven golf courses, on one of which you may intermittently find Bill. The island has a substantial permanent population, which was an important factor in his decision to buy a business there. But it also attracts the tourists with an annual shrimp festival and a medley of music festivals – chamber music, jazz, and blues. For those who like their sports unhurried, each year it hosts the Pétanque America Open.

Amelia Island is clearly treasured by its visitors. Readers of Condé Nast Traveller have named it one of

their top 10 US islands for the last seven years on the trot, and in 2013 they voted it one of “The Top 25 Islands in the World”.

Paradise So, Amelia is something of an island paradise. Even if it seems far from lower Manhattan, it’s light years away from Cambridge, Ontario where Bill grew up. While he was taking an economics degree at Wilfrid Laurier University, he took a summer job with the Bank of Montreal. The bank had created a derivatives portfolio and was looking for students with good maths to write code. Bill’s professor put him forward and, in the summer of 1986, he began writing option models. He didn’t know it, but he had just begun a career that would take him to the heart of the international financial markets, a fast ride from the birth of complex derivatives trading to its spectacular implosion.

“I had no idea that this world existed,” he recalls. “There wasn’t the public awareness of investment banking, trading and capital markets that there is now.” In this state of blissful ignorance, he had set his sights on a different life altogether, planning to go to graduate school and to study for a PhD at the University of Western Ontario.

“I was going to be a professor,” he says. “But getting a pocketful of cash as a student was a real eye-opener.” The following summer, Bill did the same job for Chemical Bank. Just as he was preparing to report P

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TALKING BUSINESSMARKIT LIFE

to graduate school, the bank offered him a job as a derivatives trader. “It was too good to refuse.”

So, in the first of many trades, Bill swapped the placid pond of academia for the noisy roller-coaster of the markets. This being the Autumn of 1987, it wasn’t long before the markets popped their first surprise, with Black Monday and that year’s October crash. Chemical responded by closing down in Toronto, and Bill moved to the Bank of Nova Scotia, where he spent the next seven years.

Own codeHe had worked with some “real luminaries” at Chemical – including Lee Wakeman, a pioneer of

the interest rate swap, and Joe Baumann, head of Chemical’s derivatives group and the first chairman of the International Swaps and Derivatives Association.

“The derivatives market was just starting out,” Bill remembers. “Banks were not running swap portfolios back then. It was all on paper. You had to find a customer who wanted to receive and one who wanted to pay. You would get them to agree and the bank took a spread out of the middle.”

The personal computer was only a couple of years old, and traders had to create their own pricing models and write their own code. “I was considered a rocket scientist back then, with my undergraduate degree in economics,” Bill says. “Today a PhD in particle physics is a minimum requirement.”

As commercial software became more available, Bill and his colleagues were able to focus more on trading, and by the end of his time at Bank of Nova Scotia he was running their US swaps and options portfolio. As he points out, before the consolidation that took place in the US industry, Canadian banks were among the biggest in the world and had a significant presence in the derivatives market. They were very visible and so were the people who worked there. One man who decided he could make use of Bill’s presence and connections in the market was Michael Spencer, chairman of London-based interdealer brokers Icap. He had been trying to get a New York office up and running, but never entirely successfully, and offered the job to Bill – who accepted.

Though Bill would have an enduring association with Icap, broking had not yet fully claimed him. Only nine months later, he got a call from Deutsche Bank’s Gopal Veradhan – “the biggest BSD in the

After 25 years in the financial business, entertaining and being entertained on expense accounts, I had become a foodie.

Swapping CDS for grand cru.

41 Summer 2014

2013 Readers of Condé Nast Traveller named Amelia Island one of the Top 25 Islands in the world in 2013.

market” – asking what he thought he was doing broking when he should be back trading. Veradhan was number two on the derivatives book at Deutsche, under Vince Balducci, later head of global risk finance at Barclays Capital. Bill didn’t take much persuading and took on the running of Deutsche’s Bermudan callable swap business and their structured and exotic notes.

Credit derivatives Then in 1996 Deutsche bank started a credit derivatives book. “Credit derivatives were brand new in 1996,” Bill says. “I was always a guy who gravitated towards the new, and they needed a trader.” While still running his interest rate swaps business, Bill became the German bank’s sole trader in the nascent market for credit default swaps (CDS). This was all good, until 18 months later when the bank hired a young Boaz Weinstein, and he would rapidly become a star of the credit derivatives trading universe.

“The kid was remarkable,” Bill acknowledges. “He was on his way to stardom, and had more talents than I had. I was at an awkward level of seniority, and I knew I was vulnerable. They didn’t need me any more, so they let me go.” He doesn’t sound bitter. That’s life on the Street. And with the Asian financial crisis of 1998 under way, the Street was downsizing. Trading positions were tight, so Bill returned to brokerage for a couple of years before partnering with his old chums at Icap (including Doug Rhoten, now chairman of Icap Americas) to trade bandwidth. That market tanked with the collapse of Enron, which had been trying to turn bandwidth into a financial product. The inflated prices of bandwidth assets promptly crashed to zero.

Bill then moved to London for a time to run the credit derivatives broking desk for Tullet & Tokyo, the international interdealer broker. Later he was contacted by a Citi team, led by Andy Hollings, working on a new product for managing counterparty credit risk, the contingent credit default swap (CCDS). They were looking for a broker who would help them to fire up the market. “The firm I was then with was not interested in investing, so in 2005 I

went to Icap,” he reports. They gave him a seat, a headcount and a budget and, as head of credit hybrids, he got to work.

“It took two or three months to get the first trade,” he remembers. “But before too long we were making serious money.” The sub-prime crisis and Lehman Brothers were coming down the track, however, and by late 2008 CCDS had gone down in flames along with CDS. Before the crisis, there was no shortage of sellers of protection, and the market was driven by buyers. By the end of 2008, everyone was a buyer..

“After 2009, some balance returned to the market,” Bill says. “And there was another innovation – quanto CDS, which allowed you to hedge currency risk in your credit portfolio.” In quanto CDS, premiums and payments on default are in a different currency to that of the reference asset.

“While it was very bespoke at the beginning, we standardised the product,” says Bill. “Then the sovereign debt crisis hit Europe. It turned out there was masses of quanto risk attached to sovereigns, so that market exploded. But the sovereign brokers had more weight, and we had standardised so well that they could take [the business] away from us.”

By now the tide was moving against credit hybrids. Trading was “severely inhibited” by a push towards central clearing and regulatory uncertainties as the Basel rules were rewritten. When Icap decided it was time to pack it in, Bill and his team moved to New York broker-dealer Avatar Capital. They continued with CCDS and tried to win back quanto business, but it was an uphill battle. Bill began to cast his eyes beyond the city wall.

Becoming a foodieIcap had given him more than a serial career. It was where he met his wife, Dominican Republic-born Yamilka. Now the two of them checked over their capital and agreed it was time to get out, to find a small business that could provide an income big enough to support them and their two children. They zeroed in on northeast Florida and began to check out what businesses were for sale, ones that they knew something about, could afford and could be passionate about. That led them, in a more or less straight line, to the restaurant business.

“After 25 years in the financial business, entertaining and being entertained on expense accounts, I had become a foodie,” Bill explains. “I was conversant with wine. I was writing restaurant reviews, saying why this one was succeeding and that one was not.” With all that experience of observing

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restaurants in operation, he reckoned he had the skills to run one. And they found just what they were looking for on Amelia Island.

They were familiar with the location, having vacationed on the island, and the business looked profitable, so they were comfortable with their purchase. Due diligence verified the revenues that were being claimed, and the expense ratios, as reported by the previous owner, were healthy. “You want labour cost ratios below 25 per cent, and Gourmet Gourmet’s were around 20 per cent. The ideal food cost ratio is 30 per cent to 35 per cent, and these were in the low 20s.”

The island demographics were comforting too. Down in southern Florida, you can run a restaurant business for only perhaps five months a year, from December to May, and then everyone leaves, including many locals, Bill reckons. Here, further north, there were two large resort complexes, the Summer Beach/Ritz Carlton and the Omni Plantation, both with year-round residents as well as holidaymakers. Average annual income for island residents is over $100,000.

Gourmet Gourmet had a very good Sunday brunch business, and a good lunch and catering business, though it did poorly at dinner. “We saw an obvious opportunity to bring in a good chef, build the dinner business and double the revenues,” Bill says. He and Yamilka closed the deal in summer 2012 and began their new lives as restaurateurs.

Challenging financialsIt took only a couple of weeks for reality to set in. “The financials were not truthful,” says Bill, with some restraint. “In fact, both the labour and the food cost ratios were over 40 per cent, and they had been paying staff in cash off the books.” Nor, on closer inspection, were the comforting demographics quite so comforting. The local residents’ income may have been comparable to that of New Yorkers, but their fondness for spending it – most having been retired for 20 years or more – was not.

“Yes, they will spend on capital assets like cars and some fantastic houses,” Bill notes. “But they don’t like to spend more than $7 on lunch.” What’s more, they don’t drink much, or at all. Gourmet Gourmet provides full service using the freshest, highest quality ingredients, and it can’t do that for $7. “We need $18 per person and we need to turn over the table three times. They love coming here for lunch, but they all show up at precisely 12 noon and spend an hour and a half hanging out, spending next to nothing.”

Bill and Yamilka started to tackle their costs and to develop their dinner offering. Some staff members were “absurdly” overpaid and they either had their wages negotiated down or were replaced. Bill says some waiters are now earning one third of what they had been getting and haven’t walked.

Next, they took a hard look at everything on the menu. They shrank the lunch menu, which was a staggering 65 separate items or thereabouts, requiring a huge inventory. Then they analysed the component cost of what remained. They found which items were selling below cost and either raised their prices or eliminated them. Then they created a lot more cross-over between lunch and dinner – the new dinner menu uses elements of the lunch menu and vice versa.

Getting the dinner business going became a priority. “We found a very talented chef and developed a fantastic menu,” Bill says. Then they set about converting their lunch customers into dinner customers. It’s key to the financial services industry – you own a customer on this product, then you get them to buy that one. Except that while the Amelia Island crowd liked lunching at Gourmet Gourmet, they went to another place for dinner.

New customersIt took the couple a while to realise that a) the lunch mob wouldn’t convert and b) they didn’t really want them to, because they were so cheap. “They are not heavy drinkers and they split meals,” Bill observes. “We had to get out and find new customers, and we found them at my golf club.”

This was a whole new demographic of retired and semi-retired men who like to have a drink, like to dine out with their wives and are open-minded about where they go. “Through my involvement in the club, I became known and got them to come to the restaurant,” Bill says. “They have loved our products

and given us great word of mouth – and they spend money.”

The two best-selling dishes are ‘Slow-braised Italian short ribs’ (braised for a mere 11 hours) and ‘Shrimp and lobster fettucine’. The wine list is a judicious mix of good-value sleepers and well-known names, and Bill is particularly pleased with a recent “significant” allocation of Sea Smoke Californian pinot noir. “It’s the best pinot in the world and we are probably the only restaurant in north east Florida to have it,” he says.

It has been a tough couple of years for team Mertens, and Gourmet Gourmet has yet entirely to fulfill its promise. But the expense ratios are now close to where they ought to be, and the dinner trade is starting to prove its worth. “We are now reaching the cusp,” Bill reckons. “The lunch business is what it is. But if we can grow the dinner business by another 25 per cent, that puts us over the top. Potential growth could take it up by 300 per cent and, if we can hit that, we’ll have a home run success.”

The lunch business is what it is. But if we can grow the dinner business by another 25 per cent, that puts us over the top.

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