S01 the Investment Banking Industry

1. Introduction: Financial Institutions

2. Introduction: Investment Banks2.1What are Investment Banks2.2Types of Investment Banks

3. Trends in Investment Banking

4. Measure of Performance

5. Sub-prime Impact on Investment Banks

© DR. YEO Wee Yong for FIN4112H (Semester II 2010/2011)

The Investment Banking IndustryThe Investment Banking Industry

Financial assets

1. Introduction: Financial InstitutionsIntroduction

What are some of the roles of financial assets play? from surplus units to deficit units resources from non-productive to productive Pooling Management

Financial assets


Types of financial assetsDebtEquityDerivatives: forwards, futures, options, swapsCommoditiesSecuritized assetsCredit derivatives

Financial markets


A structure where financial assets are exchanged or tradedRole of financial markets

discovery processDetermination of of financial assetsInfluence by many factors (eg. liquidity, risk, information, transaction process)

Provision of Provide a place of gathering of

Reduction of Reduce time and costReducing cost and risk

Financial markets


Types of financial marketsThere are many ways to classify

Primary and secondaryPrimary:

New IssuesPrivate placement

Secondary: Trading of issued assets

Debt, equity, or derivatives

Financial markets



Money and capitalMoney

Short-term: 1 year or lessFederal funds and discount windowsCertificates of deposits (negotiable and nonnegotiable)Repurchase agreementT-billsShort-term municipal securitiesCommercial papers

Financial markets



Money and capitalCapital

More than 1 yearStocks and bonds

Exchange or OTCSpot or forward, future

What are investment banks?

2. Introduction: Investment BanksIntroduction

Investment banks are financial institutions that engage in public and private market transactions for corporations, governments, and investors

Examples of market transactions: of equity and debt securities



Other activities: on its own capital pooling and repackaging of financial assets into securities using mathematical and numerical methods and simulations to create financial products, or to make trading, hedging and investment decisions



Other activities: helping individual and institutions to brokerage

The offering of tools and services to clients to support their operations in trading and portfolio managementThe offering of services, such as borrowing of securities and funds, to hedge funds and other professional investors to support their investment strategies

Types of investment banks


Financial holding companiesLarge financial companies, under universal banking, have always existed in places other than the USGramm-Leach-Bliley Act 1999 created large financial holding companies in the USExamples: HSBC, Deutsche Bank, UBS, Citigroup, JPMorgan Chase, BOA



Financial holding companiesBusinesses includes:

Retail (or consumer) bankingCorporate bankingInvestment bankingAsset managementWealth (private) managementCredit cards


Full service investment banks: Goldman SachsMorgan StanleyMerrill LynchLehman BrothersBear Stearns

Boutique housesSandler O’Neill: specializes in financial institutions (provides research, acts as market markers, trading)Greenhill: specializes in M&A and financial restructuringLazard: specializes in M&A and asset management



Number of investment banks: Local: (under the local banking holding groups)Others: (called merchant banks)

Activities:Normal investment banking activitiesOperate in Asian Dollar Market through their ACUsNo SGD deposits or borrowings from the general publicCan accept SGD deposits or borrow from banks, finance companies, shareholders, and companies controlled by their shareholders

Investment banks in Singapore

http://masnet.mas.gov.sg/fin/findir/SDWFIDIR.NSF/Merchant+Banks?OpenView#top1

3. Trends in investment banking Introduction

Regulation to deregulation to re-regulation to …..The financial industry has always been oscillating between regulation and deregulationRegulation leads to but hamper Deregulation on the other hand promotes

but give room for and ultimately cause too much to the market

Deregulation


Regulation to deregulation to re-regulation to …..Striking a balance is the responsibility of regulators. Two schools of thoughts:

A dynamic optimal balance exist and the regulators are responsible to locate it and keep it current Only minimal regulation is necessary. The illusion of the existence of an optimal system will only delay the occurrence and increase the intensity of crisis and hence do more harm than good.Discussion: What do you think in the light of the recent financial crisis?

Deregulation


Regulation to deregulation to re-regulation to …..There is no perfect system against the innovativeness of the human mind General long term trend is towards less regulation as market matures

Deregulation


Deregulation: Most countries have over the years taken significant steps to deregulation

UK: Big Bang Margaret Thatcher government's reform program in the 1980s to deregulate the financial market London, once a global financial centre was losing ground to New YorkProblems: overregulation and the dominance of elitist old boys' networksSolution: free market doctrines of unfettered competition and meritocracyResults: London is still one of the most important financial centre in the world

Deregulation



Japan: Big Bang Financial reforms in the late 1990sIn reaction of the deteriorating condition of the economy and financial sectorTo open up Japan’s banking, insurance, pension, and stock exchange to global competition

Deregulation



Japan Postal system reform Up to 2007, Japan Post offers postal services, banking services, and life insurance.One third of all government employee worked for the PostLargest saving system: US$3.2trPrivatize in 2007: Split into 4 units (Japan Post, Network, Bank, and Insurance)

Deregulation



Singapore: “Privatization” ofOpening competition for theRelaxing control of

Deregulation

Deregulation of the investment banking sector

Introduction

Gramm-Leach-Bliley Act vs Glass-Steagall Act Glass-Steagall Act 1933: What and why?

In the light of the greatTo curb interestCommercial banking, investment banking, and insurance activities cannot be under

Lead to the break up of big banks. Example JP Morgan and Morgan Stanley

3. Trends in investment banking


Introduction

Gramm-Leach-Bliley Act vs Glass-Steagall Act Gramm-Leach-Bliley Act 1999: What and why?

Repeal of the Glass-Steagall Act occurred in steps1987: Fed allowed banks to underwrite and deal in Tier 1 securities: commercial papers, munis, MBS, etc1988: Fed allowed banks to underwrite and deal in Tier 2 securities: all types of debt and equity instruments1989: underwriting revenue cap raised from 5% to 10% of total revenue



Introduction

Gramm-Leach-Bliley Act vs Glass-Steagall Act Gramm-Leach-Bliley Act 1999:

1997: underwriting revenue cap raised to 25%1999: Total repeal of Glass-Steagall ActIn the light of the financial crisis, what do you think would happen if the Glass-Steagal Act was not repealed?Gramm-Leach-Bliley Act 1999 created large financial holding companies in the USThese are big banks with underwriting arms initially known as Section 20 subsidiaries



Introduction

Gramm-Leach-Bliley Act vs Glass-Steagall Act Gramm-Leach-Bliley Act 1999:

Deutsche Bank bought Morgan GrenfellUBS bought Swiss Bank Corp and thus Dillon Read and WarburgCitigroup bought Travelers Group and thus Smith-BarneyThe repeal of the Glass-Steagall has been under attack since the subprime crisis begin


Introduction

Sarbanes-Oxley Act 2002 Securities analysts were still giving “buy” and “strong buy” recommendation just before collapse of Enron and WorldComRestrict securities analysts from seeking approval from investment banks before publishing research reportsLimiting supervision and compensatory evaluation of securities analysts to officials that are not engage in investment banking activitiesInvestment banks cannot retaliate against securities analysts for unfavorable research reportsIf securities analysts belongs to an investment bank, measures must be taken to ensure impartiality of the research reports

3. Trends in investment banking New regulations in the investment banking sector

Introduction

Sub-prime related In the light of the recent failure of investment banks, who should regulate investment banks? The FED or SEC?

3. Trends in investment banking New regulations in the investment banking sector

Introduction

Globalization Tapping overseas market for growthEmerging economies swell opportunitiesFirst mover advantageChallenges:

Political instabilityRegulatory biases and prejudicial changes and protectionism

SGX & ASX Cultural differences

3. Trends in investment banking Other trends in the investment banking sector

Introduction

Advance in technology Information Settlement system from T+5 to T+3 to T+1Algorithmic tradingInternalization of tradesInternet trading


Introduction

Diversification What is diversification?Financial institutions, especially investment banks, have become more diversified Financial holding companies are diversified behemoth (thanks to Gramm-Leach-Bliley)Investment banking represent a smaller and smaller portion of total incomeOther income sources: trading, hedge funds, securitization, asset and wealth management, prime-brokerage, credit cards


Introduction

Income sources Underwriting spreadM&A feeTrading profitsPrime-brokerage (interest and fee)Market making (spread)Research

4. Measure of Performance Risk and Returns: Returns

Introduction4. Measure of Performance Industry Size:

Source: Financial Times

Introduction4. Measure of Performance Industry Size: M&A


Introduction4. Measure of Performance Industry Size: Equity Underwriting


Introduction4. Measure of Performance Industry Size: Debt Underwriting


Introduction4. Measure of Performance Industry Size: Loans


Introduction

League tables Ranking of investment banks in terms of underwriting, M&A, fee earned, etcInvestment banks treat this very seriouslyMany have specialist teams devoted to supplying data to the firms that compile the rankings, and to challenging the positions of rivalsBlamed for the sub-prime crisis

4. Measure of Performance Risk and Returns: Returns

Introduction4. Measure of Performance League Tables:


Introduction4. Measure of Performance League Tables: M&A


Introduction4. Measure of Performance League Tables: Equity Underwriting


Introduction4. Measure of Performance League Tables: Debt Underwriting


Introduction4. Measure of Performance League Tables: Loans


Introduction

Market riskInterest rate

Trading in fixed income securitiesSecurity prices

Trading in stocksTrading in commodities

ForexForex exposure

4. Measure of Performance Risk and Returns: Risks

Introduction

Credit riskCounterparty default risk: swap, derivatives, credit derivativesPrime-brokerage: Hedge fund failuresIssuers default: MBS, bonds, commercial papersIn the light of the increasingly complicated securities, who can really understand?


Introduction

Operating risk Settlement and clearingEntry errors

Legal Tons and tons of regulations - other than all the different acts: fair disclosure, money laundering, funding of terrorists, etcLiability law suits: eg Enron and WorldCom


Introduction

Funding risk Borrowing: capital and money marketThe credit squeeze

Liquidity RISK What is liquidity risk?


Introduction

HSBC 2007 Mar: write-off US$11bn sub-prime losses2007 Sept: Close U.S. Subprime Mortgage Unit2007 Nov: write-off another US$1bn losses2008 Mar: annual reports - $17bn credit crisis lossTotal losses by 2010: US$76.0bn

5. Sub-prime and the Credit Crunch Impact on Investment Banks

Introduction

UBS 2007 May: close its hedge fund arm, Dillon Read Capital Management (DRCM)2007 Oct: write-down of US$3.5bn losses2007 Dec: write-down of US$10bn losses2008 Jan: write-down of US$4bn losses2008 Apr: write-down of US$19bn losses2008 May: sell shares at 1/3 discount to raise fund


Introduction

UBS 2008 July: possible write-down of a further $7.5bn of losses2008 July: CEO Peter Wuffli replaced by Marcel RohnerSelling major stakes (to Blackstone and Temasek) and cut thousands of jobsPossibility of chopping off of the investment banking arm Total losses by 2010: US$52.4bn


Introduction

Citigroup 2007 Oct: write-down of US$5.9bn of losses2007 Nov: chairman and CEO, Charles Prince resignSell stakes (to Abu Dhabi, Kuwait Investment Authority, and GIC) and thousands of job loss2008 Jan: write-down of US$18bn of losses2008 Q4: $25 bn and $20 bn injection by government2008 Dec: ratings cut to A2 by Moody’sTotal losses by 2010: US$130.5bn


Introduction

JPMorgan Chase 2008 Jan: write-down of US$1.3bn2008 Mar: bought Bear Stearns2008 Sept: bought WaMu’s assets2009 Jan: profits drop 76%Total losses by 2010: US$52.1bn


Introduction

BOA 2007 Nov: write-off of US$5.3bn of losses2008 Jan: buys Countrywide2008 Sept: forced to buy Merrill Lynch2009 Jan: cut 1,000 jobs from investment banking unitTotal losses by 2010: US$87.6bn


Introduction

Merrill Lynch 2007 Oct: $8.4 bn losses ($5.5 bn sub-prime)2007 Dec: injection of $5 bn by Temasek and $1.2 bn by Davis Selected Advisors2008 Jan: sold another $6.6 bn to foreign investors2008 Apr: raise another $9.55 billion by debt and preferred shares2008 July: $5.7 bn writedown2008 Sept: sold to BOATotal losses by 2010: US$63.7bn


Introduction

Lehman Brothers2007 Aug: shut sub-prime lending units2008 June: ratings cut to A by S&P2008 June: $3bn losses2008 June: $6bn block sales2008 June: sell $130bn of assets2008 Aug: secret talks of selling 50% stake2008 Sept: failedTotal losses by 2008: US$26.5bn


Introduction

Bear Stearns 2007 June: 2 hedge funds collapsed2008 Mar: merge with JP Morgan Chase (with the help of Fed) at US$2 per shareTotal losses before acquired: US$3.2bn


Introduction5. Sub-prime and the Credit Crunch

Total Losses for US and European BanksTotal Losses for US and European BanksBANK 2007 2008 2009 2010 TOTALS

29.1 63.4 30.7 7.3

12.1 29.2 35.5 10.8

4.0 73.4

19.3 30.3 26.4

25.1 38.6

50.6 1.8

JPMorgan Chase 4.5 10.2 29.5 7.9 $52.10

Royal Bank Scotland 7.0 23.5 21.3 $51.80

Washington Mutual 5.1 36.7 $41.80

Barclays 7.0 16.5 12.7 $36.20

Wells Fargo 3.5 8.7 18.2 5.3 $35.70

Lehman Brothers 12.5 14.0 $26.50

Others

TOTAL

Documents

S01 the Investment Banking Industry