S01 the Investment Banking Industry
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Transcript of 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
1. Introduction: Financial InstitutionsIntroduction
Types of financial assetsDebtEquityDerivatives: forwards, futures, options, swapsCommoditiesSecuritized assetsCredit derivatives
Financial markets
1. Introduction: Financial InstitutionsIntroduction
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
1. Introduction: Financial InstitutionsIntroduction
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
1. Introduction: Financial InstitutionsIntroduction
Types of financial marketsThere are many ways to classify
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
1. Introduction: Financial InstitutionsIntroduction
Types of financial marketsThere are many ways to classify
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
What are investment banks?
2. Introduction: Investment BanksIntroduction
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
What are investment banks?
2. Introduction: Investment BanksIntroduction
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
2. Introduction: Investment BanksIntroduction
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
Types of investment banks
2. Introduction: Investment BanksIntroduction
Financial holding companiesBusinesses includes:
Retail (or consumer) bankingCorporate bankingInvestment bankingAsset managementWealth (private) managementCredit cards
2. Introduction: Investment BanksIntroduction
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
Types of investment banks
2. Introduction: Investment BanksIntroduction
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
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
3. Trends in investment banking Introduction
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
3. Trends in investment banking Introduction
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
3. Trends in investment banking Introduction
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
3. Trends in investment banking Introduction
Deregulation: Most countries have over the years taken significant steps to 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
3. Trends in investment banking Introduction
Deregulation: Most countries have over the years taken significant steps to 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
3. Trends in investment banking Introduction
Deregulation: Most countries have over the years taken significant steps to 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
Deregulation of the investment banking sector
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
3. Trends in investment banking
Deregulation of the investment banking sector
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
3. Trends in investment banking
Deregulation of the investment banking sector
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
3. Trends in investment banking
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
3. Trends in investment banking Other trends in the investment banking sector
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
3. Trends in investment banking Other trends in the investment banking sector
Introduction
Income sources Underwriting spreadM&A feeTrading profitsPrime-brokerage (interest and fee)Market making (spread)Research
4. Measure of Performance Risk and Returns: Returns
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
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?
4. Measure of Performance Risk and Returns: Risks
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
4. Measure of Performance Risk and Returns: Risks
Introduction
Funding risk Borrowing: capital and money marketThe credit squeeze
Liquidity RISK What is liquidity risk?
4. Measure of Performance Risk and Returns: Risks
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
5. Sub-prime and the Credit Crunch Impact on Investment Banks
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
5. Sub-prime and the Credit Crunch Impact on Investment Banks
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
5. Sub-prime and the Credit Crunch Impact on Investment Banks
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
5. Sub-prime and the Credit Crunch Impact on Investment Banks
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
5. Sub-prime and the Credit Crunch Impact on Investment Banks
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
5. Sub-prime and the Credit Crunch Impact on Investment Banks
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
5. Sub-prime and the Credit Crunch Impact on Investment Banks
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
5. Sub-prime and the Credit Crunch Impact on Investment Banks
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