Finance Club 2 nd Meeting September 28 th, 2014.

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Finance Club 2nd Meeting

September 28th, 2014

Introduction

Guest Speaker – Warren Kornfeld

Expanded discussion on specific areas of finance

Market news and updates

Young Alumni in Finance Weekend

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Colgate Finance Club

Moody’s Ratings AgencyIntroduction to Credit Ratings

Warren KornfeldSVP Financial Institutions Group

The presentation are my personal views and not the views of Moody’s or any

other party

What is a Financial Obligation

A financial obligation: loan or a bond is created when a borrower borrows money from a lender/creditor and promises to repay such money along with interest over a period of time

Example 1: People typically finance a portion of the purchase price of their home US mortgages are typically repaid over 30 years in

360 equal monthly installments. Today, the average interest rate on US mortgages is approximately 4.25%.

Example 2: a corporation is building a new $100 million plant To partially finance the building they may elect to

issue $80 million of 5 –year bonds at a rate of 5%.

Financial Obligation Terms

Fixed rate or floating rate

The amount borrowed is only repaid at maturity or is paid periodically

The financial obligation may be secured (e.g. by a house or other assets) or unsecured

Credit Rating Definition

Credit ratings are forward-looking opinions of the relative credit risks of financial obligations What is the likelihood that the lender will be repaid on time

Long-term ratings: obligations with an original maturity of one year or more. Reflect on the likelihood of a default on payments and the

expected financial loss suffered in the event of default.

Short-term ratings: obligations with an original maturity of thirteen months or less Reflect the likelihood of a default on contractually

promised payments.

Moody’s Long Term Rating Scale

Short Term Rating Scale

Industry Sectors and Rating Examples

Corporates: Apple: Aa1/P-1 McDonalds: A2/P-1 IBM: Aa3/P-1 Dell: Ba3 GM:

Financials (Banks and Insurance Companies): Bank Of America: A2/P-1 American Express: A3/P-2 Discover: Baa3/P-3 AIG: Baa1/P-2

Industry Sectors and Rating Examples

Countries: United States: Aaa Germany: Aaa UK: Aa1 Argentina: Caa1 Japan: Aa3 China: Aa3

States, Other Municipalities, Schools: New York: Aa1 Illinois: A3 Detroit: Caa3 Colgate: Aa3

Structured Finance Residential Mortgage Backed Securities Commercial Mortgage Backed Securities Credit Card Backed Securities

Three C’s Of Credit

Capacity How much money does the obligor make

Character Does the obligor have a history of repaying their debts

Collateral If the loan is secured, the value of the collateral (e.g. the

value of the home)

Who is to Blame for the Financial Crisis?

The Rating Agencies?

Aaa mortgage backed securities ratings which performed poorly

Did not predict the failure of Bear Stearns, Lehman Brothers, WaMu, AIG, Fannie and Freddie, GM, . . .

The Banks?

They underwrote and sold all of the securities which later defaulted

Their research reports did not warn of the dangers

They lost billions of dollars Many banks failed and many more would likely

have failed if they were not bailed out by the government

Some shorted the market while continuing to sell the same securities and sectors they were shorting

The regulators?

They missed the crisis They were/are in a unique position to demand

receipt of information They were/are in a unique position to enforce

regulated institutions to take certain actions

The mortgage originators?

Countrywide, WaMu, Lehman, Bear, and many more failed because of the poor loans they made

Homeowners?

Many purchased properties and took out loans they could not afford

Many misrepresented their income and their net worth

Who is to Blame?

Everyone It was a classic this time is different

Better models More liquidity

Consensus mindset was of market efficiency and deregulation was good for the economy

The US had not seen national home prices decline in 75 years

Consensus was that overvalued home prices would remain flat or decline only slightly until income caught up

Classic Financial Crisis

Shocks to the system: 2007:

RMBS market froze Two Bear Stearns RMBS hedge funds failed BNP Paribas suspended redemptions in a couple of their

mutual funds due to an inability to price RMBS investments 2008:

Bear Stearns failed in March but was essentially bailed out by the Fed

Lehman failed in September and was not rescued setting off panic in the markets

Opacity, interconnectiveness and complexity did not allow for participants to know who was at risk

The markets froze, liquidity dried up, asset prices plummeted

Careers in Finance

Investment Banking

Sales and Trading

Mergers and Acquisitions

Hedge Fund/Mutual Fund

Private Equity/Venture Capital

Commercial Banking

Finance/Wealth Management

Accounting

Consulting

Investment Banking

Bankers help companies figure out how they want to raise capital through either debt or equity (or hybrid) offerings

Bulge Bracket

Top Middle Market

Boutique

Buy-side vs Sell-side

Sales and Trading

Sales: Pitches the asset to potential investors

Trading: Actually does the buying and selling in financial markets

Research: Analyzes specific company or sector’s financial performance to provide info for the sales pitch

Structuring: Works with the sales team to understand the needs of clients whose requirements are either very specific or highly complex

They are the market-makers through secondary market: provides liquidity for investors, price discovery for the issuer

Diagram for IB

Mergers and Acquisition

Branch within Investment Banking

1 + 1 = 3

Acquisition: Apple acquires Beats Electronics for 3b

Merger of equals: Daimler-Benz + Chrysler = DaimlerChrysler

Hedge Fund/Mutual Fund

Mutual Fund: A collection of stocks and/or bonds, each with a share price. You buy shares in the fund for partial ownership and pay a management fee (1%).

Hedge Funds: Not publicly traded, is an investment partnership reserved for high net worth clients

More freedom, on the buy-side of trading

Private Equity/Venture Capital

Private Equity: Firms that buy companies through leveraged buyouts, across all industries, with a full 100% take over

Venture Capital: Invest in companies that are in their infancy, focusing on technology, bio-tech, and clean-tech. Only acquire a minority stake – less than 50%

Google Private Equity vs Venture Capital www.mergersandinquisitions.com/private-equity-vs-venture-

capital/

Commercial Banking

Focus on credit and rate risks

Checking/Saving Accounts, CDs

Loan Origination

New Emphasis after 2007

Finance/Wealth Management

Financial Advisors

Clientele interaction and expansion

Variable occupation

Accounting

Within most industries dealing with finance

It is an information system that measures business activities, processes information, and communicates financial information

Balance Sheet, Income Statement, and Cash Flow

Financial Accounting and Management Accounting

Consulting

Management consulting firms

Technology focused consulting firms

Niche & boutique consulting firms

Independent

Current Market News