Introduction to Investment Banking

An Introduction to Investment Banking

By Prof. Samie

Prof. Samie’s profile

• 8 years of work experience • Started career as a Mechanical Engineer. • Graduated from the City University of New York with a

specialization in Marketing. Followed it up with an MBA in Finance.

• Joined Royal Bank of Scotland (ABN AMRO) in 2004. Worked across various departments of the offshoring division of RBS including Credit Analytics, Strategy and Planning, Project Management.

• Currently, working for the Corporate Finance Analytics Group of RBS. Major activities involve working on ECM deals of RBS Investment Banking Division in Australia and analyzing performance of global financial markets.

Origins of IB

• The NYSE traces its origins to a small group of New York brokers who traded in a handful of securities and commodities.

• A historical 1792 agreement called as a Buttonwood Agreement was signed among 24 New York brokers to band the brokers into an investment group.

• The name stemmed from the buttonwood tree that served as the Wall Street meeting place for members of the group. The tree was located at 68 Wall Street.

• The agreement allowed brokers to trade with each other for a commission.

• In the early 1800’s, the US government regularly issued bonds to finance wars, banks and infrastructure which were sold by merchants along with other commodities.

History of IB• By the middle of 1800’s, professional investment banks had

sprung up in the US to help government raise funds for infrastructure projects and the civil war.

• In the 1830’s, commercial banks started adding investment banking services to their regular banking activities in the US.

• Investment Banking hit a milestone in the 1870’s when a syndicate of banks from Europe and US teamed up to buy $50 million worth of US Treasury Bonds for resale to public.

• The syndicate sold billion dollars' worth of government bonds to large numbers of individual investors through the use of thousands of salesmen and an extensive advertising campaign. This venture marked the first mass securities-selling operation carried out in the United States.

History of IB• In Great Britain, since 1600’s, merchant banks or acceptance

houses had been in existence. • These concerns financed foreign trade and later the

acceptance houses also floated foreign issues in London and accumulated funds for long-term investment abroad.

• Also important in the evolution of investment banking were private banks, many of which were family enterprises, and finance companies.

• One of the former, the House of Rothschild, attained a dominant position in the financial centers of Europe during the 1800s and was still influential in the 1900s.

• European Investment banks (excluding UK) stuck with the universal banking concept and they remained active primarily in their local markets through the 1900’s.

History of IB

• In the early 1900’s, JP Morgan and Company put together another syndicate to reorganize US Steel from an array of affiliated companies into the first billion dollar corporation by trading shares of its smaller affiliates for the merged entity.

• The Great Depression in the 1920’s and World War 2 was a bad phase for the investment banking industry.

• Investment Banks were accused of excessive speculation and the US government stepped in to curtail the same.

• The Glass-Steagall Act, passed on June 16, 1933, and officially named the Banking Act of 1933, introduced the separation of bank types according to their business (commercial and investment banking), and it founded the Federal Deposit Insurance Corporation for insuring bank deposits.

History of IB

• In the mid-20th century, large investment banks were dominated by the dealmakers.

• Advising clients on mergers and acquisitions and public offerings was the main focus of major Wall Street partnerships.

• These firms included Goldman Sachs, Morgan Stanley, Lehman Brothers, First Boston and others.

• That trend began to change in the 1980s as a new focus on trading propelled firms such as Salomon Brothers, Merrill Lynch and Drexel Burnham Lambert into the limelight.

Did you know that Morgan Stanley is an offshoot of JP Morgan ?

History of IB

• Investment banks earned an increasing amount of their profits from proprietary trading.

• Advances in computing technology also enabled banks to use more sophisticated model driven software to execute trades and generate a profit on small changes in market conditions.

• In the 1980’s, leveraged buyouts and hostile takeovers drove the investment banking business.

• Investment banks profited handsomely during the boom years of the 1990s and into the tech boom and bubble.

• IPO’s of tech companies was the key investment banking activity through the 1990’s.

Current Scenario

• Two collapses of the stock market – the tech bubble and the sub-prime crisis have taken their toll on the investment banking industry.

• Landmark companies including Bear Stearns, Lehman Brothers and Merrill Lynch have been destroyed in the sub-prime crisis.

• Goldman Sachs and Morgan Stanley have moved from pure play investment banks to become commercial banks after the repealing of the Glass-Steagall Act.

• But still, investment banking remains a key element of our capital markets.

• Goldman Sachs, UBS, Credit Suisse are the major players in the global investment banking industry.

So what is IB?

• In a very broad perspective, Investment Banking as the term suggests, is concerned with the primary function of assisting capital market in the movement of financial resources from those who have them (investors) to those who want them (issuers).

• It can be inferred that investment banks are the counterparts of banks in the capital markets in discharging the critical function of pooling and allocation of capital.

• Over the decades, Investment Banking has transformed itself to suit the technological needs of the world of finance. Investment bankers have always enjoyed celebrity status, but at times have paid the price for excessive flamboyance as well.

IB Defined

• The Dictionary of Banking and Finance defines ‘investment bank’ as a term used in the US to mean ‘ a bank which deals with the underwriting of new issues and advises corporations on their financial affairs.

• Bloomberg provides a more consolidated definition for an investment bank – a financial intermediary that performs a variety of services, including aiding in the sale of securities, facilitating mergers and other corporate re-organizations, acting as brokers to both the individual and the institutional clients and trading in its own account.

• Much of the investment banking in its present form owes its origins to the financial markets in USA, due to which American investment banks have been leaders in the world. Therefore, the term Investment Banking can arguably be said to be of American origin.

Goldman Sachs – A global investment bank

• Goldman Sachs is a bank holding company and a leading global investment banking, securities and investment management firm that provides a wide range of services worldwide to a substantial and diversified client base that includes corporations, financial institutions, governments and high-net-worth individuals.

• Goldman Sachs is the successor to a commercial paper business founded in 1869 by Marcus Goldman. On May 7, 1999, the Company converted from a partnership to a corporation and completed an initial public offering of its common stock.

• On September 21, 2008, the Group became a bank holding company regulated by the Board of Governors of the Federal Reserve System under the U.S. Bank Holding Company Act of 1956 (BHC Act).

Goldman Sachs Businesses

• Goldman Sachs primarily offers services in three major categories– Investment Banking– Trading and Principal Investments– Asset Management and Securities Services

• The Group offers two major services as an investment bank:– Financial Advisory which includes M&A Advisory and

Financial Restructuring Advisory– Equity and Debt Underwriting

• Investment Banking represented 23% of 2008 net revenues for GS.

Financial Advisory at GS• Financial Advisory includes advisory assignments with

respect to mergers and acquisitions, divestitures, corporate defense activities, restructurings and spin-offs.

• Its mergers and acquisitions capabilities are evidenced by its significant share of assignments in large, complex transactions for which the bank provides multiple services, including “one-stop” acquisition financing and cross-border structuring expertise, as well as services in other areas of the firm, such as interest rate and currency hedging.

• In particular, a significant number of the loan commitments and bank and bridge loan facilities that the group enters into arise in connection with its advisory assignments.

Underwriting at GS

• Underwriting services offered by GS includes public offerings and private placements of a wide range of securities and other financial instruments, including:– common and preferred stock, – convertible and exchangeable securities, – investment-grade debt, – high-yield debt, – sovereign and emerging market debt, municipal debt, – bank loans, – asset-backed securities and real estate-related

securities, such as mortgage-related securities and the securities of real estate investment trusts.

League Tables – M&A YTD Sep09Adviser Rank Market Share(%) USD Volume (m) Deal Count

Goldman Sachs & Co 1 38.8 330229.19 114

Morgan Stanley 2 33.1 281013.66 118

Citi 3 31.3 266066.75 111

Bank of America Merrill Lynch 4 29.4 250244.47 88

JP Morgan 5 25.5 216443.58 125

Deutsche Bank AG 6 20.2 171453.34 84

UBS 7 20.1 171264.05 114

BNP Paribas Group 8 14.8 125673.1 45

Lazard LLC 9 13.8 117245.29 95

Rothschild 10 10.7 90695.63 97

RBS 11 9.3 79131.64 41

Barclays Capital 12 8.7 74380.74 32

Credit Suisse 13 8.6 72751.23 80

Wachovia Corp 14 8.2 69381.93 6

Greenhill & Co 15 8.0 68129.19 11

League Tables – ECM YTD Sep09Underwriter Rank Mkt Share(%) Amount USD (m) Fees(%) Issues

JP Morgan 1 13.7 48,625.98 3.195 229

Morgan Stanley 2 11.1 39,263.16 3.027 156

Goldman Sachs & Co 3 10.3 36,499.05 3.385 135

Bank of America Merrill Lynch 4 7.4 26,285.65 3.943 188

UBS 5 7 24,663.47 2.899 146

Credit Suisse 6 6.3 22,456.36 3.214 106

Citi 7 5 17,833.39 3.344 154

Deutsche Bank AG 8 4.2 14,840.51 3.793 106

Nomura Holdings Inc 9 3.7 13,267.96 4.187 26

Barclays Capital 10 2.7 9,576.30 3.442 64

China International Capital Corp 11 2.1 7,494.57 1.34 2

Wells Fargo Bank NA 12 2 7,260.87 3.027 51

RBS 13 1.6 5,705.02 1.96 48

Daiwa Securities Group Inc 14 1.3 4,447.62 4.184 6

Calyon 15 1.1 4,035.13 n/a 15

League Tables – DCM YTDSep09

Underwriter Rank

Mkt Share(%) Amount USD (Mln) Fees(%) Issues

JP Morgan 1 7.4 402,203.28 0.25 2,231

Barclays Capital 2 6.5 356,142.53 0.171 2,345

Deutsche Bank AG 3 5.4 294,913.56 0.214 2,231

Citi 4 5.3 288,965.42 0.351 1,519

Bank of America Merrill Lynch 5 5.1 277,447.56 0.339 1,331

HSBC 6 4.3 235,858.02 0.26 2,543

RBS 7 4.2 228,119.87 0.3 1,322

Morgan Stanley 8 4 218,563.45 0.267 3,485

UBS 9 3.8 208,923.57 0.179 1,936

Goldman Sachs & Co 10 3.7 199,953.88 0.234 695

BNP Paribas Group 11 3.6 195,787.70 0.326 1,018

Credit Suisse 12 3.5 192,471.46 0.211 1,001

Hypo Real Estate Bank AG 13 2.2 117,572.04 n/a 22

Societe Generale 14 2 111,489.94 0.211 484

Landesbank Baden-Wuerttemberg 15 1.7 90,679.33 0.207 620

• As a general rule, investment banks focus on initial public offerings (IPOs) and large public and private share offerings. Merchant banks tend to operate on small-scale companies and offer creative equity financing, bridge financing, mezzanine financing and a number of corporate credit products.

• While investment banks tend to focus on larger companies, merchant banks offer their services to companies that are too big for venture capital firms to serve properly, but are still too small to make a compelling public share offering on a large exchange.

• In order to bridge the gap between venture capital and a public offering, larger merchant banks tend to privately place equity with other financial institutions, often taking on large portions of ownership in companies that are believed to have strong growth potential.

Merchant Banking vs. Investment Banking

• Merchant banks still offer trade financing products to their clients. Investment banks rarely offer trade financing because most investment banking clients have already outgrown the need for trade financing and the various credit products linked to it.

• Merchant banks can also be said as a British term for investment banks.

• Merchant Banker has been defined under the Securities & Exchange Board of India (Merchant Bankers) Rules, 1992 as "any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities as manager, consultant, advisor or rendering corporate advisory service in relation to such issue management".

Merchant Banking vs. Investment Banking

• To conclude the argument, merchant banking has different connotations in the US and other markets.

• In the US it is primarily a fund based activity while in the UK and in India it is implies intermediation and advisory activity in connection with public floatation of securities.

• Investment Banking thus can be defined as a broader term which covers both fund and fee based activities.

• Merchant banking can either be a fund based activity or a fee based activity.

Merchant Banking vs. Investment Banking

The role of equity research

• Equity Research is the division which reviews companies and writes reports about their prospects, often with "buy" or "sell" ratings.

• While the research division generates no revenue, its resources are used to assist traders in trading, the sales force in suggesting ideas to customers, and investment bankers by covering their clients.

• There is a potential conflict of interest between the investment bank and its analysis in that published analysis can affect the profits of the bank.

• Therefore in recent years the relationship between investment banking and research has become highly regulated requiring a Chinese wall between public and private functions.

Investment Banking in India

• Grindlays bank began Investment Banking (Merchant Banking) in India in 1967 with RBI issuing the second license to Citi in 1970.

• These two banks primarily provided services which included loan syndication, equity raising and other advisory services.

• In 1972, a Banking Commission report asserted the need for Merchant Banking services in India by public sector banks.

• The commission recommended the same structure as American investment banks (Glass-Steagall Act).

• Merchant banks were meant to manage investments and provide advisory services.

• SBI was the first Indian public sector bank to set up its merchant banking division in 1972.

• This was followed by Bank of India, Central Bank of India, Bank of Baroda and many more.

• SBI Caps and IDBI Caps are two prime examples of merchant banks in India today.

• Currently, there are 136 merchant banks registered with SEBI.

• Currently, without holding a certificate of registration granted by the Securities and Exchange Board of India, no person can act as a merchant banker.

Investment Banking in India

• The categories for which merchant banking registration may be granted by SEBI: – Category I – to carry on the activity of issue

management and to act as adviser, consultant, manager, underwriter, portfolio manager

– Category II - to act as adviser, consultant, co-manager, underwriter, portfolio manager.

– Category III - to act as underwriter, adviser or consultant to an issue

– Category IV – to act only as adviser or consultant to an issue

• The capital requirement depends upon the category. The minimum net worth requirement for acting as merchant banker are Category I – Rs. 5 crores, Category II – Rs, 50 lakhs, Category III – Rs. 20 lakhs and Category IV – Nil

Investment Banking in India

SBI Capital Markets

• SBI Caps is one of the leading merchant banks in India. • SBI Caps has three major services to offer:

– Project Advisory & Structured Finance – Capital Markets– M&A Advisory

• Project Advisory and Structure Finance includes project appraisals, debt and equity syndication, securitization.

• Capital Markets primarily includes IPO’s, Follow On Offers, Rights Issues, Buybacks and other capital markets related activities.

• M&A Advisory includes M&A, Private Equity and Corporate Advisory.

Conclusion

• Investment Banking could be termed as a relatively American phenomenon.

• Indian Investment Banking industry has still a long way to go before it catches up with its global peers.

• The sub-prime crisis of 2008 has been a hammer blow for pure play investment banks.