Investment Banking, Credit Rating & Broking

What is investment banking?

• Investment banking is a field of banking that aids companies in acquiring funds. In addition to the acquisition of new funds, investment banking also offers advice for a wide range of transactions a company might engage in.

How Investment Banking operations differ from Commercial Banking?

• Investment banks instead make their money primarily

• By advising corporate clients on the creation of stocks, bonds and other securities

• By underwriting securities • By facilitating mergers and acquisitions, along with

any due diligence and securities exchanges that may go along with them.

• And by brokering (or selling) securities to investors.

Structure of an Investment Bank

Core functions of Investment Banking

• An intermediary between the capital markets (investors) and corporations (borrowers)

• Offers strategic advice and financial analysis on Mergers & Acquisitions, Divestitures, and Capital Structure

• Offers Equity and Fixed Income Underwriting (e.g.. IPO’s, High Yield Offerings)

• Provides Sales and Trading of Equity (Stocks), Fixed Income Securities (Bonds), Derivatives (Options).

• Provides asset management advice to high net worth individuals and institutions

• Offers research and advice on publicly listed stocks and bonds to institutional and individual investors

Underwriting Stocks and Bonds

• The process of underwriting a stock or a bond issue requires that the investment banker purchase the entire offering at a predetermined price and then resell the offering (securities) in the market. The services provided during this process include:• Giving Advice

• Filing Documents

• Underwriting, Best Efforts, or Private Placement

Underwriting Stocks and Bonds(2)

• Giving advice• Explaining current market conditions in to help

determine what type of security (equity, debt, etc.) to offer

• Assisting in determining when to issue, how many, at what price (more important with IPOs than SEOs)

Underwriting Stocks and Bonds(3)

• Filing Documents• SEC registration (filing) is required for issues greater than

$1.5 million and with a maturity greater than 270 days.

• A portion of the registration statement known as the prospectus is made available to the public.

• Debt issues require several additional steps, including acquiring a credit rating, hire a bond counsel, etc.

• For equity issues, the investment banker may also arrange for the securities to appear on one of the exchanges

Underwriting Stocks and Bonds(4)

• Underwriting (firm commitment)• The investment banker purchases the entire

offering at a fixed price and then resells the offering to the market.

• An underwriter may form an underwriting syndicate to diffuse part of the underwriting risk.

Underwriting Stocks and Bonds(5)

• The goal of underwriting is for all of the shares in an offering to be spoken for. However, this may not occur.• Fully subscribed: all shares are spoken for• Undersubscribed: underwriting syndicate unable

to generate interest in all of the available shares• Oversubscribed: interest in more shares than are

available (may lead to rationing).

Underwriting Stocks and Bonds(6)

• Best Efforts: An alternative to a firm commitment, the underwriter does not buy the issue, but rather makes its “best effort” to sell the entire issue.

• Private Placements: The entire issue is sold to a small, select group of investors. This is rarely done with equity issues.

Facebook e.g.

• Book runner- initially expected was Goldman Sachs but eventually won by Morgan Stanley.

• Co-managers – 12 other prestigious banks.• Fees -1.1% which is about $176 million.• Usually other banks earn about 7% fee.

•Individuals•Pension Funds•Insurance

Companies•Asset Managers•Corporate

Treasuries•Sovereign Wealth

Funds

•Corporations•Governments•Municipalities

Providers of Capital

Investment Banking

Investment Banks serve as intermediaries between providers and users of capital

Chinese Wall

Sales & Trading

Research

Users of capital

Public sidePrivate side

Strategic advisorySecurities

underwriting

Overview of Investment Banking

AdvisoryCapital Markets

•Equity capital-raisingoInitial public offerings

(IPOs)oFollow-on offeringsoEquity-linked (convertible)

•Debt capital-raisingoHigh-grade or investment

gradeoHigh-yieldoSyndicated loansoTax-exempt

•Mergers & AcquisitionsoBuysideoSellsideoSpin-offs / Splitoffs / Carve-

outsoHostile defenseoHostile takeovers / proxy

fightsoJoint Ventures

•Restructuring•Ratings

MERGERS AND ACQUISITIONS

•Investment bankers may assist both acquiring firms and potential targets (although not both in the same deal)

•Deal may be a hostile takeover, where the target does not wish to be acquired

•Investment bankers will assist in all areas, including deal specifics, lining up financing, legal issues, etc.

MERGERS AND ACQUISITIONS

SECURITIES BROKERS AND DEALERS

Securities firms with brokerage services offer several types of services:

•Brokerage Service

•Other services

•Full-Service Brokers v/s Discount Brokers

Divestitures A demerger (the opposite of merger) involves divestitures. It is the splitting up of

a corporate body into two or more separate and independent bodies.

Some of the reasons for divestitures/demerger could be:i. A subsidiary/associate/investment is not adding value or

eroding value. The buyer may be the management of the subsidiary, i.e.,

management buyout;ii. A subsidiaries/associate/investment does not or longer fits in

with the group’s strategic plan;

iii. Subsidiaries/associates/investment with high risk could be sold to reduce the business risk of the group as a whole

iv. To profit from the sale of the subsidiaries/associate/investment

• In Malaysia, divestitures are more commonly known as disposals.Disposals by a corporation may be in the form of fixed assets such as plant and equipment, land and properties,etc

• When a company decides to divert part of its operations, it will try to get the highest value by selling off the business unit, or selling individual assets

Investment Banking (Mergers & Acquisitions (M&A) and Corporate Finance ).

• The traditional aspect of investment banks which involves helping customers raise funds in the Capital Markets and advising on mergers and acquisitions. Investment bankers prepare idea pitches that they bring to meetings with their clients

• With the expectation that their effort will be rewarded with a mandate when the client is ready to undertake a transaction.

• Once mandated, an investment bank is responsible for preparing all materials necessary for the transaction as well as the execution of the deal, which may involve subscribing investors to a security issuance, coordinating with bidders, or negotiating with a merger target.

INVESTMENT MANAGEMENT

•The professional management of various securities (shares, bonds etc) and other assets (e.g. real estate), to meet specified investment goals for the benefit of the investors. Investors may be institutions (insurance companies, pension funds, corporations etc.) or

•private investors (both directly via investment contracts and more commonly via collective investment schemes, mutual funds)

SALES AND TRADING•Is often the most profitable area of an investment bank.

•responsible for the majority of revenue of most investment banks

•In the process of market making, traders will buy and sell financial products with the goal of making an incremental amount of money on each trade. Sales is the term for the investment banks sales force

•whose primary job is to call on institutional and high-net-worth investors to suggest trading ideas (on caveat emptor basis) and take orders. Sales desks then communicate their clients' orders to the appropriate trading desks, who can price and execute trades, or structure new products that fit a specific need.

RESEARCH•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. In recent years the relationship between investment banking and research has become highly regulated, reducing its importance to the investment bank.

RISK MANAGEMENT

• Carried out at Middle Office

• Risk Management involves analyzing the market and credit risk that traders are taking onto the balance sheet in conducting their daily trades, and setting limits on the amount of capital that they are able to trade in order to prevent 'bad' trades having a detrimental effect to a desk overall

• Another key Middle Office role is to ensure that the above mentioned economic risks are captured accurately (as per agreement of commercial terms with the counterparty) correctly (as per standardized booking models in the most appropriate systems) and on time (typically within 30

minutes of trade execution).

BACK OFFICE

•Operations involves data-checking trades that have been conducted, ensuring that they are not erroneous, and transacting the required transfers. While it provides the greatest job security of the divisions within an investment bank

•It is a critical part of the bank that involves managing the financial information of the bank and ensures efficient capital markets through the financial reporting function. The staff in these areas are often highly qualified and need to understand in depth the deals and transactions that occur across all the divisions of the bank.

Investment Banking Competitive Landscape

Bulge bracket

Boutique

Middle Market

Low HighCapabilities

Credit Rating

• Definition Evaluation of the timely repayment ability of an individual, firm, of debt security (such as a bond).

• Credit rating is built up on the basis of the 1. credit history, 2. present financial position, and 3. The likely future income.

Credit Rating Process• The process/procedure followed by all the major

credit rating agencies comprises of the following steps.

1. Receipt of the request2. Assignment to analytical team3. Obtaining information4. Plant visits and meeting with management5. Presentation of findings6. Rating committee meeting7. Communication of decision8. Dissemination to the public9. Monitoring for possible change

Rating Methodology

The main factors that are analysed into detail by the credit rating agencies.

1. Business Risk Analysis2. Financial Analysis3. Management Evaluation4. Geographical Analysis5. Regulatory and Competitive Environment 6. Fundamental Analysis

Business Risk Analysisa. Industry risk: Strength, demand & supply position, structure, pattern of business cycle etc.b. Market position: Percentage of market share ,Diversity

of products ,Customer base ,R&D projects undertaken etc.

c. Operating efficiency: Cost structure, availability of raw-material, compliance to pollution, capital employed etc.

d. Legal position: Assessed by letter of offer containing terms of issue ,mode of payment of interest +principal in time, provision for protection against fraud etc.

e. Size of business: The size of the business operations.

Financial AnalysisThis includes an analysis of 4 important factors namely:a. Accounting qualityb. Earnings potential/profitabilityc. Cash flows analysisd. Financial flexibility

Management Evaluation

• Management goals, plans and strategies,• Capacity to overcome unfavourable conditions,• Staff’s own experience and skills,• Planning and control system etc.

Geographical Analysis

• To determine the locational advantages enjoyed by the issuer company

• Benefits of diversification• Benefit of lower cost of operation

Regulatory and Competitive Environment

• Evaluates structure and regulatory frameworkof the financial system

• CRAs evaluate the impact of regulation/deregulation on the issuer company.

Fundamental Analysis1. Liquidity management :study of capital structure, availability of liquid assets , matching of assets and

liabilities.2. Asset quality :credit risk management, exposure to

individual borrowers and management of problem credits etc.

3. Profitability and financial position :past profits, funds deployment, revenues on non-fund based activities

4. Interest and tax sensitivity :sensitivity of company due to the changes in interest rates and changes in tax law.

Objectives of credit rating

(i) provide superior information to the investors at a low cost(ii) provide a sound basis for proper risk return

structure(iii) subject borrowers to a healthy discipline(iv) assist in the framing of public policy guidelines

on institutional investment

Factors Involved in Credit Rating

•Overall fundamentals and earnings capacity

•Overall macro economic and business environment

•Liquidity position of the company

•Financial flexibility of the company

•Guarantee/support from financially strong external bodies

•Level of existing leverage (borrowings) & Financial risk

Uses of Credit Rating

Credit ratings are critical to the activities of securities markets, as they are dependent on to create and manage investment portfolios, the pricing of new securities, trading of securities, financial contracts (and loans) and for some financial institutions to meet regulatory requirements.

CreditRatings

BuildingPortfolios

Pricing

Contracts

RegulatoryRequirements

Trading

Advantages of Credit Rating

Benefits to Investors

Safety of investments Recognition of risk and returns Freedom of investment decisions Wider choice of investments Dependable credibility of issuer Easy understanding of investment

proposals

Benefits to Company

Easier to raise funding Reduced cost of borrowing Reduce cost of public issues Ratings can build up image Ratings facilitates growth Recognition to unknown

companies

Benefits to IntermediariesFor brokers ratings make it easier to persuade clients to select an investment proposal of investment in highly rated instruments.

Disadvantages of Credit Rating

Non-disclosure of significant information

Static study

Rating is no certificate of soundness

Rating may be biased

Rating under unfavorable conditions

Difference in rating grades

Improper Disclosure May Happen

Impact of Changing Environment

Problems for New Companies

Downgrading by Rating Agency

Non-disclosure of significant information

Static study Rating is no certificate of

soundness Rating may be biasedRating under unfavorable

conditionsDifference in rating gradesImproper Disclosure May HappenImpact of Changing EnvironmentProblems for New Companies Downgrading by Rating Agency

Credit Rating does not serve

• Not an overall evaluation of the organisation

• Not a recommendation for purchasing, selling or holding of a security

• No comprehensive audit of the operations of the issuing organisation.

• Rating not valid for the entire life of the security.

• No legal relationship between the agency and the user

Rating Agencies in India• CRISIL - The oldest rating agency was originally promoted by ICICI.

Standard & Poor, the global leader in ratings, has recently taken a small 10% stake in CRISIL.

• ICRA - Promoted by IFCI. Moody’s, the other global rating major, has recently taken a small 11% stake in ICRA.

• CARE - Promoted by IDBI.

• Duff and Phelps(Fitch) - Co-promoted by Duff and Phelps, the world’s 4th largest rating agency.

CRISIL is believed to have about 42% market share followed by ICRA with about 36%, CARE with 18% and Fitch with 4%

Credit Rating CaseRELIANCE INDUSTRIES LTD.

• Experienced promoter group and management

• Approval of the natural gas pricing formula by the Oil Ministry

• Dominant leadership position in the petrochemical segment

• Strong financial risk profile characterized by robust capital structure and liquidity profile

DISHMAN PHARMACEUTICALS AND CHEMICALS LTD.

• Lower than envisaged utilization of recently commenced manufacturing facilities in India and China

• Stressed liquidity with continued reliance on short term unsecured borrowings

CARE AAA CARE BBB

Broking• Services offered by people / firms for buying and selling securities

BOMBAY STOCK EXCHANGE• Oldest stock exchange in the Asian region

• Traced back to 1830s

• A group of Traders trading in banking and cotton holdings

• Initially known as the Native Share and Stock Brokers Association

• Moved to Dalal Street between 1874 to 1875

Broker

• An individual / organization who are specially given license to participate in the securities market on behalf of clients

• Role of an agent

• Governed by SEBI Act, 1992, Securities Contracts (Regulation) Act, 1956

Role of a Broker in Financial Markets

Primary Task • Buying and Selling of securities

Other Tasks• Providing advisory services

• Offering limited banking services

• Brokering other securities

Charges Levied • Brokerage commissions

• Margin interest charges

• Service charges

Leading Stock Brokers in India

• Motilal Oswal

• ICICIdirect

• Share khan

• India bulls

• Geojit Securities

• HDFC

• Reliance Money

• Religare

• Angel Broking

Types of Broking Firms in India Full service brokers

• Provide the best information on the different profitable stocks. 

• Charge very high

Direct access brokers

• Dual advantage for traders

• direct access to the market

• Transactions carried out

Other Types of Broking Firms

Captive Brokers

• Owns part of the mutual fund company

• Inclined to sell only their own

Independent Brokers

• Not connected to any mutual fund company nor are they part of a chain brokerage

Discount Service Brokerage Firm

• Deals with the trading aspect of managing investments for their customers

Deep Discount Brokerage Firms

• Deal with specific aspects of investing, specializing in one area of trading

Online Discount Brokerage Firms

• Immediate trading

• Good investment services offered

Types of Brokers

• Stock Broker

• Mortgage Broker

• Insurance Broker

• Commodity Broker

• Options Broker

• Real Estate Broker

Types of Services

• Advisory Services

• Expensive

• Have to maintain good relationship and contact

• Provides financial consultant and financial advisory services

• Range of products to buy E.g. Bonds, MF, ETF, CD etc.

• Discretionary Management

• Expensive

• Have to maintain good relationship and contact

• Takes complete control over the investment

• Takes investment decision on behalf of customers and provides only periodic statements to the customers.

Common Broker Services Offered

• Online Trading Platform

• Different types of platforms

• Charting Packages

• Charting Costs

• Example of Charting Services : Charting services can be found at TradeStation, Esignal, and FXCM

• Paper Trading

• Perfect for beginners

• Other Services

Types of Brokerage Accounts

• Custodial Account: brokerage account for a minor that requires parent or guardian to handle transactions

• Cash Account: brokerage account that can only make cash transactions

• Margin Account: brokerage account in which the brokerage firms extends borrowing privileges

• Wrap Account: account that shifts investment decisions to a professional money manager and charges a flat annual fee

Basic Types of Orders

• Odd-lot Orders

• Round-lot Orders

• Market Orders • Limit Orders

• Fill-or-Kill Orders

• Day Orders

• Good-’til-Cancelled (GTC) Orders

• Stop-Loss (Stop) Orders

• Stop-Limit Orders

Competition

• Banks give brokers tough time in third – party products sale

• Bigger broker networks can compete with the big banks

• The non – bank lending sector will disappear when the exit fee is banned

Key Trends in Broking

• Trading in other platforms

• Advent of foreign and new Indian players

• Hard selling of Demat Account

• Stock Brokers foray into real estate broking

• MFs pose less risk when invested for a long term

• Lifetime offers by brokerage houses to lure customers

• Tie-ups between big and small brokers

Challenges Drivers

IPO showing strong return

FIIs showing strong return

Franchise Model fuels expansion

Undercutting and consolidation

Global Uncertainties

Rising rate of FD proving to be attractive

Under Penetration of equities

Rising Income Levels

THANK YOU