International Banking - 4

BA (Hon) Banking and Finance Sunderland Business School Dr Tim Zhou

INTERNATIONAL INVESTMENT BANKING

Overviews

Investment banks are more active internationally than other types of banks International network Highly skilled salespeople, traders, consultants, analysts Sophisticated computer systems

Overviews

International investment banks underwrite and sell financial securities to investors (in primary markets)
Important long-term equity and debt finance for corporations (industrial firms, public utilities, banks, insurance companies) and governments and sub-national entities (municipalities, states, provinces etc) Market making and trading Investment banks also trade securities in secondary markets offering a range of advisory services

Overviews

Three typical organisational forms of investment banks

Partnership Goldman Sachs, this form is disappearing ! A Unit of conglomerate an arm of an universal bank, e.g. Barclays Capital Publically listed firm maximisation of the shareholder value

Functions of Investment banks Underwriting

Underwriting raising capital on behalf of companies and governments from investors, i.e. selling new securities
Underwriter provides advice for issuer, distribution of securities, sharing of risks of issue, and stabilisation of aftermarket Underwriter also certifies the issue by putting its reputation behind the issue To actually start the underwriting process, an investment bank needs to win the mandate first as the issuers may ask few potential investment banks to offer their terms and conditions If an investment bank wins the mandate, it become the lead manager and can form a syndicate

Functions of Investment banksUnderwriting

Firm commitment contracts Vs best efforts contracts

The majority of issuances contracts are the firm commitment contracts Firm commitment contracts entail the commitment of an investment bank to purchase the whole issue first before selling to potential investors Best efforts contracts do not guarantee that investment banks will sell all the securities. The investment bank only makes its effort to do so Standby underwriting is when an issuer offers new shares to exiting shareholders (rights offering) and an underwriter sells the unsold shares to potential investors

Underwriting Sequence

Engagement: Mandate signed by issuer engaging lead manager Due Diligence: Conducted by Lead manager Documentation: Loan agreement, Prospectus Signing: Underwriting agreement signed and issue priced Closing: Settlement of the offering

Beauty Contest Engagement Due Diligence and Documentation Signing and Pricing

Closing

The Beauty Contest

Criteria for Selecting a Lead Manager 1 Experience with similar transactions (sector, market, currency, maturity, high or low-quality issuers) Ranking in League Tables Placement power with institutional and/or retail investors Standing in secondary market as market maker and commitment to secondary market trading

The Beauty Contest (Cont.)

Criteria for Selecting a Lead Manager 2 Quality/reputation of research Proposed marketing strategy (pricing, timing, issue size, etc.) Proposals for Roadshow Relationships with potential co-managers Senior management commitment to backing issue with people and capital

The Roadshow

Organized by global coordinator and lead managers Informal presentation by management to potential investors Attendance limited to professional intermediaries and investing institutions Content must be consistent with information in draft version of prospectus or offering circular.

Stabilisation

A form of market manipulation by the underwriter near the time of the issue Underwriting syndicate legally allowed to conspire to fix prices in market until entire issue is sold out

From a 1929 Textbook on Investment Banking

In floating any new issues of securities, therefore, the seller desires to have conditions so shaped that the price of the issue will remain stable, or perhaps it will rise slightly, during the period in which the securities are being absorbed by the market. . .establishing a favorable psychological attitude of investors. . The term manipulated market is not altogether a misnomer.

The Tombstone

Newspaper announcements of securities issues, listing underwriting syndicate Why called tombstones? Origin of term forgotten. Resemblance? The only kind of ad allowed during cooling-off period Cross between birth announcement and obituary. Tombstones appear after the securities have already been sold, of course they are now on the market. Investment bankers love to read them

Underwriting Economics
Management Fee 20% Underwriting Fee 20%
Underwriting Fee: Based on underwriting commitment (often less expenses of offering)

Management Fee: Normally shared equally among managers (may be subject to a praecipium for Global Coordinator or Lead Manager) Praecipium - The amount
of the front-end fee not distributed to the joining members of a syndication

Selling Concession 60%

Selling Concession: Payable as a percentage of allocation (determined by book-runner)

Variations on the Usual Underwriting Process

Preemptive rights offering: existing shareholders have rights to buy issue below market value Directly Public Offering (DPO): Company itself sells its securities directly to public, usually over the web. Small firms. Example: Internet Ventures, a web service provider, raised $3.8 million in 1998 by advertising the securities to its customers on the web.

Private Placement

Sold only to sophisticated investors, exempt from SEC registration. Regulation D: Private issues cannot be advertised, defines sophisticated investors SEC has provided that privately placed securities cannot be sold for two years after purchase. SEC Rule 144a April 1990 eliminates two-year holding period for institutions with over $100 million in the security

Functions of Investment banksIPOs

Initial public offering a company raises capital by selling common stock to the public for the first time
Investment banks advise firms about pricing, information disclosure help issue the prospectus and actually sell the shares on effective date to the public Investment banks earn management fee, underwriting fees and selling concession

Secondary market trading

Apart from underwriting and IPOs (primary market making), investment banks also engage in secondary market trading Investment banks have skilled traders, salespeople, analysts to help them generate profits Investment banks do arbitrage - the practice of taking advantage of a price difference between two or more markets

Arbitrage

Suppose that the exchange rates (after taking out the fees for making the exchange) in London are 5 = $10 = 1000 and the exchange rates in Tokyo are 1000 = $12 = 6. Converting 1000 to $12 in Tokyo and converting that $12 into 1200 in London, for a profit of 200, would be arbitrage. In reality, this type of arbitrage is so simple that it almost never occurs Arbitrage has the effect of causing prices in different markets to converge. As a result of arbitrage, the currency exchange rates, the price of commodities, and the price of securities in different markets tend to converge

Advisory services

Corporate restructuring mergers and acquisitions Large number of M&As in the US, EU Cross-border M&As and the role of international banks M&As in financial industry also occur more frequently due to deregulation, the development of capital markets International banks provide advisory services to either acquiring firms or target firms

Advisory services

The popularity of leveraged buyout LBO the acquisition of a company or division of a company with a substantial portion of borrowed funds The assets of the acquired company are used as collateral for the borrowed capital, sometimes with assets of the acquiring company

LBO

Typically, leveraged buyout uses a combination of various debt instruments from bank and debt capital markets. The bonds or other paper issued for leveraged buyouts are commonly considered not to be investment grade because of the significant risks involved
an existing internal management team (a management buyout) an external management team (a management buy-in), or a third party (a leveraged acquisition)

Many other services

International investment banks also provide project financing, leasing, derivatives trading, merchant banking, help hedge financial risks (i.e. tailor-made derivative securities )

Reading list

The partnership of investment banks the example of Goldman Sachs http://www.independent.co.uk/news/business/analysisand-features/the-firm-inside-goldman-sachs-428415.html A Guide to the Initial Public Offering Process by Ellis and Michaely, 1999 (on SunSpace) The role of bank advisors in mergers and acquisitions page 197-203 (non-technical part only) http://wlxt.whut.edu.cn/new/syyhjyygl/otherSource/liter ature/englishHandpick/The%20Role%20of%20Bank%20 Advisors%20in%20Mergers%20and%20Acquisitions.pdf

Reading list

Leveraged buyout http://mba.tuck.dartmouth.edu/pecenter/research/pdfs/ LBO_Note.pdf