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Investment Banking - A Industry Report

Executive Summary

This report seeks to present a holistic picture of the Investment Banking industry with an objective of helping the authors to shorten the induction time during their summer internship in leading investment banks. Investment banking covers a range of activities which include underwriting, selling and trading stocks and bonds, providing financial-advisory services such as mergers and acquisitions, and managing assets.

Coming a long way from its inception on the Wall Street in the 1th century, the industry recently witnessed a wave of mergers and acquisitions with the repeal of the Glass-Stegall Act in 1. The current size of the industry, measured by the revenues of the ten largest investment banks, is close to $4 billion. The key players comprise the Bulge Bracket firms like Goldman Sachs and Merrill Lynch that provide a full range of service offerings; and Boutique firms like Soundview Technology Group, which are smaller and more specialized.

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The major service categories include Corporate Finance, Mergers and Acquisitions, Public Finance, Fixed Income and Equity Sales, Trading and Research. The end-customers include corporate clients, high net worth individuals and large institutional investors. I-banks rely on human capital as their most precious asset.

An analysis of the impact of various environmental factors on the industry reveals that the industry is pro-cyclical with economic cycles. The recent deregulation by the government and the advent of technologies like the Internet has opened new doors of opportunities for financial services.

An analysis of the competition in the industry using the Porter’s Five-Force Model brings out the threat to the existing players from new entrants and substitutes like specialized regional firms.

At present, the industry has been severely hit by the US-led global economic recession and the slowdown was aggravated by the recent spate of accounting scams. The long-term outlook for the industry is positive with a moderate growth rate of 7.5%, increasing consolidation and globalization; and new opportunities in the emerging markets of Asia-Pacific. The existing I-banks face a major challenge in regaining public confidence by ensuring corporate governance and compliance with the expected increase in regulations.























EXHIBIT 1 U.S./Europe Wholesale Banking Revenues (i)

EXHIBIT Company-wise Industry Performance in 00 (ii)

EXHIBIT Projected Global Wholesale Revenues (iii)

EXHIBIT 4 Individual Industry Rankings (00 Q1-Q) (iv)

EXHIBIT 5 Skills Needed to Succeed in Investment banking (v)

EXHIBIT 6 Porter’s five forces model (vi)

EXHIBIT 7 Global Market Shares of Mono-line Investment Banks (vii)

1. Introduction

Investment banking is an industry that covers a range of activities which include underwriting, selling and trading stocks and bonds, providing financial-advisory services such as mergers and acquisitions, and managing assets. An investment bank (I-bank) acts as an adviser to corporations for the creation and issuance of financial products; a sales-and-distribution organization for the same financial products; and a research organization for various financial instruments.

Investment banking differs from commercial banking in the sense that it does not maintain cash deposits to lend as a commercial bank does. It only acts as an intermediary, and matches sellers and buyers of securities.

. Evolution of Investment Banks

The Early Years 186-1

The industry owes its genesis to the brilliance of individual entrepreneurs like Markus Goldman and J.P. Morgan who set up banks on the Wall Street in the late 1th century. This period was considered as a golden era, which saw the emergence of several investment and commercial banks.

Separation of Investment Banks from Commercial Banks 1 to 170

The Glass-Steagall Act of 14 erected barriers between commercial and investment banking on grounds of a conflict of interest and prevention of a monopoly control. This led to structural changes in the industry such as the split of the former JPM into J.P. Morgan, the commercial bank and Morgan Stanley, the investment bank.

Development of the Modern Investment Bank 170-16

The reduction in trading profitability initiated the integration of investment banks aimed at providing sales, trading, research and investment banking under one roof and the emergence of a number of financial products such as derivatives, high yield and structured products, which provided lucrative returns for investment banks.

Consolidation and Convergence 16 �001

After a series of industry-wide consolidations in response to the repeal of the Glass-Steagall Act in 1 , the industry has turned into a consortium where a group of top ten global investment banks dominate the market.

. Growth rate and Size

The last decade saw an explosion in the global capital markets which led to a Compounded Annual Growth Rate CAGR of 0% for the investment banking industry. Exhibit 1 shows that the major contributor to growth was the Technology, Media and Telecom industry (TMT), which grew by 15 %.

The global economic recession starting in 001 has negatively impacted investment banking. As seen from Exhibit , the current size of the industry, measured by the revenues of the 10 largest investment banks, is close to $4 billion, a 10% fall from last year’s revenue. With a fall in TMT revenues by more than 50%, Exhibit shows that the future growth is expected to be close to 7.5%.

4. Players in the industry

The industry can be classified into two categories according to their size and market focus

a) Bulge Bracket Firms, consisting of the biggest full-service investment banks including Merrill Lynch, Morgan Stanley Dean Witter, Goldman Sachs, Salomon Smith Barney, Credit Suisse First Boston, and Lehman Brothers Firms. Each of these firms has developed its own area of expertise. The industry rankings in Exhibit 4 show that in 00, while CitiGroup/Salomon Smith Barney dominated the equity and IPO underwriting, Goldman Sachs was the leader in Merger and Acquisitions (M&A) advisory services.

b) Boutique firms are niche firms targeting segment divisions or operating in a particular industry, such as the Soundview Technology Group which focuses on technology. Regional firms provide financial and investment services in a particular geographic region, such as the Wachtel & Co. Inc. which provides private and public equity capital to companies in the Washington DC area.

5. Service Categories

An investment bank consists of three major professional divisions Investment Banking Division (which includes Corporate Finance, Mergers and Acquisitions, and Public Finance), Sales and Trading, and Research.

5.1 Investment Banking Division

5.1.1 Corporate Finance

The Corporate Finance Group provides various financial and business advices to clients and is in charge of pricing and purchasing securities for an initial public offering (IPO), a secondary offering, or a debt issuance. The Corporate Finance Group

Underwrites equity and fixed income offerings

Determines valuation for offerings

Analyzes the client’s financial needs and helps the firm to design and implement an appropriate financial strategy, such as in the area of structuring its balance sheet.

5.1. Mergers and Acquisitions (M&A)

This division provides advice to various client firms on appropriate merger and acquisition strategy. The M&A Group

Determines target company valuations

Designs a defensive strategy for the target of a hostile acquisition

Conducts due diligence on a target or acquiring company

Negotiates the price, terms and conditions of an acquisition or a merger in the process of structuring the deal

5.1. Public Finance

Public Finance is similar to corporate finance but instead of dealing with corporations, this group deals with public institutions such as city and state government or housing authorities. In the process of structuring a deal, numerous political and regulatory considerations must be assessed. The Public Finance Group

Advises public entities on capital raising strategy, portfolio management and project financing

Restructures debt and determines valuation of debt offerings for municipal entities

Underwrites tax exempt notes, derivatives and other municipal securities

5. Sales and Trading Division

The Sales Group is responsible for selling the financial products sponsored by the investment-banking department. It serves as a vital link between the sell-side (corporations and government entities) and the buy-side (investors). Salespeople

Work with the investment banking group in order to market new security issue

Arrange conferences between client, research group and company management

The Trading Group is responsible for taking positions in the market through purchases and sales of securities. Traders

“Make markets” i.e. maintain positions in stocks or securities that the firm has underwritten, quote bid-ask prices and buy-sell at those prices

Perform valuation analysis of derivatives, convertibles or basket of stocks

Advise clients, salespeople and research analysts on the basis of above analysis.

5. Research Division

The Research Group provides analytical support to Investment banking division, Sales and Trading activities. It is divided into two groups Fixed Income Research and Equity Research. The Research Group

Prepares updates on market trends and company performance

Offers investment recommendations and forecasts based on trend analysis

Recommends positions on stocks to the sales force, traders and investment bankers.

6. End Users

The customers for this industry include

a) Private Sector

The large corporate clients

High net worth individual customers.

b) Public Sector

Large Institutional Investors

National Governments.

Non-profit organizations.

7. Suppliers Human Capital

Being a service-oriented industry, human capital is the most valuable asset that drives the industry. I-banks rely heavily on the expertise of their traders, dealmakers, analysts and associates to clinch major deals. (Exhibit 5)

An I-bank typically has a vertical organizational structure, comprising of an analyst, associate, vice president, director, managing director and department head in the ascending order of hierarchy.

8. Environmental Analysis

8.1 Economic Factors

The volatility of capital markets is pro-cyclical with business cycles. 1 was a golden year for the financial markets, with secondary capital markets growing by 70% due to the upsurge in consumer confidence. However, post-1, markets crashed due to the US-led global economic slowdown resulting in a halt in M&A and IPO activity and a decline in earnings for most I-banks.

8. Political and legal Factors

Various government policies and regulations determine the functioning of I-banks. The Securities and Exchange Act passed in the US in 14 set up the Securities and Exchange Commissions (SEC), which made it mandatory for all I-banks to adhere to strict financing and governance procedures. The passing of the Glass Steagall Act in 14 led to a significant growth in the industry. Repeal of the Act in 1 and passage of the Gramm-Leach-Bliley Financial Services Modernization Act has led to a wave of mergers and acquisitions in the industry. Any infringement of the existing rules of the capital markets by a bank today, can lead to charges of embezzlement or insider trading.

8. Technological factors

Most I-banks have started trading securities on the internet, offering individual investors the opportunity to trade in big corporate bond issues for the first time. Since Morgan Stanley pioneered an online trading system, Discover Brokerage Direct in 1, most bulge bracket banks have followed suit. The advent of electronic exchanges has enabled trade 4 hours a day. Several “net centric investment banks” like EOffering, W.R. Hambrecht and Wit Capital have come up.

8.4 Socio-Cultural Factors

An I-banker’s family life suffers greatly due to the high stress levels of the job. The changing social paradigms and new lifestyles associated with the Internet era have generated fresh opportunities for financial services.

. Industry Analysis

.1 Competition Analysis

Porter’s Five-Force model (Exhibit 6) has been used to analyze the competition in the industry.

1) Threat of New Entrants

The huge capital requirement acts as a major entry barrier in the industry. The repeal of the Glass Steagall Act enabled the entry of large commercial banks like Citigroup and Deutsche into I-banking. The advent of Internet-based investment banks like Wit Capital and online retail brokerage firms like Charles Schwab are major threats to the industry.

) Rivalry among existing firms

Despite the presence of over 400 I-banks worldwide, the top ten account for almost 70% of the total business deals. As banks merge and consolidate their operations, the rivalry among the remaining players would increase. They are likely to compete on differentiated service offerings customized for each client.

) Threat of Substitutes

Regional firms like Hambrecht & Quist (California based) that are dominant players in their respective regions and specialized (niche) firms like Volpe Brown Whelan (San Francisco based) focusing on technology are likely to capture business at the expense of the larger I-banks. Accounting firms like KPMG and PricewaterhouseCoopers moving into financial advisory services have also generated alternatives for small corporate and individual investors.

4) Bargaining Power of Suppliers

The industry witnesses a very high attrition rate. The professionals, the most valuable asset of any I-bank, can demand very high compensation packages during periods of economic boom.

5) Bargaining Power of Buyers

The product and service offerings are seldom differentiable; hence there is a high risk of customers switching over to competitors. Large institutional investors also pressurize the banks to give them favored deals and access to confidential information.

. Current Trends in the Industry

a) Slowdown Over the past years, the financial environment has been severely hit by a substantial global economic recession, the September 11 and subsequent terrorist attacks, the sudden decline of equity markets and a string of corporate frauds and failures. Responding to these unexpected unfavorable events, several I-banks, including Merrill Lynch, JP Morgan Chase and Goldman Sachs have resorted to widespread cost-cutting measures resulting in an industry-wide retrenchment of over 6% of the total workforce and a decrease in compensation to the extent of 5-50%.

b) Deregulation and Consolidation Investment banks are increasingly focusing on emerging as a “one-stop financial services provider” by entering into a spate of cross-industry M&A activities such as the acquisition of Alex Brown by Deutsche Bank and of First Boston by Credit Suisse.

c) Globalization With the increase in cross-border business activity and deals, I-banks are aggressively seeking partners or acquisitions to strengthen their global presence.

d) Increase in Asset Management business Since asset management services are believed to provide a steadier revenue stream compared to the cyclical revenues from IPOs and sales commissions, firms like Goldman Sachs and Societe Generale are significantly stepping up their investments in asset management activities.

10. Future Scenario

10.1 Projected Trends

a) Growth rate prediction The industry growth rate of 0% per annum in the late 10s is believed to have been driven by extraordinary factors like the over-estimation of the potential of the Technology, Media and Telecommunications (TMT) sector (Exhibit 1). Having hit its lowest point in late 00-early 00, the industry is expected to grow at a moderate rate of 5-10%, which means that the industry will reach its 1 level earnings only by 005 (Exhibit ).

b) Convergence of Investment and Commercial banking Given the falling market shares of mono-line investment banks (Exhibit 7), I-banks are expected to consolidate financial services further to stabilize revenues and establish a strong global market presence.

c) Changes in the regulatory framework Reforms are expected in the near future to ensure the separation of equity research and investment banking, to examine the treatment given to the IPO process and to challenge the relationship between corporate lending and investment banking to ensure that inappropriate linkages do not exist between these two key sources of capital. The strengthening of regulatory oversight and corporate governance will benefit the industry over the long term as the efficiency and fairness of the capital markets are improved.

d) Short-term outlook Owing to tough market conditions and increased competition in the limited banking business, I-banks may face further pressure for cost, compensation and headcount reduction. A reduced inclination to take business risks will lead to a shift to more conservative business strategies, fewer complex deals, and, in some cases, to the unwinding of highly diversified business models in favor of a more focused, specialized approach.

e) Long-term outlook Considering certain positive structural trends in the world economy like increasing productivity, privatization of state-owned enterprises, institutionalization of savings and reforms towards liberalization, I-banks, particularly the bulge bracket firms are expected to recover quickly from the current major shocks. Further consolidation and internalization may force the exit of marginal players.

The critical success factors for a firm in the long-term would be its ability to serve increasingly global clients, use technology to design customized service offerings, focus on core products in selected geographical markets and leverage on a world-class reputation.

f) Potential Threats The economy could be pushed back into a recession if a negative scenario like a lack of the required global support for economic recovery, faltering of consumer spending or an escalation of the Middle East conflict was to materialize. In such an event, the banking industry could be pushed into severe losses.

g) New Opportunities The emerging markets in Asia-Pacific and Russia are expected to offer attractive opportunities to the major players.

10. Emerging Challenges

• Restoring public confidence Investment banks will need to adhere to ethical business practices and ensure greater transparency and information disclosure to regain the public confidence lost owing to the recent accounting scandals, bankruptcies and regulatory investigations of I-banking practices.

• Compliance with increased regulation The regulatory pressure to separate research from the investment banking department and the increased scrutiny will increase compliance costs besides posing functional challenges for I-banks. This will force firms to restrict their research budgets.

• Change in product design In the light of the heightened awareness of risk owing to the recent business cycles, firms would need to alter their risk management practices in terms of evaluation and pricing of risks besides designing strategies that mitigate risk-taking.

Thus, while the direction of the global economy would decide the future of the investment banking industry, the future of a firm will largely depend on its characteristics its ability to effectively respond to both the complex challenges as well as exciting opportunities generated by dynamic market conditions

Exhibit 1

U.S./Europe Wholesale Banking Revenues

- M&A, New Issues and Equity Trading

(Revenue figures in billion $)

Source Swiss-American Chamber of Commerce, Developments in the Global Investment Banking Industry, October, 00


Company-wise Industry Performance in 00

Company 00 revenues

($ million) % change from 001

JP Morgan Chase 50,4 -16

Morgan Stanley 4,77 -4

Merrill Lynch 8,7 -14

Goldman Sachs Group 1,18 -6

Citigroup/Salomon SB 7,74 -11

Lehman Brothers , -15

UBS Warburg 1,760 5

Bear sterns 8,701 -15

Credit Suisse First Boston 7,548 4

RBC Dain Rauscher 1,181 16

Total 4,04

Source Wetfeet Insider Guide (00), Careers in Investment Banking, Wetfeet Inc., San Francisco


Projected Global Wholesale Revenues

For 10 Largest Investment Banks

(Revenue figures in billion $)

Source Swiss-American Chamber of Commerce, Developments in the Global Investment Banking Industry, October, 00

Exhibit 4

Individual Industry Rankings (00 Q1-Q)

Area Global Debt and Underwriting

Company Q1-Q 00 ($ billion)

CitiGroup/Salomon SB 44.8

Merrill Lynch 17

JP Morgan Chase 18.

Credit Suisse First Boston (CFSB) 175.4

Morgan Stanley 15.5

Area Global IPO Underwriting

Company Q1-Q 00 ($ billion)

CitiGroup/Salomon SB 7.7

Credit Suisse First Boston (CFSB)

Merrill Lynch .

Morgan Stanley 1.8

Deutsche Bank 1.7

Area Worldwide completed mergers and acquisitions advisory

Company Q1-Q 00 ($ billion)

Goldman Sachs 170.

Morgan Stanley 145.

Merrill Lynch 11.8

Credit Suisse First Boston (CFSB) 111.5

CitiGroup/Salomon SB 10.1

Area Overall Global Research Strength

Company Total Position

UBS Warburg

Merrill Lynch 1

Credit Suisse First Boston (CFSB) 18

Goldman Sachs 18

Morgan Stanley 18

Source Wetfeet Insider Guide (00), Careers in Investment Banking, Wetfeet Inc., San Francisco

Exhibit 5

Skills Needed to Succeed in Investment banking

Skill Level of Requirement

People skills High

Sales skills Medium

Communication skills High

Analytical skills Extremely High

Ability to synthesize High

Creative ability High

Initiative Medium

Work hours 60 �100 /week

Source www.wetfeet.com

Exhibit 6

Porter’s Five-Force Model

Source Kotler, Philips, Marketing Management, pp 14

Exhibit 7

Global Market Shares of Mono-line Investment Banks

Source Swiss-American Chamber of Commerce, Developments in the Global Investment Banking Industry, October, 00


Articles on Internet

Can wit outwit the competition? (July 1), BusinessWeek Online, Retrieved February 14, 00 from http//www.businessweek.com/1/_/b68177.htm

Careers in Investment Banking, Retrieved on February 14, 00 from http//www.campusaccess.com/campus_web/career/c4job_inv.htm

Hillebrand M. (October 00), Morgan Stanley online operations get facelift E-Commerce Times, Retrieved February 14, 00 from http//www.ecommercetimes.com/perl/story/154.html

Lacy S. (November, 001), Investment Banking Firms make quiet cuts, Silicon Valley San Jose Business Journal. Retrieved February 14, 00 from http//sanjose.bizjournals.com/sanjose/stories/ 001/1/0/story4.html

Stein B., Oakley D., (00), State of the Industry Where do we go from here?, Retrieved February 14, 00 from http//www.ey.com/GLOBAL/content.nsf


Freeman and Company Research Report (February 00), Investment Banking Back to Basics in the Future, Freeman and Company, New York

Freeman and Company Research Report (October 00), Investment Banking State of Investment Banking 00 and beyond, Freeman and Company, New York

Mack J. J. (October, 00), Developments in the Global Investment Banking Industry, Swiss-American Chamber of Commerce, Zurich

Megginson W. L. (1), The International Investment Banking Industry, Swiss Banking Institute, Zurich

The state of the US Investment Banking and Securities Industry, July 000, KPMG.

The Banker, Top 1000 World Banks, July 000.

Wetfeet Insider Guide (00), Careers in Investment Banking, Wetfeet Inc., San Francisco

Valance Nikos, Choosing an investment banker is no longer a limited proposition, US Banker, Dec.000.


Foster, G. Fidelity and Lehman in Deal on Broad Range of Services, The New York Times, June , 1. - pp.

Very, P; and Schweiger, D.M., “The Acquisition as a Learning Process”, Journal of World Business, 6,1, (Spring 001), pp 11-1.


Brealey, Richard and Myers, Stewart C., Principles of Corporate Finance. New Delhi Tata McGraw Hill, 000. pp 5-70

Kotler, Philip, A Framework for Marketing Management, Delhi Pearson Education (Singapore) Pvt. Ltd., 00, pp 14

Brown L., Goldman Sachs The Culture of Success, New York, McGraw Hill, 1, pp 1-78

Eccles, Robert and Crane, Dwight B., Doing Deals Investment Banks at Work, New York Harvard University Press, 18, pp 16-46

Marshall, John and Casey, Frederick B., Investment Banking and Brokerage The New Rules of the Game. London Probus Publishing Company, 1, pp 0-8

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