Investment Banking

Institute of Business Administration

Class 01

21 January, 2017
I sincerely believe that banking establishments are more dangerous than standing
armies, and that the principle of spending money to be paid by posterity, under the
name of funding, is but swindling futurity on a large scale.
Thomas Jefferson

"The banking business is no favorite of ours. When assets are twenty times equity
-- a common ratio in this industry -- mistakes that involve only a small portion of
assets can destroy a major portion of equity. And mistakes have been the rule
rather than the exception at many major banks." -- Warren Buffett, chairman and
CEO of Berkshire Hathaway

A bank is a place that will lend you money if you can prove you don't need it.
Bob Hope
What should you expect to learn from this course
What is investment banking

How does IB add value for its customers, employees, sponsors, etc.

Synergies and conflicts in IB

IB in offshore markets

IB in Pakistan

Equities

Debt / Fixed Income

Trading / Derivatives

Mergers and Acquisitions

Wealth Management
What is Investment Banking
Investopedia.com:
Investment banking is a specific division of banking related to the creation
of capital for other companies, governments and other entities. Investment
banks underwrite new debt and equity securities for all types of
corporations, aid in the sale of securities, and help to facilitate mergers and
acquisitions, reorganizations and broker trades for both institutions and
private investors. Investment banks also provide guidance to issuers
regarding the issue and placement of stock.

Our definition: Investment banks help individuals and companies in:

Raising capital via equity or debt instruments
Trading of securities through sales and trading desks
Investments through Equity Research, HY Research, Wealth Management
Mergers and Acquisitions by providing valuation advisory services
Underwriting or arrangement of underwriters for issue of new securities
Reorganization through financial advisory services

Investment Banks need to be regulated

Types of Investment Banks
Full Service Provide complete suite of investment banking products:
Underwriting
Trading
Merger and acquisition
Research
Investment management
Security services
Merchant banking = Invest in companies + advisory

Boutique Niche approach with focus only on:

M&A
Financial institutions
Industry, e.g. TMT, healthcare, biotech, etc.
Emerging markets
Any single country
Region
Raising Capital Via Equity or Debt Instruments
Equity Instruments
IPO or secondary offering of Common Stock
IPO or secondary offering of Preferred Stock
Private equity investment in common or preferred stock
Participatory Term Certificates

Debt Instruments
Loans from banks and other financial institutions
Bonds (144A or Reg S)
Term Finance Certificates (Listed or Privately Placed)
Sukuks
Sales & Trading
Definition: Involves buying and selling of securities or other financial
instruments on behalf of clients or for own portfolio of investments.

Key tool to service clients

Key source of base line revenue for an investment bank

Traders and sales staff rely on the input from research to service clients

The sales and trading desk serves as the market maker for supporting IPOs
originated by an Investment Bank

Key focus is to get the lowest price while buying for its clients and give the best
perspective on investment

Conflict of interest arises where investment bank is also invested in the same
securities as the client. Which one should the trader sell or buy first. Own
portfolio or that of clients?
Equity Research
Definition: Make Buy or Sell recommendation on a stock on the basis of
valuation analysis that involves financial forecasting, ratio analysis and scenario
analysis

Target audience for the research are investors who look for most updated
analysis on the basis of latest information available in the market

Various valuation methods are used for forecasting the value of stocks:
Intrinsic value: DCF, FCFF, FCFE
Comparables: Multiples, P/E, P/B, P/S

Analysts usually specialize in industries they cover, e.g. Oil & gas, cement,
fertilizer, energy, etc.

Research is published at initiation of a companys coverage and the on every

major news event, especially upon every quarterly and annual results

Analysts carry professional and personal responsibilities to be ethical at all times

to not use insider information and not to do front running.
High Yield / Fixed Income Research
Definition: Analysis of fixed income securities including regular bonds as well as
high yield (junk) bonds where the value of the bond is determined based on the
capital structure of a company

Target audience is bond holders and fixed income investment funds. These
include hedge funds as well.

Valuation method of bonds includes ratings analysis, capital structure analysis,

credit/risk analysis and a view on the repayment history of the issuing company

High Yield / junk bonds usually involve companies that are near bankruptcy.
Bonds of these companies trade at a discount to the par value.
Why do people buy bonds they think are going to default?

HY Research is mostly done by large bulge bracket investment banks

Bonds that have ratings lower than BBB- by S&P or lower than Baa3 by Moodys
are considered high yield or junk
Wealth Management
Definition: Professional service to high net-worth individuals involving financial
planning , investment advice, accounting and tax services, retirement planning,
investment management, etc.

Wealth managers charge fees for their advice, which is a % of the assets being
management

Investors must qualify with a minimum amount of net worth, which amount
varies by firm

Planning usually includes saving for retirement, saving for mortgage, saving for
education, etc.

Best wealth managers should be completely objective and should not earn any
hidden fees from third party that can influence their advice

Wealth managers mostly focus on diversification of investments by any single

client. Diversification can be into equities, fixed income, etc.
Regulations and Regulators
International mainly originating from the USA
Glass-Steagall Act of 1933: Separate banks from securities companies
Gramm-Leach-Bliley Act of 1999 (GLB): Allowed banks to engage in
investment banking activities
Securities and Exchange Commission
Federal Reserve System

Local in Pakistan
Companies Ordinance
SECP Securities and Exchange Commission of Pakistan
PSX Pakistan Stock Exchange
SBP State Bank of Pakistan
CCoP Competition Commission of Pakistan
OGRA Oil and Gas Regulatory Authority
NEPRA National Electric Power Regulatory Authority
NHA National Highway Authority
PTA Pakistan Telecommunication Authority
CAA Civil Aviation Authority
PPRA Public Procurement Regulatory Authority
The Subprime Crisis
Bird and Fortune Subprime crisis
Mergers & Acquisitions (M&A)
Definition: This area of investment banking deals with buying and selling of
companies resulting in mergers of equal size companies or acquisition of one
company by the other.

Valuation: Valuation is the key to M&A activity where the main focus of the job
to determine the price at which one company should buy the shares of the
other company.

Various forms of M&A

Merger: Faysal Bank and RBS Pakistan merged
Acquisition : OBS acquired Ali Gauhar Pharma
Consolidation: New company is formed by merging two companies
Tender offer: One company announces the offer to purchase the shares of
another at a specific price
Acquisition of Assets: HSBC consumer portfolio was purchased by HBL
Management Acquisition: Engro Fertilizer

Key motivations leading to M&A activity include product suite enhancement,

cost savings through synergies, regional growth, market share, etc.
Venture Capital & Private Equity
Definition: These are two forms of equity investment where the capital invested
is not listed on the stock exchange until a later date. Venture Capital investment
is a form of private equity investment in very early stage companies.

Some famous private equity funds include:

Blackstone Group
Kohlberg Kravis Roberts
The Carlyle Group
Bain Capital
Oaktree Capital Management

Four stages of VC fund cycle:

Fundraising (1 2 years)
Investment (3 7 years)
Growth of portfolio companies
Closing via liquidation (IPO, sale or bankruptcy)

Private equity investors seek board seats in their invested companies in order to
manage them more closely compared to equity investor in the stock market
Underwriting
Definition: When an issuer of debt or equity gets a guarantee from an
underwriter to take up the portion of the Initial Public Offering or Secondary
Public Offering that remains unsubscribed.

Underwriters take on the most risk in the issuance of a new security and get
compensated for it through fees

If the underwriter is a bank then it has to sell off its take in the underwritten
amount within a few months of the take up date. This increases the risk of loss
in case the price of the stock does not rise above the take-up price within the
stipulated time

Similar rules apply for underwriting of equity and debt instruments

Underwriting in Pakistan is governed by Securities and Exchange Commission

Underwriting Rules 2015:
Underwriters have to first register with the SECP
Criteria: Banks, DFIs, Housing or Investment Finance Company, Leasing
Company, or Corporate Brokerage House
Reorganization and Restructuring
Definition: The process of reviving a company that is in financial distress. This
may involve fresh capital injection, negotiation of repayment terms with the
lenders, bankruptcy protection (Chapter 11 not available in Pakistan), sale of
certain assets, etc.

The process usually starts when a company misses or is about to miss its
scheduled repayment for a loan or a bond

Creditors first try to negotiate the repayment terms directly with the client
depending on the reduced ability of the client

In case the client does not agree to repayment terms then courts are asked to
intervene under Section 284 of the Companies Ordinance 1984. As per Section
284, 75% or more of the creditors can agree on a scheme of arrangement and
have it enforced through the court and all other remaining creditors will have to
agree to the same

In the USA, Chapter 11, Chapter 7 and Chapter 13 are commonly used for
reorganization of companies
Asset Backed Securitization
Definition: Sale of future cash flows at a discounted value to raise upfront cash.

Usually a Special Purpose Vehicle (SPV) is created to facilitate the transaction.

The SPV purchases future cash flows from the issuer and raises funds against
these future receivables. The funds raised are paid to the issuer as the
consideration for the purchase.

Securitization transactions are covered under:

The Companies Ordinance, 1984
The Companies (Asset Backed Securitisation) Rules, 1999
The Transfer of Property Act
The Stamp Act
The Income Tax Ordinance; and
State Bank of Pakistan Rules (BPD Circular 31)
Asset Backed
Sale of Assets Security
Originator /
SPV Investor
Issuer Proceeds Proceeds
Thank you