Transcript Saunders Cornett Chapter 4

Chapter 4
Securities Firms
and Investment
Banks
K. R. Stanton
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Overview
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In this segment ... Securities Firms and
Investment Banks:
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Activities of securities firms and investment
banks
Size, structure and composition
Balance sheets and recent trends
Regulation of securities firms and investment
banks
Global issues
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Securities Firms &Investment Banks
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Nature of business:
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Underwrite securities.
Market making.
Advising (example: M&A, restructurings).
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Securities Firms &Investment Banks
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Growth in domestic M&A:
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Less than $200 billion in 1990.
$1.83 trillion in 2000
In US: bottomed out at $458 billion in 2002
($1.2 trillion worldwide)
$525 billion 2003 ($535 trillion worldwide)
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The Largest M&A Transactions
Deal
Price (billions) Year
Citicorp/Travelers
$83.0
1998
BOA/Fleet Boston
49.3
2003
J.P. Morgan/Bank One
60.0
2004
Chase/J.P. Morgan
35.0
2000
UBS/Paine Webber
12.0
2000
CSFB/DLJ
11.5
2000
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Size, Structure and Composition
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Dramatic increase in number of firms from 1980 to
1987. Decline of 31% following the 1987 crash, to
year 2003.
1987: Salomon Brothers held $3.21 billion in
capital.
2003: Merrill Lynch held capital of $24.8 billion.
Many recent inter-industry mergers (i.e., insurance
companies and investment banks).

Role of Financial Services Modernization Act, 1999
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Types and Relative Sizes of Firms
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National full-line firms are largest.
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Merrill Lynch, Morgan Stanley
National full-line firms specializing in corporate
finance are second in size.
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Goldman Sachs, Salomon Brothers/Smith Barney
Remainder of industry:
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Specialized investment subsidiaries of BHCs.
Discount brokers.
Regional securities firms (subdivided into large, medium
and small).
Specialized electronic trading securities firms
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Top U.S.Underwriters, 2003
Manager
SSB
Amount
(Billions)
$542.8
Market Share
10.2%
Morgan Stanley
394.8
7.4
Merrill Lynch
380.3
7.1
Lehman Bros.
354.1
6.7
JPM Chase
353.9
6.6
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Key Activities
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Investing
 Investment banking
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Market making
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Activities related to underwriting and
distributing new issues of debt and equity.
Increasing importance of online trading
Trading
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Position trading, pure arbitrage, risk arbitrage,
program trading
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Key Activities (continued)
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Cash management
 Assisting with M&A
 Back-office and service functions.
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Trends
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Decline in trading volume and brokerage
commissions
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particularly since crash of 1987, although some
recovery since 1992. Record volumes 19952000.
Declines in market values--and commission
income 2001-2002
 Resurgence in market values and
commissions 2003-2004.
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Trends (continued)
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Pretax net income over $9 billion per year
1997-2000
 Pretax profits soared to $21.0 billion in 2000
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curtailed by economic slowdown and
September 11 attacks 2001.
2003 record pre-tax profits of $22.5 billion.
 Continuing concerns over conflicts of
interest and other ethical concerns
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Soft dollars
Analysts’ recommendations to buy or hold
collapsing technology stocks
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Balance Sheet
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Key assets:
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Long positions in securities and commodities.
Reverse repurchase agreements.
Key liabilities:
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Repurchase agreements major source of funds.
Securities and commodities sold short.
Broker call loans from banks
Capital levels much lower than levels in
banks
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Regulation
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Primary regulator: SEC
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Reiterated by National Securities Markets
Improvement Act (NSMIA) of 1996.
Prior to NSMIA, regulated by SEC and states.
Regulate trading activities such as shelf
registration
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Regulation
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Early 2000s erosion of SEC dominance
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Increased vigilance by State Attorneys General
Spring 2003, $1.4 billion in penalties over
investor abuses.
Sarbanes-Oxley Act of 2002
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Independent auditing oversight board under
SEC
Instigated by Enron, Global Crossings, Tyco,
WorldCom
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Regulation (continued)
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Day-to-day regulation: NYSE, NASD
 October 2003 implementation of provisions
of Patriot Act to combat money laundering
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Scrutiny of individual identities and affiliations
with terrorists
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Investor Protection & Other Monitoring
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Securities Investors Protection Corporation
(SIPC).
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Protection level of $500,000
Federal Reserve also has role in overseeing
securities firms and investment banks
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Vulnerability of the financial system
Issue of timely settlement raised by Greenspan
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Web Resources
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For details of regulation of securities firms
and investment banks, visit:
SEC: www.sec.gov
NYSE: www.nyse.com
NASD: www.nasd.com
SIPC: www.sipc.org
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Global Issues
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Global nature of securities firms
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Demonstrated by recent mergers such as
Deutsche Bank/Bankers Trust
Dominance of UBS in U.S. mortgage backed
securities markets
Growth in securities trading and
underwriting is a global event
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Pertinent Websites
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Federal Reserve: www.federalreserve.gov
NASD: www.nasd.com
NYSE: www.nyse.com
SEC: www.sec.gov
Securities Industry Association: www.sia.com
SIPC: www.sipc.org
The Banker: www.thebanker.com
Thompson Fin. Securities Data: www.tfibcm.com
Wall Street Journal www.wsj.com
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