Transcript Chapter 2

CHAPTER 4
Financial Services: Securities Brokerage and Investment Banking
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All Rights Reserved.
Overview
 This chapter discusses securities
brokerage firms and investment banks
– 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
4-2
Securities Firms & Investment Banks
 Nature of business
– Underwrite securities
– Market making
– Advising (example: M&A, restructurings)
4-3
Securities Firms & Investment Banks
 Growth in domestic M&A:
– Less than $200 billion in 1990
– $1.83 trillion in 2000
– In US: bottomed out at $458 billion in 2002
($1.2 trillion worldwide)
– Topped $1.7 trillion 2007 ($4.5 trillion
worldwide)
– Effects of financial crisis: fell to $808 billion
in 2009 ($1.7 trillion worldwide)
 Worst financial crisis since 1930s, but M&A
activity still greater than early 2000s
4-4
Mergers and Acquisitions, 1990-2009
4-5
Structural Changes in Recent Years
 Acquisition of Bear Stearns by J.P.
Morgan Chase
 Bankruptcy of Lehman Brothers
 Acquisition of Merrill Lynch by Bank of
America
 Only two remaining major firms:
– Goldman Sachs and Morgan Stanley
 Converted to commercial bank holding
companies in 2008
4-6
Largest M&A Transactions
4-7
Size, Structure & Composition
 Dramatic increase in number of firms from
1980 to 1987; Decline of 37% following the
1987 crash, to year 2006
 1987: Salomon Brothers held $3.21 billion in
capital
 2006: Merrill Lynch held capital of $35.5 billion
4-8
Size, Structure & Composition
 Many recent inter-industry mergers (i.e.,
insurance companies and investment
banks)
– Role of Financial Services Modernization Act,
1999
 Lehman Brothers, Bear Stearns, Merrill
Lynch, Goldman Sachs, and Morgan
Stanley gone by end of 2008
4-9
Types & Relative Sizes of Firms
 National full-line firms are largest
– BOA (via acquisition of Merrill Lynch) Morgan
Stanley
 National full-line firms specializing in
corporate finance are second in size
– Goldman Sachs, Salomon Brothers/Smith Barney
(Citigroup)
4-10
Types & Relative Sizes of Firms
 Remainder of industry:
– Large investment banks (Lazard Ltd. And
Greenhill & Co.)
– Regional securities firms (subdivided into large,
medium and small)
– Specialized discount brokers, electronic trading
firms, venture capital firms, and other firms
4-11
Top Bank Holding Companies 2009
(by brokerage fee income)
4-12
Key Activities
 Investing
 Investment banking
– Activities related to underwriting and
distributing new (IPOs) and secondary
(seasoned) issues of debt and equity
 Public offerings & private placements
 Market making
– Increasing importance of online trading
 Technology risk
– Decimalization
4-13
Activities (continued)
 Trading
– Position trading, pure arbitrage, risk
arbitrage, program trading
 Cash management
 Assisting with M&A
 Back-office and service
functions
4-14
Recent Trends
 Decline in trading volume and
brokerage commissions
– Particularly since crash of 1987, although
some recovery since 1992; Record
volumes 1995-2000
 Declines in market values--and
commission income 2001-2002
 Resurgence in market values and
commissions during mid-2000s
 New lows in 2008
4-15
Trends (continued)
 Pretax net income over $9 billion per
year 1996-2000
 Pretax profits soared to $21.0 billion in
2000
– Curtailed by economic slowdown and
September 11 attacks 2001
 Worries over securities law violations
and investor confidence
 Financial crisis, 2008
 Profits recovered, 2009
4-16
Securities Industry Pretax Profits, 1990-2009
4-17
Balance Sheet
 Key assets:
– Long positions in securities and commodities
– Reverse repurchase agreements
– Implications: Market, interest rate & F/X risks
 Key liabilities:
– Repurchase agreements major source of
funds
– Securities and commodities sold short
– Broker call loans from banks
 Capital levels much lower than in banks
4-18
Regulation
 Primary regulator: SEC
– Reiterated by National Securities Markets
Improvement Act (NSMIA) of 1996
– Prior to NSMIA, regulated by SEC and states
4-19
Regulation
 Early 2000s erosion of SEC dominance
– Increased vigilance by State Attorneys
General
 Criminal cases brought mainly by states
against securities law violators
∙ New York State vs. Merrill Lynch
 Spring 2003, $1.4 billion in penalties over
investor abuses
 New rules brought by SEC for greater
disclosure by analysts of potential conflicts of
interest
4-20
Regulation (continued)
 Sarbanes-Oxley Act of 2002
– Independent auditing oversight board
under SEC
– Instigated by Enron, Global Crossings,
Tyco, WorldCom
4-21
Regulation (continued)
 SEC sets regulatory standards
– Day-to-day regulation: Financial Industry
Regulatory Authority (FINRA)
 Example: Floor trader at Fleet specialist fined
$25,000 for mishandling customer orders
(10,000 shares of GM sold from Fleet’s account
on rumors of problems at GM)
4-22
Extension of Oversight
 Additional oversight from US Congress
– Hearings focused on role of investment
banks in the financial crisis
 Goldman Sachs bundling of toxic assets
4-23
Extension of Oversight
 2010 Financial Services Regulatory
Overhaul Bill
– Financial Services Oversight Council
– New authority for Federal Reserve to
oversee payment, clearing, and
settlement systems
 Executive compensation in the
financial crisis culminated in “pay
czar” (Feinberg)
4-24
Investor Protection & Other Monitoring
 Securities Investors Protection
Corporation (SIPC)
– Protection level of $500,000
 October 2003 implementation of
provisions of Patriot Act to combat
money laundering
– Scrutiny of individual identities and
affiliations with terrorists
4-25
Web Resources
 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
4-26
Global Issues
 Global nature of securities firms
– Competition between US and European
firms
– Foreign investors’ transactions in US
securities and US investors’ transactions in
foreign securities exchanges increased
– Global concern about capital, liquidity
and leverage following the financial crisis
 Implications for global competitiveness
∙ Strategic alliances
∙ Exits from foreign markets
4-27
Pertinent Websites
Federal Reserve
NASD
NYSE
SEC
Securities Industry
Association
SIPC
www.federalreserve.gov
www.nasd.com
www.nyse.com
www.sec.gov
www.sia.com
www.sipc.org
4-28