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Page 1: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

Securities Firms Securities Firms and Investment and Investment

BanksBanks

Chapter 4

© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.McGraw-Hill/Irwin

Page 2: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

-24-2

Overview

In this segment ... Securities 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

Page 3: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

-34-3Securities Firms &Investment Banks

Nature of business: Underwrite securities. Market making. Advising (example: M&A, restructurings).

Page 4: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

-44-4

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) $1.3 trillion 2006 ($2.9 trillion worldwide)

Page 5: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

-54-5

Mergers and acquisitions 1990-2006

Page 6: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

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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

BOA/MBNA 35.0 2005

Wachovia/Golden West 25.5 2006

Page 7: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

-74-7

Size, Structure and 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. Many recent inter-industry mergers (i.e., insurance

companies and investment banks). Role of Financial Services Modernization Act, 1999

Page 8: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

-84-8Types and Relative Sizes of Firms

National full-line firms are largest. Merrill Lynch, Morgan Stanley

National full-line firms specializing in corporate finance are second in size.

Goldman Sachs, Salomon Brothers/Smith Barney Remainder of industry:

Specialized investment subsidiaries of BHCs. Discount brokers. Regional securities firms (subdivided into large, medium

and small). Specialized electronic trading securities firms

Page 9: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

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Top U.S.Underwriters, 2006

Manager Amount (Billions)

Market Share

SSB $668.8 8.7%

J.P. Morgan 506.1 6.6

Deutsche Bank 475.0 6.2

Morgan Stanley

454.6 6.0

Lehman Bros. 446.5 5.8

Page 10: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

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Key Activities

Investing Investment banking

Activities related to underwriting and distributing new issues of debt and equity.

Market making Increasing importance of online trading

Technology risk Decimalization

Trading Position trading, pure arbitrage, risk arbitrage,

program trading

Page 11: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

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Key Activities (continued)

Cash managementAssisting with M&ABack-office and service functions.

Page 12: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

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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.

Page 13: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

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Trends (continued)

Pretax net income over $9 billion per year 1997-2000

Pretax profits soared to $21.0 billion in 2000 curtailed by economic slowdown and

September 11 attacks 2001. 2003 record pre-tax profits of $24.1 billion. Continuing worries over investor confidence

Page 14: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

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Balance Sheet

Key assets: Long positions in securities and commodities. Reverse repurchase agreements.

Key liabilities: Repurchase agreements major source of funds. Securities and commodities sold short. Broker call loans from banks

Capital levels much lower than levels in banks

Page 15: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

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Regulation

Primary regulator: SEC 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

Page 16: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

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Regulation

Early 2000s erosion of SEC dominance Increased vigilance by State Attorneys General Spring 2003, $1.4 billion in penalties over

investor abuses. Sarbanes-Oxley Act of 2002

Independent auditing oversight board under SEC

Instigated by Enron, Global Crossings, Tyco, WorldCom

Page 17: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

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Regulation (continued)

Day-to-day regulation: NYSE, NASD October 2003 implementation of provisions

of Patriot Act to combat money laundering Scrutiny of individual identities and affiliations

with terrorists

Page 18: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

-184-18Investor Protection & Other Monitoring

Securities Investors Protection Corporation (SIPC). Protection level of $500,000

Federal Reserve also has role in overseeing securities firms and investment banks Vulnerability of the financial system Issue of timely settlement raised by Greenspan

Page 19: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

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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

Page 20: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

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Global Issues

Global nature of securities firms Demonstrated by recent mergers such as

Deutsche Bank/Bankers Trust Dominance of Royal Bank of Scotland in U.S.

mortgage backed securities markets Growth in securities trading and

underwriting is a global event US accounting standards issues Depreciation of the dollar against the yen

and the euro

Page 21: Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

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Pertinent Websites

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.thomson.com

Wall Street Journal www.wsj.com


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