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Investment Banking Articles

Posted: January 31st, 2020, 4:11 pm
by MBACrystalBall

What is Investment Banking?

Posted: January 31st, 2020, 4:23 pm
by MBACrystalBall
Investment Banking is a field that generates a lot of interest, but for most outsiders, it is also shrouded in mystery. The conventional image of an Ibanker is a young, ambitious guy in a pin-striped designer suit puffing on a Cuban cigar after closing a deal.

But not all investment bankers spend 100-hour weeks chasing money. There are also quite a few kind-hearted ones who want to help others understand this esoteric field.

We discovered one such exceptional star to help us make sense of an opaque and largely misunderstood industry. He prefers to stay behind the scenes, so we’ll just call him ‘MCB I-Banker’ (‘MIB’ has a familiar ring to it).

He is completing his MBA from an elite university. He spent the past three years in the Indian investment banking industry and has worked on deal volume in excess of Rs. 50,000 million. MIB is also a power & green energy infrastructure finance specialist.

Most of the websites and blogs with good I-banking related content focus on the US investment banking industry. So we thought it might be a good idea to launch our own desi I-banking Overview series where we try to retain a balance between domestic and international flavour. MIB kick-starts his Investment Banking 101 Series with the basics. So grab a coffee and join us on the journey.

What is Investment Banking?
by MIB

Unlike commercial banking (what we’re so accustomed to referring to as banking here in India), Investment Banking is a concerted effort to connect the capital markets with firms that need the money.

The capital markets take the form of investors in debt (such as banks who give firms loans) and equities (such as private equity players) and publicly traded equity markets (primary – IPOs and secondary – trading in the stock exchanges).

Investment Banks also advise clients on strategic acquisitions, divestments and restructurings that are connected with enhancements to firms’ balance sheets (if you don’t understand some of this – don’t worry, I will get into this in more detail later in the series).

Thus, investment banks play the role of an advisor and arranger, helping to bring firms an ability to do better by accessing capital and financial advice.

Business Model: Fee-based structure. Fees are paid based on success milestones

On the other hand, Commercial Banking is the process by which firms (banks) take deposits from the public and lend it to various classes of borrowers.

Some of these borrowers could be personal loans, house loans, loans to companies directly, loans to companies on a syndicated [See footnote 1] basis, etc. To put it concisely, commercial banks lend from their own balance sheet.

Business Model: Money that the bank has lent generates interest which counts as revenue for the bank

Investment banking as an industry developed in the United States and as of today, can still be referred to as a US industry.

You can typically infer the stage of development of an industry by looking at the levels of regulation that it is subject to (seems like a backward way to look at it, but it’s a great rule of thumb).

Banking in the US is well-regulated and a tremendously organized activity -you need a license to be an investment banker as well as to operate an investment bank, amongst a whole host of other activities that you need regulatory approval for.

So what does the scenario look like for the major financial centers across the world? Well, here’s a quick breakdown:

London: is seeing an exodus of bankers to New York and Hong Kong. Apparently, excessive government regulation is pushing bankers to move to locales where their compensation could be more directly proportional to the money they bring in to the bank and not limited by some arbitrary cap imposed by the government.

EMEA (excl. London): I don’t know what is happening in the Europe & Middle-East & Africa with regard to finance – but I cannot imagine that it amounts to very much in comparison to NY.

Toronto: The financial district of Toronto houses Canadian banking giants such as CIBC, RBC, as well as probably ever other banking mega-entity you can think of. However, the investment banking market still lacks the complexity and diversity in product that New York is so famous for.

Hong Kong: Poised to be the capital market of choice for Chinese companies. The Hong Kong stock exchange, for example, has stolen the march from the Singaporean stock exchange (prompting the latter to seek top-line growth by trying to buy the Australian stock exchange – a deal which was doomed due to the protectionist tendencies of the Aussies). With things going as they are, you can count on this destination to be the next most exciting financial location to be in after NYC.

Mumbai: Extremely shallow (low liquidity and a small number of participants) investment banking market with comparatively shallow capital market access. Financially insulated from the rest of the world (which also helped protect us from the recent sub-prime melt-down), Mumbai is developing as an investment banking location, but very slowly.

[Note 1] This is when banks get together to fund a single company. Unlike regular single-bank lending, here the loan is shared because either the loan amount is too high and / or the risk is too high for any single bank

Investment Banking: Coverage

Posted: January 31st, 2020, 4:27 pm
by MBACrystalBall
If you are trying to find out how to get an investment banking job, your best bet is to first understand the basics.

What is investment banking? What do Ibankers do? Why is Ibanking such a hot post-MBA destination? Which fairness cream do investment bankers use?

Our resident MCB Investment Banker or MIB as we call him started a series to explain just that. His first post (‘What is Ibanking‘) set the ball rolling. If you missed it, read that first before you continue with this next article in our Investment Banking 101 Series.

Investment Banking: Coverage
by MIB


In this article, I shall explore the offerings of a developed investment bank and then draw parallels with Indian investment banks. This should help you understand what bankers do and how to position yourself better for recruiting at an investment bank.

As a recap: Investment Banks work to allow firms access to the capital markets. They do this by helping firms raise equity or debt (or variants of equity or debt) or by advising them on strategic financial decisions (such as mergers, acquisitions, et al).

Investment banks aim to provide the best possible advice to their clientele. This ensures that the client is able to gain maximum value from the transaction as well as turn into a recurring business relationship for the bank. Since clients stem from a vast variety of industries, it is practically impossible to be an expert in each and every one of these industries.

Being the ‘jack-of-all-trades’ will do a bank no good because they deal with very savvy C-suite executives who will not tolerate the banker running a ‘trial & error’ operation at the client’s expense. Therefore, banks have developed ‘Coverage’ groups.

The coverage group focuses on a sector or a group of allied sectors and develops and expertise in them.

It is the coverage group’s responsibility to know, understand and be the authority on that sector in a bank. Typical coverage groups are:

Industrials: Cover manufacturing, may also cover aeronauticals, chemicals, etc

Power / Energy / Utilities / Natural Resources: Called different names, these groups typically look at power generation, distribution and energy sources (may include renewables also)

Real Estate: Cover broad real estate trends and events

Technology, Media & Telecom (TMT): May operate as one group (in the case of Goldman Sachs), or several; TMT covers, well, Tech, Media & Telecom

… and a whole lot of other groups, depending on the bank.

Coverage bankers, therefore, can be looked at as sectoral experts. They bring their sector-specific expertise to the bank and its clients in various transactions.

Apart from this coverage bankers are also involved in ‘pitching’. Pitching is the process of carefully analyzing a firm and understanding how an investment banking transaction could bring value to the firm’s activities.

A typical example of such an investment banking process would be an M&A process, where clients may not be sophisticated enough to be able to calculate the financial impact of a prospective acquisition.

Another investment banking transaction that bankers may pitch is an IPO to a firm that seems like it would be able to access good value given the condition of the capital markets.

Apart from being sectoral experts, bankers in the coverage section of the investment bank typically are one of the most qualified people to build financial models for firms in the industry due to their deep understanding of industry benchmarks, production ratios as well as growth cycles and expectations.

All of this knowledge translates to a better understanding of their client – which in turn helps them pitch a better transaction (product) to the client and therefore better help the client.

Of course, the investment banker is not doing this for free (or because they enjoy pitching!). Successful pitches turn into business in terms of an investment banking transaction, which generate substantial fees. Typical fees on an IPO, for example, could range from 3% – 7% of the amount raised.

Amongst coverage groups there is a pecking order. The smartest and most talented Analysts and Associates tend to gravitate toward whichever coverage group is the ‘hottest’ at that bank.

The degree of ‘hotness’ stems from various sources, such as how much business the MD brings in, how big the mandates are as well as how often deals get done in that industry.

Investment Banking: Products (Part 1)

Posted: January 31st, 2020, 4:32 pm
by MBACrystalBall
In the previous article, we skimmed the surface of what the coverage side of the bank does and what coverage investment bankers do. In this episode, I’m hoping to give you a short overview of what product-side investment bankers do.

As we delve into this coverage / product structure – you must remember that not every investment bank follows this structure to the ‘T’. Large investment banks (fondly called the ‘Bulge Bracket’ due to their ‘Bulging’-sized deal reputation) follow this structure but even they differ in the manner in which groups handle work.

Even though there is disparity in the group structure across firms and geographies, the coverage / product structure is an essential model to understand if you’re looking to better understand investment banking or recruit for this line.

We tend to think of investment banking products as those services which bring a company closer to the capital markets.

When we mention capital markets, we are talking about forums where the buying and selling of equities and debt happens.

This encompasses primary (origination) markets as well as secondary (trading) markets.

For the uninitiated, an IPO is one of the most classic and well-known examples of primary market activity. An example of secondary market activity would be the trading of shares.

While coverage bankers ‘cover’ firms and industries, their activities on a standalone basis do not give the client access to the capital markets.

By this ‘access’, we're talking about allowing the client to access public money in the form of debt or equity. This is where the product bankers come in.

Broadly, the product groups in a bank may be split into:

(a) Equity Capital Markets
  • IPO issues: book-building, underwriting
  • Equity private placements
(b) Debt Capital Markets
  • Investment-grade Debt issues for loans & bonds
  • Sub-investment-grade debt issues for loans & bonds
  • Leveraged Finance
Hopefully, at this point, you’re beginning to see how coverage and product bankers work together on their assignments.

From a 20,000 foot view, this is how the groups seem to work together:
  1. Coverage bankers pitch to prospective clients
  2. When a client agrees to a proposed deal, the coverage bankers then bring in the product bankers
  3. Product bankers understand how the transaction should be priced and structured for the most acceptability by the market while bringing the client the best value.

How Investment Banking Works (LBO Example)

Posted: January 31st, 2020, 4:40 pm
by MBACrystalBall
In this article, we'll run you through an investment banking process which involves both the coverage and product banking groups.

We’ve chosen to describe this process using a transaction that we find very interesting – a Leveraged Buyout (LBO). There isn’t a lot of free material out there that describes an LBO in a simple manner. Hopefully, this article will change that.

Let’s study a generalized example of a Leveraged Buyout (LBO)

How Investment Banking Works (LBO Example)
by MIB

An LBO is a takeover of a company (let’s call it a ‘Target’) by a Private Equity (PE) firm. This is always a friendly takeover. This takeover is assisted by a large amount of debt that the Target borrows itself.

The PE firm buys a small stake in the firm by buying some of its shares. The Target then takes on this debt to buy back its shares from the market, almost completely removing its shares from the market.

This decrease in number of shares available in the market causes the PE firm to be the majority and controlling shareholder of the firm. The PE firm “creates efficiencies” (cost-cutting, headcount reduction, as well as top line growth) in the firm while using its cash inflows to repay the debt.

The effective result of this is that the firm reduces its debt while simultaneously increasing the value of its equity. PE investors typically exit the investment after 5 years, making a tidy profit.

Typical IRRs that PE firms look for are well above 20% (to give you a reference – most ‘regular’ companies that are doing well see an IRR of not much more than 15%).

So, now that we’ve got the basics of an LBO, let’s get back to our little ‘deal’ story. The bank’s Financial Sponsor’s Group (FSG) identifies a firm which has a steady cash flow as well as certain other characteristics that would make it the ideal candidate for an LBO.

This ‘identification’ would happen on one of their ‘pitch’ scans where they look for good deals in the market to pitch to prospective clients.

The FSG is a coverage group that covers Financial Sponsors (or as we are accustomed to calling them – PE firms).

The coverage group would typically pitch the idea to the PE firm or to the Target itself.

Once a suitable structure for the LBO has been arrived at and the Target and Sponsor (PE firm/s) are generally agreeable, the deal is brought to the capital markets origination desk. This is where the products groups are.

Since this is a LBO, the transaction will be funded by leveraged debt and / or high-yield bonds. The Leveraged Finance group then finalizes the structure of the transaction and prepares the marketing material for the transaction.

This marketing material consists of the Confidential Information Memorandum (CIM), various presentations on the transaction, etc.

The group also assists on pricing (setting interest rates). The roadshow is held and then the loans / bonds are put out into the market for subscription.

Most PE firms insist on committed financing for their LBOs – which is a commitment from the issuer of the bonds / loans (the Lev-Fin group) that the money will come in, no matter what.

This ‘no matter what’ phrase comprises all kinds of adverse conditions including harsh market conditions or poor liquidity situations.

Banks then ‘underwrite’ this commitment using their own funds. An underwriting is a commitment to pay, should the money not come in from the original source.

Thus, an investment banking transaction is completed.

Investment Banking in India

Posted: January 31st, 2020, 4:46 pm
by MBACrystalBall
The Indian Investment Banking scene is dotted with investment banks of the middle market variety.

In fact, international bulge brackets have been reluctant to set up a strong investment banking presence in India primarily because large transactions in the country do not happen often enough to warrant that kind of presence.

As far as I am aware, bulge bracket investment banks having functional front-office presence in Mumbai are Bank of America – Merrill Lynch, Citigroup and JP Morgan. UBS, Barclays, Credit Suisse, et al have a presence in India in the retail banking sector only.

Goldman Sachs and a few other banks have a presence in India in the back-office part of the value chain only (as of a couple of years ago – this might have changed as of today – but I doubt that their numbers exceed even 50 bankers).

Investment banking in India is still confined to simple investment banking products. Investment banking products that I have commonly seen are financing for project finance in the form of debt and equity.

In fact, the investment banking industry in India is concentrated in three major segments:

(a) Equity Syndication / Placement:

Simply put, it the process of finding sponsors to subscribe to a company’s equity. These investments may be made by strategic investors (other corporates) or by PE firms operating in India. Issuing equity in the form of IPOs is a cumbersome process and is a trade skill mastered by a few investment banking players.

(b) Debt Syndication / Placement:

Like equity syndication, this is the process of funding investors who take a lien on the assets of the borrowing company. This could be for regular debt or even sub-debt / mezzanine lending.

In this case the investment bank arranges for a third party (like a PSU bank or an NBFC) to take on the debt, therefore it assumes none of the risk of this debt investment.

(c) Structured Finance – High-yield lending:

Investment banks lend off their own balance sheet. Since they’re lending off their own balance sheet, they assume the risk of the investment.

Since the products are simple, banks in India do not have formalized discrete ‘coverage’ and ‘product’ groups.

Additionally, investment banks in India tend not to be ‘flat’ in their structures like banks in the west.

Banks in the US have a flat structure of:

Analyst < Associate < Vice President < Managing Director < Regional Head

The banks that I worked for in Mumbai had an extensive hierarchical structure of:
Associate < Sr. Associate < Manager < Sr. Manager < Asst. Vice President < Vice – President < Sr. Vice-President

Investment Banking in India: Asset & Structured Finance

Posted: January 31st, 2020, 4:49 pm
by MBACrystalBall
To recap – Asset & Structured Finance in India is the investment banking division which co-ordinates lending to a company from its own balance sheet. To help you understand this structure, I would like to revisit the basics of lending.

Retail banks accept public deposits. These are, by far, the cheapest funds that anyone can access. When I say ‘cheap’ – I am referring to their cost i.e. the associated interest rate.

This is because interest rate is directly proportional to risk associated with the deposit – and since your deposit in a nationalized bank is viewed as super-safe, the bank can get away with paying you a relatively low rate of interest.

After paying its various overheads (including administrative expenses, salaries and statutory reserves) on top of the interest payments it makes to depositors, the bank arrives at a ‘Cost of Funds’.

The bank then slaps on a small premium to allow it to make a profit and then arrives at an interest rate at which lending is feasible.

The bank then makes loans to people and corporates at rates (ideally) above its cost of funds in order to generate revenues.

To protect itself from default, the bank may take upward of one time the amount of the loan and up to thrice the amount of the loan in the form of security.

The profit that they make is in the form of a ‘Net Interest Margin’ which is widely reported.

Investment banks, however, are not allowed to accept public deposits. This is because their operations are inherently risky and it is not intelligent to allow public depositors to put their life savings in a firm that makes riskier investments.

So where do the investment banking firms get their money from?

Well, they borrow from other lenders (they could do this by issuing debt in the markets in the form of bonds).

However, in this case, the risk is measured based on the bank’s credit profile and not on the borrower’s credit profile.

These investment banks are technically called NBFCs (Non-Banking Financial Company).

The ‘non-banking’ part comes about from the fact that they’re not allowed to participate in retail banking operations.

(Even if they open a retail bank under the same umbrella brand, they’re not allowed to use the retail bank’s public deposits toward this lending).

Since the investment bank usually has a much better credit profile than the borrower, this allows the investment bank to access funds at a cheaper rate than if the borrower had attempted to borrow money on his own from the market.

What, then, would compel a CFO with a fully-functional brain to borrow at premium rates from an investment bank?

Recall the part where we mentioned that the PSU banks that provide debt also take security?
Well, what if the only security you had was one which the bank refuses to accept?

Securities that encapsulate considerable value but are unacceptable by PSU banks are shares.

A lot of companies have a ton of shares in a sister company or in another company and are willing to pledge these shares to a lending entity in order to access debt.

However, since the value of the shares (ordinarily) may fluctuate on a daily basis, the bank may not have the ability to mechanism to monitor the value of their security if they were to accept shares as collateral.

In banks which have a Structured Finance division, there also exists a credit risk monitoring & ratings division which rates various borrowers and then recommends security margins and internal ratings. Based on these internal ratings, the borrowers are subject to differing interest rates.

That’s where the Structured Finance division of an investment bank comes in. The banks have substantial infrastructure which actively monitor the price of shares and associated security.

They can then request the borrower to bring in more security should the value of the shares pledged as security fall below a certain threshold. Their systems enable them to lend based on more risky security. Of course, this isn’t free – and results in a higher cost of funds for the lender and therefore a higher lending rate.

One last thing – NBFC’s lend at various rates. PSU Banks lend at various rates. You can see a bank’s Prime Lending Rate (PLR) on its website. Usually PSU banks’ PLR’s are within 50 basis points (0.5%) of each other. NBFC’s prefer to use blended rates (mixtures of other NBFCs).

One popular rate that they like is the MIBOR which is the Mumbai Inter-bank Offer Rate. The MIBOR is the Indian version of the LIBOR which is the London Inter-Bank Offer Rate. When banks lend, therefore, they lend with a ‘spread’ over the benchmark rate.