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Giddy Global Banking: Review I/1
Global Banking&
Capital MarketsREVIEW I
Prof. Ian GiddyStern School of Business,
New York University
Copyright ©1999 Ian H. Giddy International Financial Markets 2
What is Global Banking and CapitalMarkets?
The International Financial Markets
uMoney and foreign exchange;
derivatives; international bonds &
equities; loan trading
l The Global Banking BusinessuLending; trading and transactions;
underwriting; M&A; project financing;asset management; advisoryservices; etc
Giddy Global Banking: Review I/2
Copyright ©1999 Ian H. Giddy International Financial Markets 3
What are the Global Financial Markets?
l The Foreign Exchange Market
l Domestic and International Money Markets
l Domestic and International Capital Markets
l The Derivatives
l International Equity and M&A
l Using the Global Capital Markets: GlobalBanking Strategy and Implementation
Copyright ©1999 Ian H. Giddy International Financial Markets 4
Where the Eurocurrency Market Fits In
US Domestic German
Market EUR0CURRENCY MARKET Domestic Market
Euro-Deutsche Mark
Eurodollar Market
Market Foreign
Exchange
Market Japanese
Euro-Yen Domestic
Market Market
Euro-Commercial Euro-Floating Rate Straight
Paper Market Note Market Eurobond Market
Giddy Global Banking: Review I/3
Copyright ©1999 Ian H. Giddy International Financial Markets 5
Interest Rate Linkages in theInternational Money Market
Two stories to tell:l Domestic vs. Eurol Eurocurrency A vs. Eurocurrency B
Domestic Market A The Euromarkets Domestic Market B
Trea- Bank Euro Euro Bank Trea- sury Deposit Deposit Deposit Deposit sury Bill Market Market Bill
Trea- Corp- Euro Euro Corp- Trea- sury orate Bond Bond orate sury Bond Bond Market Market Bond Bond
Global Banking:Products and Customers
Prof Ian Giddy
Stern School of Business
New York University
Giddy Global Banking: Review I/4
Copyright ©1999 Ian H. Giddy International Financial Markets 7
Products or Customers?
Sales
CapitalMarkets
CorporateFinance
Customer-DrivenInnovation
Copyright ©1999 Ian H. Giddy International Financial Markets 8
Client-Arena-Product Matrix
Pro
du
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off
ered
Clients servedMarkets covered
Giddy Global Banking: Review I/5
Copyright ©1999 Ian H. Giddy International Financial Markets 9
Products
l Credit productsl Trading and positioningl Risk management productsl Financial engineering and structured
financel Underwriting and distributionl Asset managementl Retail and private client servicesl Transactions services
Copyright ©1999 Ian H. Giddy International Financial Markets 10
Client-Arena-Product Matrix
Pro
du
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off
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Clients servedMarkets covered
Build versus buy?
Giddy Global Banking: Review I/6
Copyright ©1999 Ian H. Giddy International Financial Markets 11
Client-Arena-Product Matrix
Pro
du
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off
ered
Clients servedMarkets covered
Example: SBC and US bank equity
Copyright ©1999 Ian H. Giddy International Financial Markets 12
Client-Arena-Product Matrix
Pro
du
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off
ered
Clients servedMarkets covered
Sell? (NatWest)
Giddy Global Banking: Review I/7
Copyright ©1999 Ian H. Giddy International Financial Markets 13
NatWest Bank?
NatWest BankClients
Corporations Government Institutions High net worth RetailProductsSecurities custody x xAsset Management x x xPrivate Equity xInsurance x xLending x x x xDeposits x x x xSecuritization/Structured and Project Finance x xEquity underwritingBond underwritingMergers and AcquisitionsCredit cards x x xTrading - Money market x x - FX and derivatives x x - Interest rate derivatives x x - Bonds x x - Securitized products x x- Futures x xMortgages xStock brokerage x xCorporate Advisory xPrivate Banking x
Copyright ©1999 Ian H. Giddy International Financial Markets 14
To Succeed,Analyse the Industry Structure
COMPETITIVEADVANTAGE
SUBSTITUTES
CUSTOMERS
BARRIERSTO ENTRY
SUPPLIERS
Giddy Global Banking: Review I/8
Copyright ©1999 Ian H. Giddy International Financial Markets 15
Product Profitability Cycle
Excess returns
Time
Copyright ©1999 Ian H. Giddy International Financial Markets 16
New Financial Products:Economics of Financial Innovation
l Certain kinds of market imperfectionsallow hybrids to flourish
l But innovation are readily copied; so onlycertain kinds of firms can profit frominnovations.
l There is a product cycle and profitabilitycycle of innovations.
Giddy Global Banking: Review I/9
Copyright ©1999 Ian H. Giddy International Financial Markets 17
Financial Innovations:What to Look For
l Reallocating riskl Increasing liquidityl Reducing “agency costs”l Reducing transactions costsl Reducing issuers’ or investors’ taxesl Circumventing regulationsl Circumventing internal constraints
Copyright ©1999 Ian H. Giddy International Financial Markets 18
Battle Mountain Gold
$300/oz = Cost of Production
Forward Prices for Gold
$400
$450
$425
Each year, BMGchooses toproduce if P>300defer if P<300
Giddy Global Banking: Review I/10
Copyright ©1999 Ian H. Giddy International Financial Markets 19
Principles of Innovation ThroughFinancial Engineering
l Bundling and unbundling basic instruments
l Exploiting market imperfections (sometimestemporary)
l Creating value added for investor and issuerby tailoring securities to their particularneeds
Key: For the innovation to work, it mustprovide value added to both issuer andinvestor.
Copyright ©1999 Ian H. Giddy International Financial Markets 20
Asset Securitization
CHASE (SPONSOR)
SPECIALPURPOSEVEHICLE
CREDIT CARDRECEIVABLES
ISSUESASSET-BACKEDCERTIFICATES
SALE ORASSIGNMENT
CREDIT CARDRECEIVABLES
Giddy Global Banking: Review I/11
Copyright ©1999 Ian H. Giddy International Financial Markets 21
Example
Dayton Hudson Credit Card Maste r Trus t, Series 1995-1
Is s ue Date : 9/13/95Expe c ted Maturity: 2/25/2002Structure : Senior/Subordinated, sequential payS e lle r: Dayton Huds on Receivables CorporationCards: Private label cards for Mervyn's, Target and Dayton's Department StoreS e rvicer: Retailers National BankUnde rwrite r: Firs t Bos ton Corporation
Tranche Face Value Coupon Ave. Life RatingDe s c ription PlacementA $400 million 6.10% 3 Years AAA Senior PublicB $123 million 0.00% 3 Years AAA Subordinated Private
Collate ral Information Yie ld on portfolio 22.52% His torical yield after delinquencies 18.90% Number of accounts 22,796,667 Overcollateralization of A Tranche 23.50% Largest geographic concentration California (24.9%)
Copyright ©1999 Ian H. Giddy International Financial Markets 22
l Does the originator currently face a high cost offunding assets that would be recognized as sound,cash-generating assets if taken in isolation?
l Does it have a regulatory or capital constraint thatmakes freeing up the balance sheet important?
l Does it have data about the assets (required by ratingagencies and financial guarantors)?
l Does it have the servicing process and systems thatcan meet the more demanding standards of the asset-backed market?
l Is the originator willing to undertake a complex, time-consuming transaction to obtain a broader, potentiallycheaper, ongoing source of funding?
Is the Company Ready for ABS?
Giddy Global Banking: Review I/12
Copyright ©1999 Ian H. Giddy International Financial Markets 23
Finance Co. Ltd(Seller)
FCL 1997-A(Special Purpose Co.)
Investors
Financial GuaranteeProvider
Monthly HPPayments
GuaranteeResponsibilities
TrusteeTrustee
Responsibilities
Monthly ABSPayments
Servicing Fees
Finance Co.’sCustomers
Hire-PurchasePayments
Case Study: Ongoing Payments
Copyright ©1999 Ian H. Giddy International Financial Markets 24
Project Financing
Definitionl Lending to a single purpose entity
for the acquisition and /orconstruction of a revenue-generating asset with limited or norecourse to the sponser
l Repayment of the loan is solelyfrom the revenues generated fromoperation of the asset owned bythe entity
l Security for the loanu the revenue generating assetu all shares and interests in the
entityu real propertyu all contacts, permitsu authorizations, etc.; and,u all other instruments necessary for continuing project
operations
Giddy Global Banking: Review I/13
Copyright ©1999 Ian H. Giddy International Financial Markets 25
Project Financing
Definitionl Lending to a single purpose entity
for the acquisition and /orconstruction of a revenue-generating asset with limited or norecourse to the sponser
l Repayment of the loan is solelyfrom the revenues generated fromoperation of the asset owned bythe entity
l Security for the loanu the revenue generating assetu all shares and interests in the
entityu real propertyu all contacts, permitsu authorizations, etc.; and,u all other instruments necessary for continuing project
operations
StepsProject Identification
& Resource Allocation
Risk Allocation &Project Structuring
Bidding & MandatingContracts
Due Diligence &Documentation
Execution & Monitoring
Construction Monitoring
Term Loan Conversion& Ongoing Monitoring
Copyright ©1999 Ian H. Giddy International Financial Markets 26
Sample Structure
Sponsors /Shareholders
SINGLE PURPOSEPROJECT COMPANY
EquipmentSupplier
Contractor
Feed Stock(e.g., fuel)Supplier
Warranties and Supply Agents
Operator
TurnkeyConstruction
Long TermAgreement
Operations &Maintenance Mgmt
Purchaser
SyndicateBanks
Other ProjectParticipants:
Currency and InterestRate Hedge Providers
Multilaterals and EDA’s
Legal Counsel
Technical Consultants
Offtake (e.g,power purchase)Agreement
ArrangingBank
Giddy Global Banking: Review I/14
Ras LaffanLiquified Natural Gas
Korea Gas
Security Trustee(New York)
Bondholders
Mobil QM(Mobil Corp.)
Qatargas(State of Qatar)
Joint venture agreement
30% 70%
ContractorsContractors
Contractors
LNG
LNGpayments
Debt servicepayments
Residualpayments
Contractpayments
BanksExport Credit
Agencies
Debt servicepaymentsRas Laffan
Copyright ©1999 Ian H. Giddy International Financial Markets 28
Martell
l Martellufamilyuother shareholders
l Seagramsl Grand Met
Concept: What are the goals and tacticsof each in this ownership transfer?
Giddy Global Banking: Review I/15
Copyright ©1999 Ian H. Giddy International Financial Markets 29
Goals of Acquisitions
Rationale: Firm A should merge with Firm B if[Value of AB > Value of A + Value of B + Cost of transaction]l Synergy
u Eg Martell takeover by Seagrams to match name and inventory withmarketing capabilities
l Gain market poweru Eg Atlas merger with Varity. (Less important with open borders)
l Disciplineu Eg Telmex takeover by France Telecom & Southwestern Bell
(Privatization)
u Eg RJR/Nabisco takeover by KKR (Hostile LBO)
l Taxesu Eg income smoothing, use accumulated tax losses, amortize goodwill
l Financingu Eg Korean groups acquire firms to give them better access to within-group
financing than they might get in Korea's undeveloped capital market
Copyright ©1999 Ian H. Giddy International Financial Markets 30
Fallacies of Acquisitions
l Size (shareholders would rather havetheir money back, eg Credit Lyonnais)
l Downstream/upstream integration(internal transfer at nonmarket prices,eg Du Pont/Conoco, Pru/Bache)
l Diversification into unrelated industries(Kodak/Sterling Drug)
Giddy Global Banking: Review I/16
Copyright ©1999 Ian H. Giddy International Financial Markets 31
Using The Restructuring Framework($ Millions of Value)
RestructuringFramework
1
2
CurrentMarketPrice
3
Optimalrestructuredvalue
Potentialvalue withinternaland externalimprovements
Potentialvalue withinternalimprovements
Companyvalue as is
Maximumrestructuringopportunity
Financialengineeringopportunities
4
Disposal/Acquisitionopportunities
Strategicand operatingopportunities
CurrentperceptionsGap: “Premium”
5
$ 25
$ 975
$ 300
$ 1,275$ 350
$ 1,625
$ 10
$ 1,635
$ 635
$1,000
Eg Increase D/E
Copyright ©1999 Ian H. Giddy International Financial Markets 32
Mergers and Acquisitions: Summary
l Mergers & Acquisitionsl Divestituresl Strategic Alliances
Concept: Is a business worth morewithin our company, or outside it?
Giddy Global Banking: Review I/17
Copyright ©1999 Ian H. Giddy International Financial Markets 33
Martell -- The Conclusion
Copyright ©1999 Ian H. Giddy International Financial Markets 34
M&A Advisory Services:1. Role of the Seller's Advisor
l Develop list of buyersl Analyze how different buyers would evaluate companyl Determine value of the company and advise seller on
probable selling price rangel Prepare descriptive materials showing strong pointsl Contact buyersl Control information processl Control bidding processl Advise on the structure of the transaction to give value to
both sidesl Ensure all nonfinancial terms are settled earlyl Smooth postagreement documentation
Giddy Global Banking: Review I/18
Copyright ©1999 Ian H. Giddy International Financial Markets 35
M&A Advisory Services:2. Role of Buyer's Advisor
l Thoroughly review target & subsl Advise on probable price rangel Advise on target's receptivenessl Evaluate target's options and anticipate actionsl Devise tacticsl Consider rival buyersl Recommend financial structure and plan financingl Advise on initial approach and follow-upl Function as liasonl Advise on the changing tactical situationl Arrange the purchase of shares through a tender offerl Help arrange long term financing and asset sales
Copyright ©1999 Ian H. Giddy International Financial Markets 36
Alliance Capital
l Trends in the business?l Global business?l Continue “active growth” management?l Competition?l Fees?
Giddy Global Banking: Review I/19
Copyright ©1999 Ian H. Giddy International Financial Markets 37
Portfolio Performance Evaluation
l How well did the portfolio do?l How do we adjust for risk, to compare
different managers?l Why?uRisk
uTiming
uAsset allocation
uSecurity selection
Copyright ©1999 Ian H. Giddy International Financial Markets 38
Global Brivate BankingKey Issues to be Addressed
l Personal, family, business andpolitical/economic context
l Personal Investment Portfoliol Personal Retirement Plansl Insurancel Estate Planningl Businesses
Giddy Global Banking: Review I/20
Copyright ©1999 Ian H. Giddy International Financial Markets 39
Private BankingIndividual Solutions
Your Needs
Real Estate
Partnerships
Fine Arts
Transfer of Wealth
Liquid assets and securities Account Management
Real Estate Advice
Structured Finance
Art Consulting
Estate- and Trust
Management
Relationship--Manager
Matching your Needs
with our Expertise
Overview Private Financial Planning
Translation by our Specialists
Copyright ©1999 Ian H. Giddy International Financial Markets 40
Optimizing asset structure and taxminimization opportunities
create enjoy
entrepreneurship retirement estate
Assets accumulated
Proceeds from selling the business
financial portfolio
real estateinvestment
pension plan
health insurance
?
share transfer
Giddy Global Banking: Review I/21
Copyright ©1999 Ian H. Giddy International Financial Markets 41
Global Private Banking
l Client needsl Provision of services to meet needsl Where does the bank excel?
l Add value to the relationship by buildingfrom asset management to familyfinancial planning and family-ownedinvestment banking services
Copyright ©1999 Ian H. Giddy International Financial Markets 42
After Glass-Steagall
WholesaleRetail
Insurance
Asset Management
Universal Banking?
Giddy Global Banking: Review I/22
Copyright ©1999 Ian H. Giddy International Financial Markets 43
Citigroup
l Buy? Sell? Hold?l What’s unusual about the deal?l Will the combination produce net
positive economic value?l From where? Who will get it?l How long before gains realized?l Risks that the deal will fall through?
Copyright ©1999 Ian H. Giddy International Financial Markets 44
Valuation: The Key Inputs
l A publicly traded firm potentially has an infinite life.The value is therefore the present value of cash flowsforever.
l Since we cannot estimate cash flows forever, weestimate cash flows for a “growth period” and thenestimate a terminal value, to capture the value at theend of the period:
Value = CF
t
(1+r)tt =1
t =∞∑
Value = CFt
(1+r)t+
Terminal Value
(1+r)Nt =1
t=N∑
Giddy Global Banking: Review I/23
Copyright ©1999 Ian H. Giddy International Financial Markets 45
Models of Valuation
Choose aCash Flow Dividends
Expected Dividends to
Stockholders
Cashflows to Equity
Net Income
- (1- δ) (Capital Exp. - Deprec’n)
- (1- δ) Change in Work. Capital
= Free Cash flow to Equity (FCFE)
[δ = Debt Ratio]
Cashflows to Firm
EBIT (1- tax rate)
- (Capital Exp. - Deprec’n)
- Change in Work. Capital
= Free Cash flow to Firm (FCFF)
& A Discount Rate Cost of Equity
• Basis: The riskier the investment, the greater is the cost of equity.
• Models:
CAPM: Riskfree Rate + Beta (Risk Premium)
APM: Riskfree Rate + Σ Betaj (Risk Premiumj): n factors
Cost of Capital
WACC = ke ( E/ (D+E))
+ kd ( D/(D+E))
kd = Current Borrowing Rate (1-t)
E,D: Mkt Val of Equity and Debt
& a growth pattern
t
g
Stable Growth
g
Two-Stage Growth
|High Growth Stable
g
Three-Stage Growth
|High Growth StableTransition
Copyright ©1999 Ian H. Giddy International Financial Markets 46
Client-Arena-Product Matrix:Citigroup
Pro
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off
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Clients servedMarkets covered