Matthew Krantz - Investment Banking For Dummies

Investment banking operations are rarely identical between firms. Some banks and investment banks are engaged in some front-office areas, while others steer clear of them completely. There are also some peripheral areas of business some banks and investment banks include as part of their services that don’t fall in one of the traditional “offices.” One example of a service that is often grouped in investment banking is investment management. In an investment management unit, investment professionals are paid to invest money on behalf of individual clients or institutions.

After the tumultuous changes in the investment banking business following the financial crisis of 2007 through 2009, the entire landscape changed. Following the banking crisis, investment banks needed capital. Some of the most storied investment banks, unable to raise money, merged with other banks or became commercial banks themselves. Suddenly, the financial system was comprised of behemoth banks that have the deposit-taking abilities of banks but also engage in investment banking. The result is the formation of several mega-institutions that many people fear are “too big to fail,” including the ones shown in Table 1-1.

TABLE 1-1Among the Last Banks Standing

Source: S&P Global Market Intelligence

Insiders in the investment banking business use all sorts of terms, some decidedly derogatory, to classify the players in the business. Some classifications that investment banks fall into include the following:

Bulge bracket: Bulge bracket investment firms aren’t the ones that ate too many slices of cheesecake. Instead, bulge bracket is a commonly used slang term to describe the biggest of the big investment banking operations. The bulge bracket firms are the behemoths, like the ones in Table 1-1. They have their hands in most areas of investment banking.

Boutique: Boutique investment firms are smaller investment banks and traditional banks that choose to focus on one or a select few areas of the business. Some firms, for instance, focus on selling securities for smaller companies.

Regional: Regional firms typically focus on a particular part of the country. Whereas the bulge bracket firms continually try to grow and take market share from rivals, there seems to be plenty of room for smaller players like these. Some regional firms also often concentrate on a particular type of investment banking service, be it trading services or underwriting of securities.

As you can imagine, although investment banking plays an important role in funding economic progress, there’s also lots of money to be made. Investment bankers can’t afford those fancy suits if they’re not getting paid.

Investment bankers perform services for customers and collect money in a number of ways, include the following:

Commissions: Investment banks sometimes collect fees in exchange for conducting a financial transaction between a buyer and seller. One of the more common forms of commissions is often collected in the brokerage operations by some traditional banks and investment banks. For instance, Merrill Lynch, the brokerage and investment banking unit of Bank of America, charges commissions when purchasing stock for its customers. But that’s just a small example.

Underwriting fees: A lucrative area of investment banking generates fees for selling securities in the primary market (the collection of buyers’ and sellers’ interest in trading brand-new securities). When a company sells stock to the public for the first time, for instance, the investment banker who handles the deal, called the underwriter, collects a fee. (You can read more about companies selling stock to the public for the first time in IPOs in Chapter 3.)

Trading income: Investment banks usually handle other people’s money. But many investment banking operations also include a trading division. This unit attempts to take advantage of temporarily mispriced financial instruments. This high-risk proprietary trading is designed to generate profits for the firm.

Asset management fees: Some investment banks help their clients make decisions on how to invest their money. Investment banks generate asset management fees when they help clients decide which securities they should buy or sell.

Advisory fees: Companies often look to their investment banks for advice, especially in the cases of M&A deals. And in these cases, the investment bankers are brought in to provide in-depth, numerical analysis of a proposed deal. The companies pay substantial fees for this high-level assistance. (Read more about M&A deal making in Chapter 4.)

Of all the investment banks, few are as well known — and even as infamous — as Goldman Sachs. The firm’s long history in investment banking and its seeming omnipresence in markets around the world cement its recognized role as a premier investment bank.

Remember: It’s important to note that Goldman, too, found itself in a world of hurt during the financial crisis, and it had to turn to famed investor Warren Buffett to invest billions to help the company avoid a liquidity crisis. Goldman also borrowed billions from taxpayers, too. Nonetheless, those hoping to learn about investment banking, what it is, and how it works, are well served to look at the way Goldman Sachs structures its business and the size of those pieces, including the following:

Institutional client services: The biggest part of Goldman’s business is what it calls institutional client services. Here, the firm arranges and helps conduct transactions for clients who want to buy and sell everything from bonds to foreign currencies and commodities, in a process called market making. Typically, the clients of this part of the business include big financial institutions, governments, and companies.

Investing and lending: Goldman may consider itself to be an investment bank, but it also makes loan to businesses and governments. Most of the loans Goldman is involved in are long term; they may involve everything from financing real estate deals to building power plants.

Investment management: Here’s where Goldman serves the role of helping its clients put their money to work. Goldman offers financial advice to institutions through mutual funds, accounts it manages on behalf of clients, wealth management services, and financial counseling. Goldman serves some very wealthy individuals and families in this part of its business.

Investment banking: This part of Goldman is the one most interesting to readers of this book. Here, Goldman guides companies embarking on M&A, provides assistance in bringing companies public, and conducts financial restructurings.

You can see how the different parts of Goldman rank in order of importance to revenue in the following table.

Source: Goldman Sachs 2018 annual report