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Financial Services Dynamics

Prof. Ingo WalterNew York University

Not for public use © Ingo Walter 2002

ENVIRONMENTAL DRIVERS TRANSACTIONSINFRASTRUCTURE:

PaymentsExchangeClearanceSettlementCustody

INFORMATIONINFRASTRUCTURE:

Market DataResearchRatings

DiagnosticsCompliance

Information AdvantagesInterpretation Advantages

Transaction cost Advantages

Risk Transformation (Swaps, Forwards, Futures, Options)

Brokerage & TradingProprietary / Client-Driven

SecuritiesBroker/Dealers (B)

Banks (A)

Direct-connectLinkages (C)

DistributionOrigination

SecuritiesNew Issues

Loans &Advances

USERS OF FUNDSHouseholdsCorporates

Governments

SecuritiesInvestments

Deposits &Certificates

SOURCES OF FUNDSHouseholdsCorporates

Governments

CollectiveInvestment

Vehicles

Source: Roy C. Smith and Ingo Walter, Global Banking (New York: Oxford University Press, 1997).

0

10

20

30

40

1970 1980 1990 2000

Commercial Banks

Insurance Companies

Pension Funds

Mutual Funds

PercentU.S. Financial Assets, 1970 – 2000

Source: Federal Reserve

Private Asset Allocation in German Households

4.4

31.4

20.6

38.4

5.2 10.4

26.6

23.3

27.4

12.3

Insurance

Others*

Investment funds

Stocks

Insurance

Short-termInvest-mentswith banks

Stocks

Investment funds1990 (%) 2000 (%)

Others*

Short-term investments with banks

*includes fixed interest deposits, long-term investments with banks and buildingsociety deposits

Sources: Tecis; JP Morgan

Household Asset Allocation, Japan(2001)

Stocks5.5%

Bonds6.1%

Savings Deposits52.0%

Demand Deposits11.3%

Insurance & Pension

funds25.1%

Source: Datastream

Banks’ Share in Financial Intermediation

0 20 40 60 80 100

United States

United Kingdom

Netherlands

France

Spain

Germany

Italy

Switzerland

Austria

%











Banks (A)




Loans &Advances


Governments




Governments


Vehicles


Debt Outstanding, 2000

0

20

40

60

80

100

Long

-term

Non

finan

cial

Cor

pora

te L

iabi

litie

s (p

erce

nt)

U.S.

Japa

n

Fran

ce

Spain

Neth

erlan

ds Italy

Belgi

um

Germ

any

Swed

en

Bank Borrowing Bonds

Source: Organization for Economic Cooperation and Development

Total Securitization Market, 1985-2001($bn outstanding)

0

500

1000

1500

2000

2500

3000

3500

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Source: CS First Boston (1985-95 data); Moody’s, Schroder Salomon Smith Barney, Merrill Lynch (1996-1997 YTD data)

U.S.

Europe











Banks (A)




Loans &Advances


Governments




Governments


Vehicles


The US Financial Services Sector, 1950

InstitutionPayment Services

Savings Prod.

Fiduc. Services

Insurance and Risk

Mgt. ProductsDebtEquityRetailBusiness

Insured Depository Institutions

InsuranceCompanies

Finance Companies

Securities Firms

Pension Funds

Mutual Funds

Underwriting Issuance ofLendingFunction

Minor involvement

The US Financial Services Sector, 2001

Institution

Payment Services

Savings Prod.

Fiduc. Services

Insurance and Risk Mgt. Products

DebtEquityRetailBusiness



InsuranceCompanies

Finance Companies

Securities Firms

Pension Funds

Mutual Funds

Diversified Financial Firms

Specialist Firms

Selective involvement of large firms via affiliates

Financial Services Concentration Ratios

1995 2000 1995 2000 1995 2000 1990 2000 1990 2000 1990 2000

45%

55%

39%

61%

26.7%

39.7%37%

61.9%

26%

61%

40%

92.5%

40.6%

92.5%

Retail BankingPercentage of totaldeposits held bytop 30 bank holdingcompaniesTotal deposits:$3.6 trillion

MortgageOriginationPercentage oforiginationby top 10;ranked by valueof loans out-standingTotal originations:$1.073 trillion

Credit CardsPercentage oftotal credit issuedby top five; rankedby value of out-standingsTotal industryOutstanding:$478.7 billion

Corporate LendingPercentage of syndicated loansto large corporationin which the top fiveplayers served as theagent bank*Total syndicatedloans outstanding:$1.9 trillion

Custody BanksPercentage of total Held by top 10; ranked by global assets undermanagementTotal world-wideAssets underManagement:$37.24 trillion (approx.)

Investment BankingPercentage of wholesaleorigination held bytop-ten firms (global)Volume: $11.5 trillion

Other banksthrifts andcredit unions

Bank holdingCos.

*The agent bank arranges a financing pool in which other banks participate.Sources: First Manhattan Consulting Group; Inside Mortgage Finance; the Nilson Report; Loan Pricing Corp.; Federal Reserve; Institutional Investor











Banks (A)




Loans &Advances


Governments




Governments


Vehicles


The US Financial System in Global Perspective, 2000

US Share of global:Population 4.5%GDP 28.9%Loans:Banking assets 10.6%Syndicated lending 13.5%Securities:Bond market capitalization 44.9%Stock market capitalization 50.0%Non-government debt issues 53.2%Stock new issues 57.0%Completed M&A 52.8%Managed assets:Funded pension assets 59.4%Mutual fund assets (non-pension) 53.0%Intermediation:Loan lead-managers 77.2%Debt & equity bookrunners 66.3%M&A advisory 78.6%

STRUCTURE OF FINANCIAL INSTITUTIONS 1

United States Europe*Commercial banksSavings institutionsCredit UnionsFinance companiesSecurities brokerageOn-line brokerageInvestment banksMutual fund companiesMortgage companiesInsurance companies

BanksBanksBanksBanksBanksBanksBanksMainly affiliates of banksAffiliates of banks and mortgage banksInsurance companies & bancassuranceaffilates of banks

* Significant inter-country differences exist among European markets.1 Adapted from Gunter Dufey “The Blurring Borders of Banking”.

The European Financial Services Sector, 2001

Institution

Payment Services

Savings Prod.

Fiduc.Services

Insurance and Risk Mgt. Products

DebtEquityRetailBusiness



InsuranceCompanies

Finance Companies

Securities Firms

Pension Funds

Mutual Funds

Diversified Financial Firms

Specialist Firms

Selective involvement of large firms via affiliates











Banks (A)




Loans &Advances


Governments




Governments


Vehicles


E – Applications in Financial Services (January 2001)

Retail banking:On-line banking (CS Group, Bank-24, E*loan, Amex MembershipB@nking, ING Direct, Egg)

Insurance:ECoverage (P&C) [defunct 2002]EPrudential term and variable life

Retail brokerage:E-brokerage (Merrill Lynch, MSDW, Fidelity, Schwab, E*trade, DJL Direct, Consors)

mailto:B@nking

Specialized financial Financial Telecom/utilityservice providers conglomerates companies

LendingTree.com, DollarDEX.com, AdvanceMortgage.com, Insweb.com

Citi Privatenetworks

Vertically integrated

financial conglomerates

Vert i call y in tegrat ed m

i xed congl om

erat es

Brick and Mortar PC with Modem TV Phone Kiosk Wireless Device

Alternative Services and Delivery Channels

Electronicenablers

S1, Checkfree, Sanchez, System Access, Back-office

Home banking, Mortgages, brokerage, Insurance, e-Wallets,Electronic bill presentment and payment services, Checking,Business services, Credit cards

Financialproducts

Financialinstitutions

Aggregators

Portals

Accessdevices

Source: Claessens, Glaessner, Klingebiel, World Bank, 2000

E-Finance Penetration in Industrial Countries

8.3733212Germany

8.21182France

8.211020Finland

8.41,192386Denmark

8.2204Belgium

8.110224Australia

8.2427278Industrial country average

Business Environment Ranking, 2000-04

E-money (number of merchant terminals per 100,000 people)

Online brokerage (transactions as % of brokerage transactions)

Online banking (customers as % of bank customers)

Country

E-Finance Penetration in Industrial Countries (Cont’d)Banking Brokerage E-money Environment

8.34185531Sweden

8.83266United Kingdom

8.735566United States

8.025182Spain

8.6332105Singapore

7.658972Portugal

8.01,059258Norway

8.81,8984015Netherlands

7.432Japan

7.77161Italy

Estimated Impact of E-Finance on Bank Net Interest Margins, 2005 and 2010

1.671.9520012.37Germany

1.611.6620011.72Austria

1.571.4220001.14Ireland

1.992.8420033.30France

1.601.5919981.57Finland

1.682.2019984.20Denmark

1.521.3420031.25Belgium-Luxembourg

1.641.8220012.03Australia

1.691.962.34Industrial country average

Net Interest Margin, 2010


Start of Rapid Growth


National economy

1.611.6519991.75Switzerland

1.631.8219982.46Sweden

1.702.0920012.57United Kingdom

1.872.9120014.06United States

1.862.6220023.19Spain

1.671.9520012.30Singapore

1.661.7620041.81Portugal

1.631.8219982.55Norway

1.601.6120021.62Netherlands

1.621.7220011.84Japan

1.932.5020042.74Italy

Estimated Impact of E-Finance on Bank Net Interest Margins, 2005 and 2010 (Cont’d)

NIM 1997 Launch NIM 2005 NIM 2010

Merrill Lynch 2000 Net Revenues($26.8 billion)

Merrill Lynch Investment Management (MLIM) 9%

Private Client Group (PCG)45%

Corporate & Institutional Client Group (CICG) 46%

Data: Merrill Lynch

U.S. Securities Firms Ranked By Number of Brokers World-Wide, as of Jan 1, 2000

18,100

13,072

11,333

8,165

7,576

6,682

6,398A.G. Edwards, Inc.

Prudential Securities

PaineWebber

Charles Schwab

Salomon Smith Barney

Morgan Stanley Dean Witter

Merril Lynch

Source: Securities Industry Association

Merrill and Schwab Market Capitalization, $bn

0

10

20

30

40

50

60

1998 1999 2000 2001

Charles Schwab

Merrill Lynch

@

Source: Thomson Financial Datastream

MSDW Client Options1. Traditional brokerage relationship at traditional price points.2. MSDW Online account: Discounted trades at $29.95-$39.95.3. MSDW Choice wrap account: Access to a broker + unlimited on-line ($29.95)

and off-line (39.95) trading – additional fees for orders exceeding 1,000 shares.Brokers can negotiate individual charges.

1.00%

1.00%

1.00%

1.00%

0.75%

0.75%

0.50%

0.50%

0.50%

0.50%

2.25%

2.25%

1.75%

1.25%

1.25%

0.90%

0.85%

0.85%

0.50%

0.30%

0-$99,000

$150,000

$250,000

$250,000

$250,000

$1,000,000

$1,000,000

$2,000,000

$5,000,000

$10,000,000+

Next

Mutual Fund/

Fixed IncomeEquity

Account

Asset Level

Source: Morgan Stanley Dean Witter

Top E-brokerage Players, 2001

Merrill LynchPrudential FinancialCitigroupPaineWebberCSFB DirectDiscover Brokerage DirectSchwabE*TradeFidelity Investments

“Kindly explain the asset allocation approach just once more…”

E – Applications in Financial Services(January 2001)

Primary capital markets:E-based CP & bond distribution (UBS Warburg, Goldman Sachs)

E-based direct issuance:Governments (TreasuryDirect, World Bank)Municipals (Bloomberg Municipal, MuniAuction, Parity)Corporates (CapitaLink, Intervest)IPOs (W.R. Hambrecht, Wit Soundview, Schwab, E*Trade)

CapitaLink Auction Screens

Yes

Yes

Yes

Yes

Yes

Yes

No

No

No

No

No

No

No

+62

+62

+63

+64

+64

+65

+65

+66

+67

+67

+67

+68

+68

10.0

8.0

4.5

1.0

4.5

7.5

6.5

10.0

3.0

5.5

2.5

7.0

15.5

OJ

NB

YU

VL

BC

DA

GD

KI

DL

OL

HP

SM

VI

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

+54

+56

+57

+58

+59

+59

+59

+60

+61

+61

+62

+62

+62

5.5

7.0

0.5

2.5

5.0

5.0

2.5

6.0

4.5

7.0

8.0

10.0

8.0

OL

SM

VI

BQ

KI

WC

OL

MC

RB

WC

RD

CU

SB

In-MoneySpreadAMTBidderIn-MoneySpreadAMTBidder

Merrill Lynch Comments on CapitaLink

• No prior history of automated Dutch auction distribution• Lack of liquidity – Unlike underwritten issues) and Merrill will not handle any CapitaLink issues

• JP Morgan will have to provide backstop bids (denied by Morgan)• Merrill refuses to provide any pricing service on CapitaLink issues.• Unsuited to “Reverse Inquiry” trade as with MTN programs where• Funding could be driven by investor interest, hence sacrifices flexibility• Issuer gives up control of pricing• Irrevocability of bids during auction increases investor exposure to market risk

• Narrower investor base will increase funding costs• Undisciplined dealer participation may lead to violation of securities laws

• Not suited to swap-driven deals• John Deere out on a limb as first company to include CapitaLink in its program, and may attract adverse publicity, especially due to boycott by bulge bracket firms.

“Most investment bankers lead a very hard life. After they takecare of each other they have to take care of their friends. Afterthat, they have to take care of people they’d like to have asfriends. You can imagine that after all of this hard work therearen’t many IPO shares to go around.”

W.R. Hambrecht + Co. (2000)

OpenIPOTM

W.R. Hambrecht + Co.Internet-Based Dutch Auction IPO

Hambrecht sets an expected price range to provide a sense of potential value.

Investors bid price and number of shares.

Offering price is set a lowest at which all shares will be sold.

Those bidding above offering price get all bid-for shares at the offering price

Those bidding at offering price will get some (pro-rata).

Those bidding below offering price get none.

Hambrecht underwrites the shares at clearing price and sells them to investors.

Hambrecht reserves the right to limit shares to anyone bidding for over 1% of the IPO.

No more than 10% of shares can go to a single bidder.

No research – only quantitative analysis of comparables.

Fees: 3-6% (vs. 6-7%).

Reduced underpricing

First deal: 1 million shares Ravenswood Winery February 1999.

Expected dealflow: 6-12 annually.

Key issue: Quality of the deals with no inv. Banker reputation on the line.

Paired Comparison, Traditional U/W vs. E-auction

Issue Salon.com Theglobe.comUnderwriters Hambrecht & Bear Stearns &

Daiwa Volpe BrownAmount raised $26 million $28 millionFee $1.3 million $2.0 millionPrice at u/w $10.50/sh $4.50/shFirst-day close $10.07/sh $31.75/shT+90 day close $9.56/sh $19.83/shLeft on table $0 $169 millionTotal cost $1.3 million $171 million

Source: Business Week, Jan. 2000

W.R. Hambrecht + Co.IPO’s 1999-2001

Issuer Year Amount RoleRavenswood Winery 1999 $ 11.55 LMSalon.com 1999 $ 27.3 LMAndover.net 1999 $ 82.8 LMNogatech 2000 $ 42.0 LMPeet’s Coffee & Tea 2001 $ 26.4 LMBriazz 2001 $ 16.0 LMInstinet 2001 $464.0 17% (CSFB LM)Smith & Wolensky 2001 $ 45.0 LMPlato Learning 2001 $ 50.0 Follow-onInterCept Group 2001 $124.0 Follow-on

Source: W.R. Hambrecht + Co. (Website). Withdrawn IPOs include Aristotle International, Inc.(2000), Sightsound.com (2000) and GreatFood.com (2000) acquired by 1-800 FLOWERS.com.

IPO Underwriting 2000 (percent)

Online 9.9

Broker-Dealers

90.1

Wit Soundview

W.R. Hambrecht

E*Trade

Charles Schwab

68 0.3

18

10

Source: Thomson Financial Securities Data

OpenBook Debt IssuesIssuer Year Amount Role

Dow Chemical 2000 $300.0 Platform*

W.R. Hambrecht + Co.

OpenFollow-on Secondary Equity IssuesIssuer Year Amount Role

* First on-line auction of corporate debt.

FT, March 10, 1999


Secondary Financial MarketsForex (Atriax [defunct 2002], Currenex, Fxall (34 Banks), FX Connect)Governments (Bloomberg Bond Trader, QV Trading Systems, TradeWeb EuroMTS)Municipals (QV Trading Systems, Variable Rate Trading System)Corporates (QV Trading Systems)Government debt cross-matching (Automated Bond System, Bond Connect, Bondnet)Municipal debt cross-matching (Automated Bond System)Corporate debt cross-matching (Automated Bond System, Bond Connect, Bondlink, Bondnet Limitrader, BondBook [defunct 2001])Debt interdealer brokerage (Brokertec – 13 firms, Primex)Equities – ECNs (Instinet, Island, Redi-Book, B-Trade, Brut, Archipelago, Strike, Eclipse)Equities-cross-matching (Barclays Global Investors, Optimark)Research (Themarkets.com)


End-user Platforms:

Corporate finance end-user platforms (CFOWeb.com – now defunct)

Institutional investor utilities

Household finance utilities (Quicken 2001, Yodlee.com)

PC-Based Personal Finance Platform

EmployeeCredit Union

Fidelity401(k)

Account CitbankMastercard

Account ChaseCheckingAccount Schwab

BrokerageAccountWashington

Mutual HomeEquity Loan American

ExpressAccount

Home PC

Quicken 2002Platform

Prototype On-Line Personal Finance Platform

SchwabBrokerageAccount

HouseholdFinances

ChaseChecking Account

AmericanExpressAccount

EmployeeCredit Union

WashingtonMut. HomeEquity Loan

CitbankMastercard

Account

Fidelity401(k)

Account

WebserviceServer

Home PC or

Other Device











Banks (A)




Loans &Advances


Governments




Governments


Vehicles


It is not the strongest of the species that survive,but rather the mostadaptable to change.

- Charles Darwin

financial services dynamics - new york universitypeople.stern.nyu.edu › iwalter › globe ›...

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