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Investment Banking

Industry Overview

Investment banks are experts at calculating what a business is worth, usually for one of two purposes: to price a securities offering or to set the value of a merger or acquisition. Securities include stocks and bonds, and a stock offering may be an initial public offering (IPO) or any subsequent (or "secondary") offering. In both cases, I-banks charge hefty fees for providing this valuation service, along with other kinds of financial and business advice.

When banks underwrite stock or bond issues, they ensure that institutional investors, such as mutual funds or pension funds, commit to purchasing the issue of stocks or bonds before it actually hits the market. In this sense, I-banks are intermediaries between the issuers of securities and the investing public. I-banks make markets to facilitate securities trading by buying and selling securities out of their own account and profiting from the spread between the bid and the ask price. In addition, many I-banks offer retail brokerage (retail meaning the customers are individual investors rather than institutional investors) and asset management services.

Not surprisingly, the center of this industry rests in the lofty aeries above Wall Street and Midtown in New York City. Other hot spots include London, San Francisco, and Silicon Valley. Firms also compete in Frankfurt, Tokyo, Hong Kong, and other foreign markets 24 hours a day.

Cooldown
As the global economic climate cools down, so has investment banking. In 2001 and 2002, I-banking heavyweights Credit Suisse First Boston, Merrill Lynch, JPMorgan Chase, and Goldman Sachs all laid off a significant chunk of their employees. But the bulge-bracket firms were not the only ones to feel the pinch of thinner profits-or to react by cutting costs via layoffs. In 2001 alone, approximately 30,000 Wall Street workers were laid off. Also, I-banking bonuses, which can comprise half or more of some employees' total annual compensation, fell by some 30 percent in 2001. I-banks have also pulled back on college and MBA recruiting-but, because it's cheaper to employ a recent grad than someone with more experience, there are still jobs to be had for the cream of the crop from the best schools. More than ever, though, those who do I-banking internships will have the best shot at full-time openings.

Deregulation and Financial-Services Consolidation
Investment banking has witnessed a rash of cross-industry mergers and acquisitions in recent times, largely due to the late-1999 repeal of the Depression-era Glass-Steagall Act. The repeal, which marked the deregulation of the financial services industry, now allows commercial banks, investment banks, insurers, and securities brokerages to offer one another's services. As I-banks add retail brokerage and lending to their offerings and commercial banks try to build up their investment banking services, the industry is undergoing some serious global consolidation, allowing clients to invest, save, and protect their money all under one roof. Coupled with a slowing economy, these mergers have also triggered layoffs, as I-banks make an effort to cut spending and reduce overlap. Among the recent M&A; activity: Donaldson, Lufkin & Jenrette was acquired by Credit Suisse First Boston; J.P. Morgan and Hambrecht & Quist were swallowed by Chase; Robertson Stephens was acquired (and then dumped) by FleetBoston; and Alex. Brown was acquired by Deutsche Bank.

PR Nightmare-Or Something Worse?
The swing in the markets from up, up, up to down, down, down focused a lot of scrutiny on firms on the Street. The biggest issue so far has been whether banks overrated the investment potential of client companies' stocks intentionally, deceiving investors in the pursuit of favorable relationships and ongoing banking revenue opportunities with those companies. The outcome: a regulatory settlement released Dec. 20, 2002, directs the nation's largest securities firms to pony up $450 million over five years to buy stock reports from independent-research firms, ones not involved in I-banking. This means investors will be able to view at least one research report that was developed outside of the brokerage firm with which they have dealings. As well, I-banking firms have been mandated to put stock ratings from various sources on brokerage statements sent to investors after they buy a stock. Citigroup/Salomon Smith Barney, Credit Suisse First Boston, Goldman Sachs, and Morgan Stanley will also have to pay fines of $50 million on up. And a restitution fund will be put into place for investors burned in such dealings.

Of course, a lot of the details still need to be worked out, such as when this regulatory settlement is to take effect and what makes a research firm truly "independent." These types of issues and other potential quagmires put into question how effective this settlement will be. According to the New York Attorney General Eliot Spitzer, all changes will take place before the end of 2003.

The Bulge Bracket
There's no clear and uniformly accepted definition of this group, but it basically includes the biggest of the full-service investment banks. This is the group that matters most in investment banking, and their names confer distinction, whether you're a start-up with an IPO to sell, a Fortune 500 company planning an acquisition, or a job seeker sending out rÈsumÈs. Merrill Lynch, Morgan Stanley, Goldman Sachs, Citigroup/Salomon Smith Barney, Lehman Brothers, Credit Suisse First Boston, and JPMorgan Chase hold top spots in this bracket, at least for the moment. A whole host of others fall into the second tier of major players, including Bear Stearns and UBS Warburg, the investment-banking division of the giant Swiss bank, UBS.

Boutiques and Regional Firms
Obviously, the investment banking world extends beyond New York and the bulge bracket, but the list of small firms is getting smaller as the market consolidates. The strongest boutique firms-Hambrecht & Quist, Montgomery Securities, and Alex. Brown-have all been acquired by commercial banks. But that's not to say independent firms are nearing extinction. The equity markets are strong, and that means big business for niche firms focusing on technology, biotechnology, and other high-growth industries. In New York, Allen & Co. and Lazard FrËres still do big business in specialized fields. Volpe Brown Whelan and Thomas Weisel are Silicon Valley firms capitalizing on their technology connections and expertise.

Investment banking is one of the best ways a young person can learn about finance and make a lot of money right out of school. Even if you ultimately decide to reclaim your personal life by pursuing other options, the skills you learn on Wall Street will be valuable in most business careers.

But before you can cash in on those potential returns, you'll have to put up with some very substantial hardships, including high pressure, long days and nights of hard work, a few difficult personalities, and the expectation-no, the requirement-that all personal plans are subject to the demands of work.

In addition, you'll find that life on the Street is very much at the mercy of the markets. Bull markets bring more work to do than is humanly possible, but you'll be rewarded with a paycheck that can sometimes double year-to-year. Bear markets can leave you sitting at your desk with a pile of deals on hold, hoping that the rumored layoffs and smaller-than-usual bonuses don't come to pass. Despite this inherent uncertainty, the field remains a popular destination for undergraduates and MBAs. And, because of the current difficult economic environment, count on competition for open spots in investment banking to be especially stiff.

Still, firms are always looking for new (read: cheaper) bodies; even though they certainly aren't hiring to the extent they did a couple of years back, banks are still bringing on best-and-brightest hires for analyst and associate programs by way of summer internships for the most part. As one recruiter puts it, "We'll never not hire new talent, even during a merger, even during a downturn."

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