Investment Banker Terms
Sometimes, people get involved in a situation or conversation and have no idea what is going on. The lingo is foreign to them. Investment banking is one of those fields where hardly anyone except the professionals have any idea what is going on. A little knowledge of some banking terms may help unravel some of the vague and unfamiliar happenings perpetually occurring in the bond markets, merger and acquisition arenas, and the investment community.
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Investment Banks
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An investment bank usually does not take deposits from the average investor. An investment bank provides financial services to corporations, governments, organizations and other financial institutions. Their services include raising capital for their clients and organizing and managing mergers and acquisitions.
The Job of Investment Banker
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Investment bankers nurture business relationships and develop, organize, administer and monitor capital ventures. They raise capital by issuing new stocks and bonds, place private equity positions for small companies, and organize mergers and acquisitions. Investment bankers help companies analyze and evaluate investment possibilities and create financial plans. They work with municipalities and governments worldwide. The banking team includes the lead investment banker and additional investment professionals and staff that work on a particular deal.
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New Bond Offerings
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One of the most common business deals investment bankers coordinate is the issuance of new stocks or bonds for municipalities and corporations. Bankers act as intermediaries or middlemen between the company issuing the securities and potential investors. Companies do not themselves do the work of issuing stocks or bonds and selling them directly to investors. They hire an investment bank to handle the deal. The bank does what is called the underwriting. The bank buys and distributes the bonds to dealers who sell the bonds to investors. The investment bank buys the securities from the company at one price, marks them up and sells to investors at a higher price. The selling price is called the public offering price. The difference between the buy and sell price is the spread.
The Contract
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When a bank agrees to work with a company, a contract is negotiated. Covered transactions are activities the investment bank completes for a fee. Carve-outs are jobs other organizations are hired to do. The term of engagement is the length of time covered by the contract. Underwriting contracts last on average six months to one year. Sometimes a deal closes after the time period specified by the contract. The contract will indicate a length of time after the contract end date, called the tail period, when a project successfully closed results in the investment bank receiving their fee. The tail period can last anywhere from six months to two years. An indemnification clause is part of every investment contract. This clause protects the investment bank from lawsuits and any claims resulting from the investment banking deal except those arising from gross negligence or willful misconduct.
A Syndicate
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Offerings of large quantities of bonds may be too large for one company to handle, or to want to process themselves. The bank takes a risk buying securities and reselling them. There is always the possibility all of the securities will not sell. A bank does not want to buy all the bonds and be left with unsold inventory. To minimize risk, banks form a syndicate. Two or more banks agree to share the risks and rewards of underwriting an offering.
Firm Commitment vs. Best Efforts
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An investment bank has three choices when agreeing to underwrite a bond offering. They can agree to buy all of the bonds and resell them. This is a firm commitment. They can agree to a best efforts deal. This is a conditional agreement. The bank markets the securities without underwriting the securities. In other words, the bank does not buy the bonds outright. They are acting as an agent. An agent receives a commission for the bonds sold. If the bank owns the securities and resells them, the bank is acting as a principal. The third option available is a standby commitment. The bank agrees to do everything it can to market the securities, and agrees to purchase any unsold securities.
Underwriting
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Financial transactions involve a lot of paperwork. Underwriting a securities issue involves preparing the Securities and Exchange Commission (SEC) registration statement, forming and managing a syndicate, developing a selling consortium, and pricing the security. Pricing involves pegging the price during the offering and distribution period. Pegging maintains a stable price before the securities are available for sale. Information is disseminated to prospective dealers and investors before the initial issue and sale date. A set price is established and preserved during this period.
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