Merchant Banking

• Merchant bank is an institution which

provides services to corporate such as
flotation of new venture and companies,
preparation, planning and execution of
new project, consultancy and advice in
technical, financial and managerial field,
restructuring of business, mergers and
acquisitions etc.
 Issue Management
• A major function of merchant bankers
• It involves following functions in respect of
issue through prospectus.
– Obtaining approval for the issue from SEBI
– Arranging underwriting
– Drafting prospectus and obtaining clearance
from stock exchange, auditors, ROC etc
– Drafting other documents like application
form, newspaper advt.etc
Functions of MB for issue through
prospectus contd….
– Selection of brokers, bankers to the issue and
finalising terms and conditions
– Coordination with brokers, bankers,
underwriters and stock exchange
– Receipt and processing of applications and
preparation for the allotment
– Arranging for listing of securities
 Other functions of MB
• Pre investment studies
– Feasibility study in a specific area
– Study for joint ventures by foreign companies
in India
– Advice on Govt. regulatory factors
• Project Finance
– Estimating and deciding pattern of financing
– Arranging for the finance
– Legal assistance
 Other functions contd….
• Portfolio Management
– Providing advice on selection of investment
– Undertaking investment in securities
– Safe custody of securities
– Collection of return on investment
– Carrying out critical evaluation of investment portfolio
• Working capital finance
– Assessment of working capital
– Arrangement for working capital
 Other functions contd….
• Merger and acquisition
– Examining pros and cons of M & A
– Obtaining approval from stake holders
– Monitoring implementation of M & A
– Assisting in compliance of legal requirement
• Foreign currency financing
– Arranging for foreign currency loans
– Providing guidance for exchange risk
mitigation
 Other functions contd….
• Loan syndication
– Helps in procurement of term loan and working capital
from banks / FIs
– Preparation of project report
– Identifying source of finance
– Submission of proposal for appraisal
– Obtaining sanction
– Documentation and creation of security
– Getting disbursement of loan to the client
 Code of Conduct for MBs
prescribed by SEBI
• Integrity and fairness in dealing
• Quality service
• Best advice
• Secrecy
• Providing correct information to the client
• No unfair, unethical practice for
manipulation in the market
• Compliance of rules and regulations
 Need for MBs
• Growing industrialisation
• Helps small and medium enterprises
• Growing complexity in rules and procedure
• Exploring possibility of joint ventures
• Promoting new issue market for saving
mobilisation
 Credit Rating
• Rating is an opinion on the future ability of
the issuer to make timely payment of
principal and interest on a specific security
• It is process of assigning value to credit
instrument by estimating the solvency to
repay debt and expressing them through
pre determined symbols
 Features of CR
• It is done by specialized institutions
• It can be for both equity and debt
• Whole organization is not graded
• It does reflect issuer's strength
• CR may be different for different
instrument issued by the same company
• It is done on the request of the company
issuing the instrument
 Features contd….
• It is done on the basis of the information
provided by the organization
• CR agency also find out some information
independently
• Factors like operating efficiency, market
position, industry risk, track record,
profitability, liquidity, assets quality etc are
taken into account for rating
 Features contd….
• After rating is assigned it can be monitored
by CR agency over entire life of the
instrument and rating can be changed or
suspended
• It is not a recommendation to buy or hold
the security
• No guarantee for the accuracy of the
information on which rating is based
 Objectives of CR
• To provide superior and low cost
information to investor for investment
decision
• It imposes discipline on the borrower
• It helps regulatory authority, merchant
bankers, brokers etc
• It is a marketing tool for the issuer
• It encourage better information disclosure
and accounting standard
 Rating Methodology
I. Business Analysis
• Industry risk analysis
– Demand supply position, future potentiality,
Govt.policy
• Market share of the firm
– Marketing strength and weaknesses
• Operating efficiency
– Production process, cost structure
• Legal position
– Statutory process, filing of returns
 Rating Methodology
II. Financial Analysis
• Accounting quality
– Income recognition methods, inventory
valuation, off balance sheet liabilities
• Earning protection
– Profitability ratio, projected earning
• Financial Flexibility
– Alternative financial plan
• Adequacy of cash flow
 Rating Methodology
III. Fundamental Analysis
• Liquidity management
– Study of capital structure, matching of assets
and liabilities
• Assets quality
– Credit management, composition of assets
and risk analysis
• Interest sensitivity
– Exposure to interest rate change, hedging
policy
 Rating Methodology
IV. Management evaluation
• Management goals, philosophy,
strategies, capacity to overcome adverse
situation
 Country / Sovereign Ratings
• Entire country is rated
• Provides information to global investors to
make decision about investment
• It is done by globally recognized
authorities on assessing credit risk
• Largest rating agencies are
– Moody
– Standard and Poor
– Fitch
What is sovereign credit rating?
• The rating scale ranges from AAA to D
• AAA are the richest economies mainly
located in North America / Europe
• Country like Japan, Singapore, Australia,
New Zealand also included here
• D signifies default
 Other ratings
• Between AAA and D following ratings are
found ( Moody and S&P )
– Aaa / AAA Caa / CCC
– Aa / AA Ca / CC
–A/A C/C
– Baa / BBB D
– Ba / BB
–B/B
 Other ratings contd….
• Each letter grade is further subdivided into
three divisions
– For e.g. A1, Baa 2, Ba 3
• Ratings of Baa 3 and above are
considered to be of an investment grade
 How rating are estimated?
• Combine quantitative & qualitative factors
– Political Risk
– Income and economic structure
– Economic growth prospects
– Fiscal Policy
– Debt Burden
– Monetary Policy
– External Liquidity
– Pub. / Pvt. Sector external debt burden
 Political Risk
• History of peaceful democratic
development
• Transparency of political institutions
• Developed civil institutions
 Income and Eco. Structure
Eco. Growth prospects
• Per capita GDP
• Average of other countries in the same
category
• GDP projection rate
 Fiscal Policy
Debt Burden
• Extent of fiscal deficit
• Average of other countries in the same
category
• Debt / GDP ratio
• Average of other countries in the same
category
 Monetary Policy
• Monetary management by Central Bank
• Inflation control
• Net foreign assets of banking sector
 External Liquidity
• Current account deficit
• Balance of Payment Position
 Pub. & Pvt. Sector External debt
burden
• Ratio of external debt of public sector to
GDP
• Ratio of external debt of private sector to
GDP
 Significance of country ratings
• Encourage FDI and portfolio flows
• Support foreign trade
• Lowers borrowing cost of the Govt.
• Vote of confidence in stability and growth
prospects of the country