Corporate Banking - An Overview

A brief, generic guide to corporate banking for beginners.

Overview: 

Corporate banking is a broad category within finance that primarily involves sell-side services to corporate clients, typically large corporations. As mentioned in the previous post, corporate banking revolves around traditional banking services like loans, cash management, and trade finance. Its core purpose is to satisfy a company's financial needs, e.g. raising capital for working capital, expansion activities etc, while cultivating strong client relationships.

Key Services:

1) Relationship Management (Coverage): Focused on business development through enhancing and establishing client relationships - the relationship managers. The modus operandi of this team is to develop relationships to facilitate cross-selling of multiple products to any one client to maximise banking revenue while optimising costs (e.g. KYC, opportunity cost, and client acquisition).

Note: Not all banks have the same structure/setup. For example, some banks may have a dedicated, sector-agnostic coverage team to focus on relationship management, while other banks have sector-specific coverage bankers who focus on that particular sector. Both have their pros and cons, but it is important to note that both roles entail different skill sets and strategies.

2) Corporate Finance: Relates to debt financing to corporations, including (a) general corporate lending like vanilla term loans and revolvers; (b) acquisition financing; and (c) dividend recaps.

3) Project Finance: Relates to raising capital via long-term debt for large-scale infrastructure or industrial projects, ringfenced to a specific project. A special purpose vehicle ("SPV") is created through which cash flows are channelled. Risk is primarily predicated on the project's own cash flows and assets, and is generally non-recourse to the sponsors.

4) Asset Finance: Relates to raising capital secured against a tangible asset, such as a ship, equipment or machinery. It is a corporate-level financing and typically has recourse to the sponsor.

5) Transaction Banking (Cash Management & Trade Finance): Primarily provides solutions to help clients optimise their liquidity and facilitate business transactions. These include bank guarantees and cash accounts for payments.

6) Corporate Sales (FX/Rates): Supports the clients' FX and hedging needs.

7) Capital Markets: While the ECM and DCM businesses typically sit separate from corporate banking, they may work hand-in-hand when a large corporate requires more capital and intends to do so via issuing debt or equity. 

Corporate and Investment Banks - An Overview

A brief, generic guide to the corporate and investment bank for beginners.

Overview: 

Corporate and investment banking is a highly coveted, dynamic, and rewarding area of finance. It is a division within the bank that provides a comprehensive suite of financial services to large clients, including corporations, governments, and other institutional clients. These services have one primary purpose: to help clients raise capital while effectively managing risks. This section of the bank is constantly at the forefront of global events and market movements to stay ahead of the competition.

Key business lines:

1) Capital Markets: Namely Debt and Equity Capital Markets (DCM/ECM), which helps clients raise funds via the issuance of bonds and shares respectively.

2) Corporate Banking: Traditional banking services including loans, cash management, and trade finance to corporate clients. As someone in corporate banking, I will elaborate on this in another post.

3) Sales & Trading: This refers to the global markets division, which involves buying and selling financial instruments, including FX and rates, commodities, and fixed income products.

4) Investment Banking: Advisory side, including M&A and other strategic actions.

The Three Offices:

1) Front Office: The client-facing division of the bank that is primarily responsible for generating banking revenue.

2) Middle Office: Bridge between the front and back offices, focusing on essential business operations such as risk, controls, compliance, and legal support.

3)  Back Office: Provides general operational and administrative services such as IT, human resources and accounting.

Japan's yield curve control and interest rates

All eyes are on Japan today for two reasons - incoming BOJ governor Ueda's first parliamentary hearing and Japan's yoy inflation report.

What's going on in japan with their ultra-low interest rates?
Japan's yield curve control (YCC) policy from 2016 was introduced to keep interest rates low and stable by intervening through buying and selling Japanese government bonds (JGB). This was to prop up the economy after years of sluggish growth by lowering the cost of borrowing to boost investments and spending. Its target for the 10-year JGB yield was 0% but it recently increased its cap to 0.50% after coming under attack from other markets speculating about an upcoming interest rate hike in the face of its highest inflation in the last 40 years.

Significance of Japan in the global markets
Japan has been the world's largest creditor for more than 3 decades, with more than $3t of net investments overseas (Reuters). In particular, Japanese investors hold a significant amount of foreign debt with about 50% in US assets and about 30% in eurozone securities. Last year, Japanese investors have already started to sell their US and Euro bonds because of increasing interest rates. If the BOJ decides to raise the bounds of the 10-year JGB yield, we might see more capital inflows from these sources back into Japan (an outflow from global markets could mean a crash). Furthermore, if the 10-year yields of the bonds from the world's largest creditor are raised, global borrowing costs will rise.

Current inflation backdrop
Japan is experiencing its highest inflation in 40 years at 4%, double the BOJ's 2% target (update: it is now at a 41-year high of 4.2%). Wholesale prices are up 9.5% yoy, putting pressure on the BOJ to give more slack to its YCC policy and cut back on its stimulus programme (Reuters). 

Japan's newly nominated governor
Ueda is expected to steer japan away from its ultra-loose monetary policy, but analysts expect this will not happen anytime soon - probably mid-2024 (CNBC). In his hearing, he mentioned that current low interest rates are appropriate, and BOJ would raise interest rates instead of selling its bonds if it was to phase out its stimulus programme. 

My thoughts on Japan's rates
The high inflation in Japan is unlikely to continue. Despite Japan's low unemployment rate of 2.50%, its workforce is decreasing and productivity has not been increasing over the long run. Manufacturing PMI has been decreasing over the last year, and retail sales are not particularly strong. One thing that prevents this is the weak yen which puts upward pressure on producer prices and imports. To ensure sustainable economic growth, Japan will need to look at increasing its labour force and productivity levels to increase its output and potential GDP. Its current low interest rates stimulus is expensive and unlikely to sustain its growth without growing labour and productivity, and while inflation is at a multi-decade high, it is still one of the lowest among other developed economies like the US and EU. Japan's rates may then depend on which is more pressing - economic growth or ability and willingness to defend its central bank against speculative attacks. Or, it may also be an in-between: phasing out stimulus but spurring economic growth through other means, such as reducing interest rates on financial institutions' reserves held by BOJ like Ueda mentioned. In the short term, the yield is unlikely to change by much, and any phasing out of the stimulus will probably only take place in the latter half of this year or next year. Yen might be a good-to-hold, but Japanese equities might take a hit from the increased input prices which will hurt its bottom line. JGB is also not as attractive in the face of the potential rate increase. 

Using ChatGPT to analyse stocks!

I recently saw a LinkedIn article on using ChatGPT to analyse stocks, so I decided to try it out on Coca-Cola (NYSE: KO):

Step 1: Understanding the business of the company
- Production and distribution of non-alcoholic beverages
- Revenue streams also include the sale of concentrate and syrup and bottling and canning operations, which produce and distribute the final product to consumers
- Sells to consumers through various channels, including retail stores, vending machines, and online platforms
- Other income streams include partnerships, sponsorships, and advertising

Step 2: Understanding the larger environment (SWOT)

Step 3: Evaluating financials
Revenue: Coca-Cola has seen steady revenue growth over the past few years, with revenue reaching over 31 billion USD in 2020. The company's revenue is primarily driven by its non-alcoholic beverage business, which includes well-known brands such as Coca-Cola, Sprite, and Fanta.

Expenses: The company's largest expenses are cost of goods sold (primarily the cost of ingredients and packaging) and marketing and advertising. In 2020, these expenses amounted to approximately 21 billion USD and 4 billion USD, respectively.

Profitability: Coca-Cola has a strong profitability, with a net profit margin of around 10% in 2020. This is higher than the average net profit margin for the beverage industry.

Growth Trends: Coca-Cola has seen modest growth in recent years, with a low single-digit increase in revenue and earnings per share. The company has been investing in its operations and expanding into new markets, which is expected to drive future growth.

Step 4: Key risks
1. Competition: The beverage industry is highly competitive, and Coca-Cola faces significant competition from both established players and new entrants. This could impact the company's market share and profitability.

2. Health and wellness trends: Consumers are becoming increasingly health-conscious, which has led to a decline in demand for sugary drinks like Coca-Cola. The company has been investing in healthier beverage options, but this may not be enough to offset declining sales of its traditional products.

3. Changing consumer preferences: Consumer preferences are constantly evolving, and Coca-Cola must be able to adapt to these changes in order to remain relevant. The company may struggle to keep up with changing consumer trends, particularly in the fast-moving beverage industry.

4. Economic conditions: The beverage industry is highly sensitive to changes in the economy, and a downturn could impact Coca-Cola's revenue and profitability.

5. Commodity price volatility: Coca-Cola's products contain a number of key ingredients, such as sugar and corn syrup, that are subject to price fluctuations. This could impact the company's costs and profitability.

6. Geopolitical risks: Coca-Cola operates in a number of countries around the world, and geopolitical risks such as economic sanctions, trade restrictions, and conflict could impact its operations and financial performance.

Step 5: Investment thesis

Overall, KO is a great defensive stock to invest in, especially during times of volatility and economic downturns. The company has a strong history, diversified revenue streams and strong brand recognition. Although consumer tastes and preferences might be changing, with strong management leaders and financial performance, KO should have sufficient dry powder to experiment and stay ahead of competitors.

Overall key learnings of using ChatGPT to analyse stocks:
- Able to discover potential weaknesses of competitors to see where companies can thrive and do better

- Able to efficiently analyse a company's business model and the industry for quick baseline understanding, but unable to contextualise this information in current markets

- Able to point out how to use discounted cash flow model to find the fair value of the stock, but unable to actually perform those calculations

- Limitation of information from its database - ChatGPT's database only contains information up till 2021

My thoughts:

ChatGPT is definitely a game-changer. We are able to find out an immense amount of information at our fingertips, at an even greater convenience than Google. From this example of stock analysis, it is able to provide several important pieces of information investors typically look out for without having to read its financial statements and company website. However, being an AI based on a database, the platform is limited to the information stored in its database - it cannot provide timely info that the stock market needs, only historical information. Even a typical retail investor looking for stocks to buy may refer to this for a brief description of the business, but it would be prudent to look at the company's financial reports for a more accurate understanding of the company.

Markets development - opportunities and challenges

I think markets have been evolving especially rapidly in the past few years since the onset of Covid. The various major market movers include Covid, the Russia-Ukraine war and China's now-abandoned Zero Covid policy (2022 markets wrap up here). These 3 major market movers have resulted in inflation in the majority of the world, from the US at 9.1% in June 2022, to Eurozone at 9.2% and Japan at 4% in December 2022. This is because of the supply crunch from factory and port closures in the last few years, coupled with the reduced commodity supply from Russia and Ukraine. Reduced supply of such commodities resulted in a spike in prices, driving up inflation. 

Central banks around the world are struggling to balance the impossible trinity - tackling inflation or generating economic growth or keeping to a target exchange rate. Notably, the US started the fight against inflation by raising rates in March 2022, as opposed to the ECB which started only in July 2022 because of recession fears. Several indicators point toward a drop in inflation in the US, except for the strong nonfarm payrolls last week, which delayed expectations of rate cuts from 2023 to 2024. Besides employment, the US savings rate has dropped to only 3.4% in 2022, and 47% of them make more than 6 figures a year (Yahoo). Thus, while prices are increasing, I think that people are perhaps sticking to their usual lifestyle more so than reducing spending, which will prolong inflation for a bit longer. On the east side, eyes are on BOJ's new governor to steer their Yield Curve Control policy which will have implications on the Japanese yen and global Japanese-owned assets. 

While market expectations have soured slightly, I think it is currently a risk-on environment, and commodities like iron and oil present opportunities, especially with China's reopening. Bond yields are expected to fall, so it would be good to hold on to high-yield investment-grade ones like US T-bills and Singapore's SSB, while we should remain cautious toward junk bonds like distressed debt, given the current economic environment. For currencies, AUD is expected to rise with its anticipated upcoming rate hikes, while JPY might not rise as much as expected because of the uncertainties surrounding the new governor. 

2022 Global Markets Wrap Up

2022 was a tumultuous year for the global markets. We've seen equities crashing $14 trillion (Reuters), the US bond market was the worst year on record (CNBC), and global currencies fluctuating. Here, I outline some of the major market movers of 2022.

1) Russia-Ukraine War
Russia and Ukraine supply oil and other commodities to other countries. The war reduced the supply, causing a spike in commodity prices, most notably oil. This fueled the fire of rising inflation. Thankfully, it was reported that a warmer-than-average winter resulted in lower demand for fuel for heating, preventing an exacerbation of oil prices. I think this will fuel the transition to alternative sources of energy like coal and (hopefully) other greener sources. 

2) Global Inflation and Recession Fears
Factory closures in 2020 and the energy crisis in 2022 reduced supply while demand increased. Shipping costs also rose -  shipping and oil companies get windfall profits because of the higher prices (see CMA CGM and Shell). The Federal Reserve expected inflation to be transitory, but it hit a record high of 9.1% in June 2022, and the Fed is still fighting it today. Interest rates went up by 25bp to 4.75% yesterday. Other central banks started raising rates later (Fed started raising rates in March 2022) on fears of an economic recession. ECB only started raising rates in July 2022, while BoE raised rates aggressively from 0.50% to 3.50% within a year, the highest in about 14 years since the GFC.

3) China's Zero-Covid Policy
Although now abandoned, the policy that ended in December 2022 had some repercussions. People could not travel, and economic activity was sluggish due to port, factory and highway closures (Santander). With China being the second biggest economy globally, reduced economic activity in China rippled through to the global markets.

What that means for the asset classes

1) Equities
S&P reported its worst performance (-19.4%) since the GFC in 2008, and DJI returned -8.9% (Reuters). Among them, tech was down significantly, with Amazon, Tesla and Meta down 51%, 68% and 66% (CNBC). 

2) Bonds
Bonds usually do well in a risk-off situation when people switch from equities to bonds for more safety. However, with the recession and interest rate hikes in 2022, bond prices and yields were hit left and right. With the rate hikes, bond prices fell, causing the "biggest spike" in the US 10-year Treasury yield since 1788 (Barrons). BoJ and its Yield Curve Control policy is a big topic. We've seen the BoJ controlling their 10-year rates at a strict 0%, which caused investors to jump to other bonds with higher yields and BoJ buying back bonds to maintain the 0% level. This would affect the yen.

3) Currencies
Yen depreciated against the dollar due to the difference in interest rates between US and Japan, which would have adverse implications, especially on inflation (happening now). On the European side, the euro fell to match the dollar for the first time in 20 years (see my blog post here).

4) Commodities
Oil prices increased due to the war, but decreased on fears of an economic recession leading to lowered demand. China's Zero-Covid policy was also an attributing factor. Supply of soft commodities was also reduced as Russia and Ukraine were major producers of crops, leading to higher commodity prices and inflation. This caused a spike in prices in 2022 (Trading Economics). Reduced gas led to higher take-up of coal. 

Just like the rooks, bishops and knights on the chessboard, major market movers like inflation, interest rates and war change the economic landscape. I believe that we can become better "big-picture thinkers" of investing by being cognizant of how these pieces intertwine and affect each other.

To look out for this week

 Mini update:

This week (week of 29th January 2023) we will see a lot of action in the markets mainly because of 2 main factors - central bank announcements and company earnings.

Central banks from the most powerful economies - Federal Reserve, ECB, and BOJ - are expected to announce rate hikes this week. Current rates are at 4.50%, 2.50% and 0.5%. 

ECB - expected to hike rates by 50bp in both February and March this year to curb inflation. With the 9.2% inflation in December and improving PMI report in the Eurozone, I think the ECB might have to further raise rates more than the anticipated 25bp in the second quarter of this year if this continues. 

BOJ - With Japan's yen falling over the last year, prices have increased substantially, causing a 41-year high inflation of 4%. BOJ has recently started to loosen its yield curve control policy from 0% to 0.5%, but analysts expect the rates to increase further.

Earnings season - Q4 earnings are coming. This week alone, there are 109 companies within S&P500 that will be releasing their reports, including megacap firms like Apple, Amazon and parent company of Google, Alphabet. 

I believe we will see a lot of movement in the markets this week, but with the earnings reports coming out, I think we will get some direction for the coming year in terms of whether inflation and rate hikes are set to continue, demand within the economy, and perhaps nonfarm payrolls further down the line. Nonfarm for January will be out on Friday.