BAUER FINANCE JOURNAL

Letter from the President Pg 1

Mines in the Mediterranean

Bankruptcy Laws Update Pg 2

Private Equity Outlook Pg 3

The Moodys Warning Pg 3

Congressional Budget Office Pg 4

Journal 1 February 18 2013

Pg 1

Dear Reader, I would like to thank you for taking the time to read our journal pieces. It is an honor for me to present the first journal to be published by the Investment Banking Scholars Club and the first Finance Journal at the Bauer College of Business. The Investment Banking Scholars Club is made up of passionate, intelligent, and personable Bauer College Undergraduates and Graduates. We are the most selective club on campus made up of 49 members after an acceptance rate of 11% and an average GPA of 3.7. Requirements to join the organization are a minimum 3.5 GPA, Honors College enrollment, or holding Graduate student status along with passing an interview process. Enrollment is not limited to the beginning of the semester and we encourage those interested to contact our recruitment team at uhibscrecruitment@gmail.com. We are supported by an Ivy League faculty through Dr. Praveen Kumar and Lindsey Honari. We engage in rigorous training for interviews and nationally held case competitions as well as plan to host an on campus case competition. Our recruitment, speakers, and networking opportunities encompass a majority of the Bulge Bracket and Middle Market investment banks, as well as many Boutique banks. Please read through our journal pieces and feel free to give us feedback. We would love to hear from you. Respectfully, Robert Dozortsev President, Investment Banking Scholars Club C. T. Bauer College of Business at the University of Houston

Mines in the Mediterranean Devin Wold Just over seven months after the write down of Greek debt, much of the Euro zones fears about the possibility of defaults and contagion have abated. This being said, a small island in the Mediterranean is generating a lot of attention as it threatens to rekindle old nightmares of undercapitalization and large banking losses. The situation the island of Cyprus finds itself in cannot be easily attributed solely to their own errant decision making. A much larger factor is the Greek bailout itself. As can only be assumed is resultant of their close proximity to Greece, Cypriot banks have held a large proportion (relative to their total assets) of Greek debt. The result is large, if not catastrophic losses and a sudden reduction in available capital following the write down of debt. For a sense of scale, the range of estimated Cypriot funding needs lie anywhere from 7bn($9.5bn) as estimated by Vassos Shiarly the Cypriot finance minister, to 10bn($13.5bn) from Pimcos provisional analysis. In either case, for the small nation of Cyprus, with a GDP of approximately 18bn($24bn) the quantities are immense. Like many other European states in the wake of an ever growing chain of crises, Cyprus finds itself in a fragile state that may serve to exacerbate potential contagion. Due to the size and nature of its predicament, Cyprus is left with few options beyond bargaining for foreign aid. Luckily for Cyprus and its residents, Russian Prime Minister Dmitry Medvedev has already (Cont pg 2)

Page 1

BAUER FINANCE JOURNAL

(cont from pg 1) promised to provide a degree of aid assuming Cypriot governors meet a set of conditions defined by the European Commission. Additionally the Troika which consists of the International Monetary Fund, the European Commission, and the European Central Bank can ill afford to sit idly by while Cyprus spirals further out of control. Following the long drawn out argument resulting in the agreement on Greek debt, the Troika vowed to allow nothing of the sort to occur again. It seems likely that this is a short term boon to both the financial world and Europe as a whole. Cyprus is simply an example (fortunately a small one) of the intricate web that connects all facets of world finance. We can only hope it does not serve to demonstrate the way foreshocks from a seemingly small problem can radiate outwards and result in financial and political disaster. If not dealt with carefully, Cyprus ability to threaten tho se around it may dwarf what was expected in the case of Greece. The concerns in Cyprus bear far more resemblance to those recently seen in Spain than those in Greece. The crisis for this nation is with its banks, not its public debt. The Cypriot banks hold in deposits around 70bn. Due to the popularity of Cyprus with the wealthy of Russia it is estimated that 10-35% of these deposits in fact tie directly to Russian entities. Although a default would obviously be extremely detrimental to a number of Eurozone nations, the impact in Russia would be the most noteworthy. The situation Russia currently finds itself in, both politically and economically, makes it uniquely vulnerable to certain types of events in the region. This is not to say that Russians or any invested in them have made egregious errors, only that due to the ambiguous nature of European banking networks, seemingly small events may set into motion a chain reaction reaching much further than ever thought possible. To paraphrase Mark Buchanan: In the world of finance, as in almost all complex systems, beginnings bear little relationship to endings. To tie a BRICS recession to the banking crisis of a tiny nation may sound like nonsense but many would have said the same thing not long ago if told securitized mortgages in the U.S. would put the majority of small nations in Europes periphery in very real d anger of bankruptcy. The best course of action for Cyprus and the neighbors with whom it interacts is far from well defined. A chain of bailouts is something that would obviously diminish the already falling support for the Troika. However, when it comes to taking action in something so small it amounts to only 1% of the European Stability Mechanism (ESM) funds; all possible consequences should be weighed and considered against the very real possibility that inaction may be the best action. The true chain of events to follow any intervention is nearly impossible to know until after the fact. As a result, the fickle nature of the public puts the decision makers in a difficult position that can often feel like taking action and moving forward is no more deterministic than a roll of the dice.
Bankruptcy Laws in the US Evan Blandford The bankruptcy law plays an important role in the economy of each nation since a favorable law will promote the start-up business, entrepreneurship and increase the growth and innovation. Specifically, a more lengthy and costly process of filing bankruptcy case will discourage the entrepreneur to open a business. We can see the relation between the length of average bankruptcy case with the development of nations economy. According to Seung-Hyun Lee (University of Texas at Dallas), Yasuhiro Yamakawa (Babson College), Mike W. Peng (University of Texas at Dallas), and Jay B. Barney (Ohio State University), the time is about 5.5 years in Chile, 3.3 years in Turkey. On the other hand, it is only 0.8 years in Canada and 0.9 years in Belgium. As stated by the World Bank in 2008, in United States, the cost of bankruptcy is about 7 percent of a firm asset versus 36 percent in Thailand. Another good point in the US bankruptcy laws is that it allow the current managers to take the role to control and initiate the reorganization plans. In Britain, for example, this role will be controlled by the creditors. Its definitely a plus in our law because it will give the business owner, especially the small business entrepreneur to rebuild their company and make success in the future. Its not rare in United States when we hear that many of todays biggest companies were built from failure. For instance, Walt Disney has failed 7 times during the time he built his Disney regime. The bankruptcy law changes will affect firstly and most significantly small businesses and entrepreneurs

Page 2

BAUER FINANCE JOURNAL

Economic Outlook on Private Equity Deals Larry Rook The perception among the investment banking commercial lending private equity world is that the number of mergers and acquisitions in 2012 have declined in year-over-year comparisons. And in truth, the data appears to support that. Overall volume is down, as are the number of deals, according to market data from Pitchbook, the industry tracking journal. While some slowdown was expected as a result of global macroeconomic factors (Eurozone economic recovery woes, Greek sovereign debt and contagion fears, the slowing Chinese economy, etc.), these factors have not completely satisfied analysts. The depressed activity in the PE market is the result of several smaller but more numerous factors that together create a wave of bad news and fiscal pressures that have subdued activity in the private equity and investment banking market. Some of the lackluster performance can be explained in activity going into 2011s 4th quarter. Many deals were hurried through in order to come to completion before years en d as banks pushed to meet their performance targets for the year. This created a natural lull in activity as the first of the year started. Expect to see a small flurry of activity as this year closes as bankers and their teams repeat the same process this year, racing the calendar to close out business before years end to meet their performance goals. Starting in October and continuing through the end of the year expect to see a pickup in activity in this market. Additionally, increased scrutiny has become commonplace in the market as companies pay closer attention to the fundamentals, screening each potential deal with a finer sieve to make sure their investors money (as well as their own) is more wisely applied. This naturally adds to the timeline necessary to complete each deal, even with the ubiquitous round-the-clock activity of the investment banking houses. One of the biggest factors continues to be funding, as the growth in the number of loans continues to be tepid. The data indicates it is still stubbornly low in comparison to its long-term average multiple close to .50. Consider the current loan growth multiple of .31 against a backdrop of .064 during the Great Depression, when banks simply had no money with which to do funding, and the heady days of 2001 where loan growth multiples peaked at 1.75. Also affecting this have been LIBOR loan spreads, which have dwindled from an average spread of LIBOR+450 bps (2009) to LIBOR+200 bps (200). Additionally, these loans are more and more asset-based. Safer for banks, but longer in the approval process and fewer people in the marketplace. The future looks brighter, however, as banks have been seeking good deals to loan money to. Truthfully, banks make profits when they loan money out, and as they sit collectively on mountains of cash they desperately seek to plow their money into the market. But they must be selective, as they cannot take as much risk per deal in the current market. So while the money is ready to be deployed, not enough opportunities have come before the decision-makers that look like higher probability profit-makers. Net sum: put together the right deals, and the money is there. Good for you. Good for the banks.
Moodys Not Pleased with Jeffries Executive Pay Sameed Gagai Earlier this week Jeffries issued a $78 Million compensation package to its top executives. As part of the $78 million pay package, Jeffries CEO Richard Handler will get a 2012 pay package of $19 million in cash and stock. Handler was one of the few CEOs on Wall Street to see a significant rise in his 2012 pay package, up 36% for last year. On top of that Handler was issued $39 million worth of restricted stock through 2015 if he met certain performance targets. The Jeffries board said they were happy with Handlers performance for the year. The biggest driver to that was the sale of Jeffries to Leucadia National, the banks biggest shareholder, for a premium of 24 percent. Handler is also directly involved in some of Jeffries businesses (Cont pg 4)

Page 3

BAUER FINANCE JOURNAL

(Cont from pg 3) including stock trading, investment banking and investing in junk bonds. This caught the attention of Moodys Investors Group. The credit agency said that the payouts are what is known as credit negative for the investment banks bond holders. Credit Negative indicates that the pay could contribute to a downgrade of the investment banks debt rating. While Jeffries has out performed its peers, an excessive focus on short term compensation has been the root of many outsized trading, credit and litigation losses at the investment banks, Moodys analyst Peter Nerby and Christian Plath wrote in a note published on Monday. Nerby and Plath also believe that the compensation amounts and short vesting period could spur excessive risk taking, which is contrary to one of the boards objectives. Contrary to Jeffries near-term compensation strategy, most of the larger banks on Wall Street are cutting back on cash bonuses to better align employees with the long-term success of the bank.

Congressional Budget Office and the Failure to Accurately Represent Proposed Budget Implications Jason Doan Time after time the CBO or Congressional Budget Office has failed to accurately represent proposed budget implications. Throughout its existence the CBO has inaccurately depicted forecasts on various projections. Two notable economists, Kevin Kliesen and economic adviser Daniel Thornton, wrote last year in the Federal Reserve Bank of St. Louis Review that, in 2000, after more than 40 years of nearly consecutive budget deficits, both the White Houses Office of Management and Budget and the CBO projected decade-long budget surpluses. Additionally, both agencies projected that publicly held government debt (then totaling $3.5 trillion in 200) would be completely eliminated by 2010. The reason could not have been because of a financial crisis at stake since publicly-held government debt had increased to over $5 trillion before the crisis began. Instead of government debt being wiped out as projected by the CBOs forecast, government debt increased to over $9 trillion by 2010. Another failure to accurately fo recast budget implication was back in January 2001, when the CBO projected a cumulative surplus of $5.6 trillion between 2002 and 2011. Instead, the government ran a cumulative deficit over the 10 year period of about $6.2 trillion. Other CBO projections have been off as well - like its economic growth forecasts. Projections indicate a bias direction of either under projecting the size of the deficit or over projecting the size of the surplus. The large part of the problem that the Congressional Budget Office has is that, by law, the CBO is confined because it cant include in its forecasts any of its own judgments about decisions made by federal and monetary policy makers. Unlike private sector forecasters, the CBO cannot anticipate future changes in fiscal or monetary policy. Instead it must adhere to strict rules when scoring legislation. By law, it essentially must assume that existing Washington policies will stay the same and never change the same policies that govern outlays and receipts will prevail over the projection horizon. The CBOs problem is not that it cannot predict the course of the economy, it is that it cannot predict the decisions made by policymakers that restrict CBOs forecasts. This contradicts CBOs non -partisan view on its forecasts. All in all, this poses detrimental effects toward policy makers in that relying on CBO forecasts can lead the economy in the wrong direction. Congress should be able to change such laws that remove the restriction against CBO so that they may make a more accurate judgment on the economies budget implications.
Brad McDonald Editor-in-Chief UHIBSCEditor@gmail.com For all other inquiries please contact Evan Blandford (Secretary) at UHIBSCSecretary@gmail.com CBB Suite 539, 4800 Calhoun Road, Houston, TX 77204 832-842-4178 (Presidents Office)

Page 4