1. Actuaries in Investment Banks
UNSW Presentation 3 May 2004
Students have this idea they want to work in
Corporates or Consulting
Life v GI or Investment Banking
But do you know what is Investment Banking

2. Agenda Investment Banks – History & Structure
Actuaries
Agenda
Investment Banks – History & Structure
Project & Structured Finance
Mortgage Backed Securities
Actuaries Role
Questions
Objectives:
To give an idea of how Investment Banks are structured
Where an actuary can work within them
The nature of the work.

3. Investment Banks History & Structure
Actuaries
Investment Banks
History & Structure
Why are they called Investment Banks?
Q. Who are the Players?
Q. How are they Structured?

4. Investment Banks History & Structure
Actuaries
Investment Banks
History & Structure
Why are they called Investment Banks?
Q to the floor – impressed if know the answer

5. Investment Banks History & Structure
Actuaries
Investment Banks
History & Structure
Q. Why are they called Investment Banks?
Glass-Steagall Bank Act 1933 (USA)
Separation of investment banking from commercial banking
The origins lie in the great depression in 1933 in the US.
A quarter of the formerly working population was unemployed & the nation's banking system was accordingly chaotic.
Over 11,000 banks had failed or had to merge, reducing the number by 40 per cent, from 25,000 to 14,000.
The governors of several states had closed their states' banks, President Roosevelt later closed all the banks in the country.
Congressional hearings into the failures at the time showed the bankers and brokers were guilty of disreputable and seemingly dishonest dealings and gross misuses of the public's trust.
The result was The (Glass-Steagall) Banking Act of 1933
The Act essentially erected a wall between commercial banking and investment banking, to counter the Banks perceived risky activities of securities trading.

6. Investment Banks History & Structure
Actuaries
Investment Banks
History & Structure
Investment Banking is the issuing, underwriting, selling, or distributing, stock, bonds, debentures, notes or other securities.
Commercial Banking is basically deposit taking and lending.
Commercial Banking = Savings & Loans
Explain Underwriting (market making)
ASIDE: Only Japan also has the separation (as after WWII they were forced to adopt the US banking statutes)
In hindsight, it was seen as an overreaction (even Mr Glass one of the original proponents tried to have the Act repealed).
One of the major reasons seen as a cause of collapse is the State based nature of the Banking system, which resulted in 90% of Banks having < $2m in assets. In the same period there were no failures at all in Canada which allowed Banks to operate Nationally.
ASIDE: US lawmakers later enacted the Bank Holding Company Act to create a barrier between banking and insurance, to prevent banks making losses from underwriting insurances
The Glass Steagall Act has actually been relaxed now

7. Investment Banks History & Structure Who are the players? Actuaries
Q to the floor

8. Investment Banks History & Structure Who are the players? Actuaries
Goldman Sachs
Merrill Lynch
Salomon Smith Barney / Citigroup
Morgan Stanley / Dean Witter
Lehman Brothers
CS First Boston Deutsche Bank
JP Morgan / Chase Manhattan ABN Amro
Macquarie Bank UBS
Global v Aus

9. Investment Banks History & Structure How are they structured?
Actuaries
Investment Banks
History & Structure
How are they structured?
Q to the floor on divisions (since must be a few people who think they want to work in Inv B’g)

10. Investment Banks History & Structure How are they structured?
Actuaries
Investment Banks
History & Structure
How are they structured?
Trading/Investing
Underwriting
Financial Advisory
Broking
Funds Management
Equity
Debt
Hybrids
M&A, Restructuring, Divestiture / Spin-Offs
Treasury
Commodities
Capital Management
Project & Structured Finance
Underwriting is the traditional “Investment Banking”
Trading / Investing is an add-on (not Investment Banking perse) – Stock brokers & Life Companies & Fund Managers
Financial Advisory also can be performed by others
NAB, Westpac all have investment or Institutional Banking Divisions
Accounting Firms (PWC, E&Y, KPMG) are also active (Corporate Finance Advisory or Taxation)
ASIDE Lately has caused all the issues of the original Glass Steagall Act about independence because of buy reccos in stocks the UW area was doing IPOs for.
Other Add-ons
Custodian
Financial Planning
Financial Advisory roles
Funds Mgt (eg Aus Share Fund,
fund manager: stock selection / sector selection / market timing or
research analyst: individual stocks or economic variables)
Lower pay
Quant funds
Broking (eg commissions)
Prostitutes of the Investment industry (> 50% have buy recco’s) slimy salesman
Rely on research analysts recos & experience of market vibe for directions
Easier hours & lower pay
Underwriting & Financial Advisory (Corporate Finance / Project & Structured Finance)
One area puts deals together, other arranges finances (sometimes Funds Management area will run a fun that provides the funds)
Financial Advisory areas:
M&A Predominantly the area of accountants/economists
No reason why actuaries cant work there, but no real skill set advantage, just intelligence
M&A (buying/selling companies) sounds exciting, but a lot of accounting, simple analysis (P/E) and also legal in due diligence /warranties&indemnities
Treasury – advice on the management of risks arising from interest rate, foreign exchange and investment markets.
Commodities - advice on risk management in areas of energy markets, the agricultural sector and resources (eg hedging)
Capital Management – optimisation of balance sheet debt/equity levels (eg share buybacks, private/public placements / IPO’s, rights offers)
Importantly, flash back to the players - different banks may be specialists in different areas

11. Investment Banks History & Structure How are they structured?
Actuaries
Investment Banks
History & Structure
How are they structured?
Further specialisation within Market Sectors.
Resources
Telco’s, Media, Entertainment & Technology
Financial Institutions
Industrials
Property
Understand Industries – special requirements
Carve up clients

12. Project & Structured Finance
Actuaries
Project & Structured Finance
Project Finance
Involves non-recourse financing of the development and construction of a particular project in which the lender looks principally to the revenues expected to be generated by the project for the repayment of its loan and to the assets of the project as collateral for its loan rather than to the general credit of the project sponsor.
Why Different to Bank lending?
Scale (is common in capital intensive industries)
Recourse / Guarantees
Multiple Investors/lenders (although top 4 banks do share risks on large commercial loans)

13. Project & Structured Finance
Actuaries
Project & Structured Finance
Project Finance
Q. Typical Projects?
Q to the floor

14. Project & Structured Finance
Actuaries
Project & Structured Finance
Project Finance
Q. Typical Projects?
Power Plants / Pipelines
Mining Facilities / Industrial Plants
Transportation Systems (eg toll roads, rail, airports)
Other Infrastructure (eg hospitals, prisons)
New concept? Social Projects – Infrastructure: Government shifted funding to the private sector

15. Project & Structured Finance
Actuaries
Project & Structured Finance
Project Finance
Q. So what do Actuaries do?

16. Project & Structured Finance
Actuaries
Project & Structured Finance
Project Finance
Q. So what do Actuaries do?
Model the future project cashflows
Model the future debt obligation cashflows
Identify & Analyse the risks
Determine & communicate the key assumptions
Set modelling assumptions
Past experience
Collateral data - Credibility issues
Overseas experience
Sensitivity Testing
Can do anything, from originate deals (where the big salaries & bonuses are) but the traditional actuarial skillset is in modelling (extends naturally to deal design)
Either build or review
for the lead manager
for an investor / fund manager
for the ratings agency
for the trustee
Now PF is really a subset of SF so will discuss most of these later, but my project was building the M2 motorway, what would be my project cash flows

17. Project & Structured Finance
Actuaries
Project & Structured Finance
Structured Finance
Put simply, it is finance that has been structured in some way that sets it aside from traditional lending
Encompasses:
Project Finance, as well as
Structured corporate finance (hybrid debt/equity)
Cross-border leveraged leasing
Subordinated Debt
Securitisations
Now I’ll focus on one aspect of structure finance - securitisations for the rest of this talk.

18. Project & Structured Finance
Actuaries
Project & Structured Finance
Structured Finance
Securitisation
Q. What is it?
Debt securities raised against a specific set of assets or cash flows.
Q. Why do it?
Cost of Funding
Access to Funding
Q. What is normally securitised?
Q’s to the floor

19. Project & Structured Finance
Actuaries
Project & Structured Finance
Structured Finance
Securitisation
Q. What is it?
Issuing securities against a specific pool of assets or cash flows (normally illiquid).
Q. Why do it?
Cost of Funding
Access to Funding
Q. What is normally securitised?
Pools of residential or commercial mortgages, car loans, credit card receivables.
Why?
Access to Funding (diversified sectors, demand deposits v wholesale market)
Also by putting assets off balance sheet can reduce capital requirements, and change ratings
Accounting
Why mortgages. Familiarisation with the asset class
The earliest securitised transactions date back to the early 1970s in the US and were the sales of pooled mortgage loans by the Government National Mortgage Association (Ginnie Mae). These transactions were followed by the Federal Home Loan Mortgage Corporation (Freddie Mac) and Federal National Mortgage Association (Fannie Mae) in the early 1980’s.
What else can be?
Virtually anything.
Other examples (insurance premiums, film receivables, lottery winnings, music royalties)
Now lets focus on the most common form of securitisation, a mortgage backed security

20. Mortgage Backed Securities
Actuaries
Mortgage Backed Securities
So what do Actuaries do?
Model the future project cashflows
Model the future debt obligation cashflows
Identify & Analyse the risks
Determine & communicate the key assumptions
Set modelling assumptions
Past experience
Collateral data - Credibility issues
Overseas experience
Sensitivity Testing
Q to the floor.
What is the Asset/Cash Flow item.
Why is it being securitised (eg Aussie Home Loans - access to funds)
Important to know the above is an Iterative Process

21. Mortgage Backed Securities
Actuaries
Mortgage Backed Securities
So what do Actuaries do?
Model the future project cash-flows for a Residential Mortgage Backed Security (RMBS)
Determine the types of mortgages in the pool
Variable v Fixed rate
Principal & Interest / Interest Only
Obtain relevant data (commencement dates, loan terms, loan amounts, loan type, fixed rate periods, interest only periods, interest rates)
Determine modelling methodology
Weighted pool v Individual loan projections
Timing and frequency of repayments etc
Understand & communicate important modelling assumptions
What is your model?
Principal repayments, interest repayments and balance outstanding at the end of every month until the end of all future loan terms.
Review Loan contract terms to understand products modelling

22. Mortgage Backed Securities
Actuaries
Mortgage Backed Securities
So what do Actuaries do?
Model the future debt obligations
Tranches of Securities / Subordination
Pass through / Redraw / Re-investment
Sequential Pay / Planned Amortisation
Coupon Periods & Rates
Call Dates & Triggers & Step-up margins
Initial Loss Reserves, Excess Spread Reserve
Trust Expenses
Liquidity facility
Cash-flow waterfall
Obtain draft debt obligation documents (informaiton memorandums)
Call Dates (soft call 10%, hard call 5 years). Why have a hard call?
What is subordinatation and why do it?

23. Mortgage Backed Securities
Actuaries
Mortgage Backed Securities
So what do Actuaries do?
Identify & Analyse the risks
Response
Credit Enhancement Techniques
UCCC certification
Mortgage Insurance
Subordination – Tranches
Excess Spread & Threshold rates
Contractual Conditions & Default Fees
Interest Rate & Basis Swaps
Disclosure

24. Mortgage Backed Securities
Actuaries
Mortgage Backed Securities
So what do Actuaries do?
Determine & communicate the key assumptions
& key attributes of the Data & their interaction.
Assumptions
Prepayment Rates
Delinquency Rates & Periods
Default rates
Mortgage Data
WARIO, WAS, WAM, WAF, WAMOT

25. Mortgage Backed Securities
Actuaries
Mortgage Backed Securities
So what do Actuaries do?
Set modelling assumptions
Past experience
Collateral data - Credibility issues
Overseas experience
Ratings Agency – Stress Testing
Established Market, but always slight changes (eg non-conforming loans) – high credit risk

26. Mortgage Backed Securities
Actuaries
Mortgage Backed Securities

27. Mortgage Backed Securities
Actuaries
Mortgage Backed Securities

28. Mortgage Backed Securities
Actuaries
Mortgage Backed Securities
So what do Actuaries do?
Sensitivity Testing - Why?
Investors - Repayment of Investment
Rating Agencies
Setting Terms of Offer
What sensitivities are looked at?
Interest rates (effect on capital outstanding)
Margins
Default Rates of underlying mortgages
Levels of Loss Reserve, Coupon Rates, …
Rating Agency
Importance because effects cost of capital depending on rating
Hence credit enhancement

29. Review Investment Banks Financial Advisory
Actuaries
Review
Investment Banks
Financial Advisory
Project & Structured Finance
Securitisation
RMBS
Drill Down

30. Actuaries
Questions

31. Actuaries in Investment Banks
UNSW Presentation 3 May 2004