Chapter 19 – Corporate Debt

1. Chapter 19 – Corporate Debt BA 543 Financial Markets and Institutions

2. Chapter 19 – Corporate Debt • Companies Borrow via Debt in four markets • Commercial Paper • Medium term Notes • Bank Loans • Bonds • Lenders face two types of risk • Default – failure to make repayment (a.k.a. credit risk) • Credit Spread – performance against other debt type instruments

3. Chapter 19 – Corporate Debt • Commercial Paper • A promissory note from a company • Usually 50 to 60 days to maturity • Less than 270 – avoids SEC registration • Less than 90 – available as collateral for bank borrowing from Federal Reserve Bank • Backed by Banks or Insurance Companies • “Collateralized” Commercial Paper – Credit Supported Commercial Paper • Letter of Credit from Bank – LOC Paper • Surety Bond from Insurance Company

4. Chapter 19 – Corporate Debt • Issuers – Financial and Non-Financial • Captive Finance Companies • GMAC, Ford Credit, Chrysler Financial • Related Financial Companies • Independent Financial Companies • The Finance Companies Issue 78% • Direct Placement vs. Dealer Placement • Firms that frequently issue commercial paper develop internal marketing for placement • Best-efforts basis for dealer placement

5. Chapter 19 – Corporate Debt • Domestic Issues • Commercial Paper • Denominated in U.S. Dollars by U. S. Company • Yankee Commercial Paper • Denominated in U.S. Dollars by Foreign Company • Samurai Commercial Paper • Issued in Japan in Yen by Foreign Companies • Eurocommercial Paper • Issued outside the currency of denomination • Example - U.S. company sells commercial paper denominated in U.S. Dollars in England • Dealer Placed • Longer Maturities

6. Chapter 19 – Corporate Debt • Medium-Term Notes • They fit between commercial paper and bonds • Fairly new • First Issue the 70s by GMAC • Merrill Lynch pioneered the market in 1981 • Secondary Market for Notes • Rule 415 – Shelf Registration in 1982 • Euro Medium-Term Notes began in 1987 • Growth strong in 90s • 57% of outstanding debt for financial companies • 12% of outstanding debt for non-financials

7. Chapter 19 – Corporate Debt • Maturities Vary on MTNs • Minimum 9 months • Maximum can be up to 30 years • Notes are issued with a range in the maturity • Investor chooses the maturity date • Issuer “approves” maturity date selection • Potential Notes are Posted against Treasury Notes (see Table 19-2) • Notes coupled with other transactions – structured notes (i.e. inverse floaters)

8. Chapter 19 – Corporate Debt • Bank Loans – Sources • Domestic Bank • Foreign Bank with a Domestic Branch • Foreign Bank in country where multi-national company does business • Subsidiary of Domestic Bank in foreign country where multi-national company does business • Offshore Bank (Eurobank) • Eurocurrency Loans

9. Chapter 19 – Corporate Debt • Syndicated Bank Loans • Usually the size of the loan is too large for one bank – Shell Oil Company purchase of Kern Ridge Oil of California • Senior Bank Loans – Take priority on interest and principal over bond issues • Floating Rate Loans – Benchmarked • LIBOR, Prime Rate, etc. • Typically Amortized Loans • Exception, principal at end is bullet loan

10. Chapter 19 – Corporate Debt • Leasing – Financing Specific Asset Acquisitions • Arrangements made by lessee with manufacturer • Lessor accepts arrangements, buys from manufacturer and then leases to lessee • Why Lease? • Sell Tax-Shields to another company • Cheaper financing • Leveraged Lease – Equity and Debt, lessor borrows from the bank to finance purchase