Chapter 19 – Corporate Debt BA 543 Financial Markets and Institutions

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

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

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

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

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

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)

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

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

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