Lecture 1&2 Debt Markets Flashcards
Role of debt capital markets
- match borrowers to lenders and tailor risks so that borrowers do not overpay and investors receive fair compensation
Tailoring Risk (6)
- Credit Risk
- Maturity
- Liquidity
- Legal
- Interest Rate
- Currency
Types of Debt (4)
- Syndicated Bank Loans
- Commercial Paper (ST, ECP, USCP less than 1 yr, Asset Backed)
- Bonds (LT, FRN, Fixed, ILBs) (around 60bn)
- Securitisation
- CP, Bonds, group of assets put into investment vehicles
- CMBS
- RMBS
- CLO
- Derivs
- Conduit, pools of assets
Bank Loan - 2 forms of bank lending
- Bilateral (250bn pa; 2 counterparties, bank & borrower)
- 1 bank
- individual docs
- based on relationships
- bank knows the company and minimises default risk by knowing the company and its mgmt
- Can lead to concentration in credit portfolio of the bank
Syndication
- Multi bank transaction
- Common documents, common terms
- Agent (single agent represents all)
- Security trustee
- Secured/unsecured
- typically larger transactions - project finance, infratructure, large corporates, leverage finance LBOs, MBOs
- underwritten
- best effort
- club
EXAM: Name the 4 ways to borrow
consider diagram as well
- Bilateral Loans
- Syndicated Loans
- One Name
- Securitisation
Name 3 types of risk that banks take on
- Credit risk
- Interest rate risk
- Liquidity risk
- liquidity: funded short, lend long; if people who lend do not roll over 90 day paper -> liq risk.
- lending to failed entity
Liquidity Risk
- Institutional (name crisis - bank specific, specific issue leads to withfrawal of deposits
- Systemic (customers worried about all banks - loss of confidence in banks more generally)
- Regional (offshore investors worried about Aus banks)
- COncentration risk (large cash outflows on a given day or over a short period; reliance on funding from a single party
- Credit Risk (c/p default)
Banks - characteristics
- highly regulated to protect depositors
- highly geared and therefore risky
Disintermediation
- banks act as dealer and arranger
- banks can originate, sales and distribution, provide research, act as structure
- originate -> warehouse -> distribute
- issuer pays fees to banks, banks may pass some of this on, their choice
- investor takes the issuer’s liquidity risk when holding the note
Role of Syndicate
- arbitrate between originator and sales
- arbitrate between sales offices
- estimate where deal will price
- run the book
Factors to consider when banks choose intermediation or disintermediation
- Risk appetite: if large, bank takes on direct exposure. If low and if higher regulation, then use intermediation
- Capital efficiency (measured by analysts, board, regulator)
- Revenue measures - lending dominates
- Capital constrained - DCM dominates
- evolves depending on business cycle
Customer Funding Index
Term Funding Index
Stable Funding Index
CFI: Customer FUnding + Core Funded Assets
TFI: Wholesale funding (remaining term to maturity > 1 year) + core funded assets
SFI: TFI + CFI
Long Term Wholesale Funding
- pre crisis averaged 0.15% to 0.20%
- Following collapse of Lehman Bros term funding increased to over 1.70%
- Weighted average cost of term wholesale funding expected to continue to rise even though marginal cost is coming down (due to maturities)
- Overall costs to increase with rising average cost of term wholesale and higher retail deposit costs (stable but more costly)
Role of Exchange
- Listing
- Trading (venue for trading)
- Clearing House
- Settlement (Austraclear, Euroclear)
Difference between LIBOR and BBSW
LIBOR: London Interbank OFFERED rate, ie it is and offer
BBSW: mid point
EXAM: Why would we list a bond on the exchange?
- To comply with section 128f of the income tax assessment act
- Listing enables you to access data as an investor - especially Eurobond
How do Banks fund themselves?
How do Corporates fund themselves?
Banks:
- Bonds - Issuance
- Corporate - Institutional Bank Deposits
- Retail Deposits
- Equity (8%) - core equity from investors
Corporates:
- Loans from relationship banks
- Bond issuance
- CP - working capital
- Equity - core equity from investors
Debt vs Equity
Debt: Non permanent, promise to repay borrowed money plus interest
Equity: Permanent
Bank debt
- revolving facility
- loan provided by borrower’s bank which pays interest
- Key: flexibility.
- revolving facility: borrow and repay without penalty and redraw at a later time.
Syndicated bank debt / bank loan
- more than one bank lending under common terms and common agreement.
- agent administers the loan and often acts as security trustee
- larger loans
- may be securitised or non securitised
Debt Capital Markets
- market for dis intermediated debt instruments (ie instruments rather than bank loans)
- includes debt for single name credits as well as securitised assets.
Tendency for banks…
tendency to lend short term (in line with deposit base) and lend long term
Roles of financial intermediaries in disintermediation
- issuers
- investors
- agent / lead manager
- issuing and paying agent
- dealer
function roles in process of originating and selling a debt capital market instrument
- origination
- syndicate
- research
- structuring
- sales and distribution
- trading
Key drivers of credit spread
- investor sentiment
- current state of markets & economiy
- probability of default
- maturity
Short Term Debt Markets
- Commercial Paper
- < 1 yr
- governed by contract law (bank bills are governed by Bills of Exchange Act)
- used by companies for short term working capital needs
- priced vs BBSW
- single name
- Bank Bills typically 185 days or shorter; CP up to 364 days
- ECP: issued internationally in another currency
- USCP Regulation: US can only fund their current assets
- Asset Backed: issued by conduits
EXAM qn: What are 4 uses of a conduit
- capital efficiency for banks
- credit arbitrage
- supplementary warehouse issuing asset backed commercial paper
- repackaging vehicle
- term securitisation issuing vehicles
Conduits
- each of the liabilities (ABCP) are backed by section of assets which are rated by agencies
- SPV - bankruptcy remote entity whose operations are limited to the acquisition and financing of specific assets.
- asset/liability structure and legal status that makes its obligations secure even if the parent company goes bankrupt.
Conduits - structure
- owned by charitable trust and therefore off balance sheet
- costs stanby 15bps; rating 1bp; issue margin 5 bps, dealer 3 bps = 24 bps ie cheap
- as conduit is off balance sheet there is no 8% capital requirement so profit hurdle is lower
- there is no equity - if there is an issue there is nothing to call upon. Market failure and transition are more likely than default.
Asset Backed Commercial Paper
- CP secured by assets typically in the form of accounts receivable, loans leases or securities
- CP is issued from a special purpose vehicle (conduit) which is structured to be bankruptcy remote
- typically highly rated
- repaid at maturity through cash proceeds from asset collections or from issuance of new ABCP
- unregistered with SEC
ABCP background
- 1980s; for large commercial banks to finance trade receivables
- 1986 Basle accord created incentive for off balance sheet funding
ABCP advantages
- extended market access to lesser or unrated companies.
- expanded funding sources for higher rated companies, funding anonymity
- growth has paralleled ABS market
- diversification of asset types & products
Why do sponsors establish ABCP programmes? (4)
- Balance SHeet mgmt (reduce reg capital req or lever capital, finance high quality low margin assets off b/s, control size of balance sheet)
- Regulatory Capital Arbitrage (better align regulatory capital with economic risk based capital, improved financial ratios, additional source of highly liquid funding, help address loan growth expectations > deposit growth
- Consistent alternative source of fee based revenue (increases non interest income as a percentage of total income, enhances market awareness of bank sponsors)
- Alternative funding (asset specific funding program separate from sponsors direct liabilities)
Types of ABCP
- multi seller
- single seller
- securities arbitrage vehicles
- structured investment vehicles
- credit arbitrage
- loan backed
- hybrid vehicles
Multi seller ABCP programme
- limited purpose, bankruptcy remote SPV that provides financing for receivables pools generated by MULTIPLE, UNAFFILIATED originators / sellers
- commonly established by corp banks that typically provide funding to those clients, bank may act as Program Administrator or Admin Agent for conduit
- Multi seller conduit structured to make loans against or purchase interests from receivables pool; warehouse assets prior to a term ABS takeout
- Perceived as low risk due to originator diversification, asset diversification & deal specific enhancement, program wide credit enhancement, 100% liquidity support sponsorship
ABCP: Single Seller ABCP Conduit
- limited purpose bankruptcy remote entity that issues CP to finance receivables of single originator. One seller therefore insolvency is greater
- credit cards, autos, mortgages
- benefits: cross benefits over participating in another sponsor’s multi seller program, allows sponsor more control over operations, favourable accounting or tax treatment
ABCP: Securities Arbitrage Vehicles
- fund purchase of various types of securities - Strcutured Investment Vehicles & Credit Arbitrage Vehicles
ABCP -> Securities Arbitrage Vehicle -> Structured Investment Vehicle (SIV)
- define
- define: mkt value programs that purchase highly rated securities (ABS, corp debt) and benefit from longer maturity assets and short term funding. Type of structured credit
- Fund itself through CP & MTN
- open ended structure (“evergreen”), planned to stay in business indefinitely by buying new assets as old ones matured. Investors had no transparency to exchange of investments.
- Virtual bank - instead of deposits, borrows short term
- How do you fund if can’t issue CP? Standby facility - this brings assets back onto balance sheet, which constrains ability to lend, which causes credit freeze.
- Credit ratings agencies told people what to buy.
- no SIVs remain (Oct 2008). All went broke
SIV Lites
- hybrid between CDOs and traditional SIVs.
- more levered than typical SIV, often invest in sub prime due to spread
- high leverage & exposure to more risky collateral -> SIV at greater risk.
ABCP -> Securities Arbitrage Vehicles
(2) Credit Arbitrage Vehicle
- Expose investors to credit risk, like cashflow CDO but not market risk (as an SIV). More passive than typical SIV
- Loan backed (similar to CLO)
- CDOs (ABCP issued out of CDOs, typically most senior class of capital structure. Usually 100% liquidity support
ABCP Conduit Characteristics
- Full support vs partial support
- Post review vs pre review
Full support:
- external facility to provide 100% coverage against credit risk & liquidity risk to support transactions
- ratings agencies focus on strength of support providers (banks)
- form could be guarantee, LOC, surety bond, TRS or liquidity facility addressing credit risk
Partial support
- use 2 support facilities, one for credit risk, 1 for liquidity. Not 100% coverage
- ratings agency focuses on receivables ratings
Post review
- allowed to enter new txn aligned to existing credit & liq policy without first getting rating agency approval. Reviewed later. Most single seller programs are Post Review
Pre Review
- New txn must be submitted to ratings agency prior to funding for confirmation of ST rating. Most multi seller programs are Pre Review
ABCP Conduit: Credit Enhancement
- FOrms of protection through credit enhancement:
- overcollateralisation
- subordination
- excess spread
- reserve account
- guarantee
- liquidity facility providing credit protection or partial seller recourse
ABCP Conduit: Credit Enhancement: Programme-wide
Cover losses across most receivables in conduit, 2nd layer of protection after transaction level
- LOC
- Surety bond
- third party guarantee
- asset purchase agreement
- loan facility
ABCP Characteristics - Conduit - Liquidity Facilities
- req’d to ensure funds avail to repay maturing CP
- often 364 day renewable facility
- typically sized @ 102% of transaction limit; the extra to partly hedge interest rate risk
- provided by highly rated financial institutions
- may be transaction specific or program-wide
- liquidity loan agreement - commitment to lend to a conduit when requested
- liquidity asset purchase agreement - commitment to purchase an asset when requested
ABCP - different forms - Extendible CP
- sponsor has option to extend notes to legal final maturity out to 397 days if CP cannot be rolled
- on extension, investors receive higher spread until CP paid down
- extendible programs are market value programs, gen no external liq support
- extendible programs used for various asset types, credit cards, mortages, floorplan etc
- market value swaps often used to hedge risk
- Some extendible programs referred to as Secured Liquidity Notes
ABCP Different Forms - Medium Term Notes
- MTNs are not CP but are used by some ABCP as incremental funding source
- maturities 180 days to 30 years, bear long term ratings, generally floating rate, interest bearing issuance
- MTN - reduce need for additional backup liquidity, diversify funding sources, lock in longer term funding to complement ST ABCP
- can come to mkt quickly
Euro Commercial Paper
- define
- HK CP
- US CP
ECP: ST instrument issued by bank of company in international markets denominated in a currency other than the issuer’s domestic currency
- HK CP (large amounts of FX in HK), always discount, off a program, can use covered interest arbitrage to raise cheaper in HKD and swap back to USD
- US CP: domestic uS mkt for ST debt instruments. SEC limit is 270 day term. Can only be issued by companies to fund current assets.
Euro Medium Term Note - Style of Notes
- FRN
- Fixed
- Index Linked - Index Linked and Capital Indexed.
index annuity bond vs capital indexed bond
IAB
- annuity is a pmt of p + i; but there is no final payment. Total of p + i is the same or can go up. Ratcheting.
CIB
- principle amount is always the same.
- you have an increased exposure over time so needs to be highly rated.
- can never be repaid less than 100
- can have reduced interest pmt if CPI goes down.
- has bullet pmt
- qtrly pmt
Australian MTN
- generally fixed, though also FRN
- A$, governed by Aus law, clears via austraclear
EXAM: withholding tax
- section 128f
- meet public offer test to avoid income withholding tax
1) offer securities to 10 investors (professional)
2) widely distributed IM (100 people)
3) List on exchange (this is unambiguous)
4) Publish info on electronic news platform: reuters, BBG
