Topic 3: Debt vs Equity

Question 1

Types of Equity (6)

Answer 1

1. public issue
2. private issue
3. rights issue
4. preference share issue
5. convertible bond
6. share buy back

Question 2

Types of Equity

PUBLIC SHARE ISSUE (4)

Answer 2

1. 2 types - IPO, Subsequent issues
2. Listing on stock exchange can be costly, but can source broad and deep capital
3. Generally underwritten by broker or bank
4. Normally use prospectus. Subject to listing rules

Question 3

Types of Equity

PRIVATE SHARE ISSUE

Answer 3

1. Private placement of shares directly to investors
2. Can be done by listed & non listed companies
3. Often issued at a discount to mkt p
4. Consider existing shareholders. Dilutive?
5. May need to be approved by existing shareholders
6. Can be underwritten
7. Reverse enquiry
8. If issue is material, may have specific demands in relation to control of company (eg seats on board)

Question 4

Types of Equity
RIGHTS ISSUE (6)

Answer 4

1. Issuance of new shares to existing shareholders
2. Each existing share gives owner right to purcashe
3. Dilutive?
4. New equity without taking on additional shareholders
5. Discount to mkt p
6. Rights can be sold if not exercised

Question 5

Types of Equity

PREFERENCE SHARE ISSUE

Answer 5

1. Pref S/H are given preference over common S/H (eg have priority over dividends and in the event of liquidation)
2. Generally pay fixed div
3. Don’t normally have voting prices
4. 5 Types: Cumulative (any divs not paid will accrue); Non Cumulative (divs lapse if not paid); Participating (divs plus earnings based on specific conditions); Convertible (exchangeable for pre agreed umber of ordinary shares); Redeemable (fixed or voluntary redemption date)

Question 6

Types of Equity

CONVERTIBLE BONDS

Answer 6

1. Bond converts into equity at predetermined date & predetermined # shares
2. Conversion is usually by bond holder but could be mandatory
3. Effectively a bond with embedded stock option.
4. Generally issued at lower rate to outright debt of same maturity
5. Debt is extinguished when/if conversion takes place

Question 7

Treasury’s role in dividend process

Answer 7

1. Set Policy - progressive vs static payment, dividend amount, timing of dividend payment, setting of exchange rates, special dividends
2. Funding of the dividend payment
3. Managing the physical payments to shareholders
4. Liaising with key shareholders

Question 8

Returning funds to Shareholders

• Buy Backs (2 types)
• Treasury’s Role

Answer 8

• Buy Backs (2 types)
  On Market (Co. stands as buyer of own stock, buying at current mkt p - predetermined level)
  Off market
• Treasury’s Role
  Determine amount / price, execute buy back, oversight of process if outsourced

Question 9

Off Market Buy back

Answer 9

• offered equally to all shareholders
• Offer is public at agreed price on agreed date
• may buy back fixed # shares on first in basis or as % of S/H holding
• Can be done by tender

Question 10

Project Finance

Answer 10

• Finance specific project or asset on stand alone basis, based on its CF, financial viability, credit worthiness
• Does not rely on financial strength of owner
• Loan generally on non recourse basis secured by project’s assets and CFs
• More restrictive covenants than general corp financing, and at higher rate
• May be underwritten / guaranteed by Economic Development Agency

Question 11

Economic Devt Agency Loans

Answer 11

• EDAs promote FDI in dev countries to support economic growth etc
• EDAs guaantee bank or private loans by providing political risk insurance and can also underwrite and form loan syndications
• Largest EDA is Multilateral Investment GUarantee Agency (MIGA) (member of World Bank)
• MIGA: outstanding guarantee portfolio of over USD 10bn
• Insurance over currency nconvertibility and transfer restrictions; expropriation; war and civil disturbances, including terrorism; breach of contract; non-honouring of financial obligations

Question 12

Debt Instruments

BOND / MTN / FRN (13)

Answer 12

• LT bearer instrument, 10+ years
• one-off or part of programme
• diversified funding
• tighter pricing, but costs of establishment
• deep & liquid secondary mkt
• various currencies
• suit large companies with good credit rating
• documentation / reporting onerous
• lead manager = underwriter, supported by co-managers
• common to be listed on an exchange to enhance secondary market trading
• Coupons generally semi annual.
• Structure fixed or floating, zero coupon available
• Markets: Domestic or international (kangaroo, yankee, samurai)

Question 13

Debt INstruments
Private Placements (6)

Answer 13

1. Private offering rather than public offer
2. STand alone or reverse inquiry to extend existing offer
3. investor diversification
4. can be done without shelf registration and the normal documentation process
5. Attracts professional investors (insurance, money market, hedge funds)
6. Highly illiquid secondary, may be difficult to buy back

Question 14

Debt Instruments

HYBRID (7, including debt-like and equity-like features, accounting / tax treatment, cost, why issue)

Answer 14

1. Debt & equity features
2. Position in capital structure
3. Debt- like: fixed coupon, redeemable by issuer, cannot be converted in equity, rank higher than eq
4. Equity like features: long dated (60 years, perpetual); early call options (5 years); coupon step up post call date; issuer defined coupons; subordinated senior debt
5. Generic hybrids are treated as debt for accounting & tax purposes; rating agency treats as 50% debt and 50% equity
6. 200 - 300bps more expense than senior bond
7. Why issue: proactive mgmt of B/S; financial flexibility, support credit rating, cheaper than new equity, enhance funding diversification)

Question 15

Debt Instruments

Securitisation (5)

Answer 15

1. Pool series of similar financial assets, transfer to SPV & sell pooled debt to investors via private placement or open sales process
2. Res mortgages, credit card rec’, motor vehicle loans
3. cash collected is paid to investors on amortised basis
4. Investment is secured against the assets of SPV, therefore has higher standalone rating
5. Very liquid, esp in US

Question 16

Debt Instruments

LEASING (4)

Answer 16

1. Lessor purchases fixed asset, provides it to lessee for a series of payments
2. Pmts are fixed rate, P&I
3. OPerating and Finance Leases
4. Accounting changes impact treatment on B/S

Question 17

Debt Instruments

SALE & LEASE BACK (3)

Answer 17

1. Sell asset, lease back for set time period
2. Frees up cash
3. Use for large items (buildings, capital equipment)

Question 18

Debt Instruments
LIABILITY MANAGEMENT
- Drivers
- Actions

Answer 18

DRIVERS
- Cash balances higher than expected
- Costs higher than current facilities
- Maturity date no longer ideal
ACTIONS
- repay loan (penalties?)
- invest surplus cash until debt matures
- restructure the pricing
- buy it back
- restructure (eg curve trade)

Question 19

Working Capital Management (5)

Answer 19

1. Alternative to new funding
2. Free up cash from business
3. Cash, AR, Inventory, AP
4. Reduce credit terms to customers; extend payment of invoices, reduce outstanding inventory, manage operating cycle
5. Receivables -> cash -> raw materials -> work in progress -> finished goods -> receivables….

Question 20

Long Term CF

Forecasting & Stress Testing) (5

Answer 20

1. ST CF forecast to approx 3 mths
2. LT CF forecast used to manage debt issues, dividend
3. Prepare monthly, align to broader business plan
4. Run stress tests through model to ensure it is robust (high p vs low p; high/low interest rate; high / low exchange rate; perfect storm; specific scenarios (GFC))
5. Could be used to model different business scenarios.

Question 21

Risks: Debt Portfolio (8)

Answer 21

1. Re financing
2. Re pricing
3. Maturity Profile
4. Instrument concentration
5. Market concentration
6. Lender concentration (spread concentration to mitigate risk of 1 lender changing lender policy)
7. Uncommitted facilities (If too many, funds may not be available when required)
8. Covenants (convenants are in place to ensure creditworthiness doesn’t deteriorate. Risk is breach. Should monitor and report regularly against covenants)

Question 22

Refinancing Risk factors (4)

Answer 22

1. Unable to raise funds when needed (aka liquidity risk)
2. Adverse market conditions prevail when debt raising required (pricing / access)
3. Mitigate: ensure not all debt securities mature at same time
4. Limits on maturities within 12 months

Question 23

Repricing risk factors (4)

Answer 23

1. Adverse market conditions on rate set days
2. Relevant for fixed & floating resets
3. Mitigate: mix of maturity and reset dates
4. FRAs or forward start swaps can also be utilised to manage risk

Question 24

Maturity Profile (2)

Answer 24

1. Spread maturities across the curve

2. Max tenor driven by underlying structure of business

Question 25

Debt Risks: Debt Instrument (2), and Market / COuntry Concentration (2)

Answer 25

Debt Instrument concentration 1. Spread different types of debt to reduce disruption in a particular segment of the debt market 2. Tradeoff between diversification and price Market / country concentration 1. Spread markets / countries 2. Reduce disruption of a particular market segment

Question 26

Features of an Effective Debt Portfolio (8)

Answer 26

1. Diverse maturities 2. Lack of refinancing concentration to any one period 3. Spread of repricing dates 4. Variety of debt instruments 5. Variety of markets / countries 6. Variety of lenders 7. Committed facilities 8. Minimise restrictive covenants, put in place detailed governance process to ensure covenants are adhered to.

Question 27

Support for Commercial Paper...

Answer 27

Committed revolving facility in place to support CP programme

Question 28

Issuance: end to end process (8)

Answer 28

1. Beauty parade from potential lead managers, mandate lead and co managers 2. Investor road show prep / document prep / due diligence 3. Hold investor road show 4. Obtain indiciative pricing 5. determine market, tenor, amount 6. Announce; order book filled, final allocation occurs 7. Pricing finalised, secondary trading begins 8. Bonds listed / funds received

Question 29

Bond pricing depends on: (8)

Answer 29

1. creditworthiness 2. credit spreads 3. bond prices (ie ACGB) 4. demand from investors (size of order book) 5. new supply in market 6. maturity 7. size 8. Note trade-off: once trading in secondary should be a guide to pricing accuracy of the primary deal.

Question 30

Verizon Case Study (8)

Answer 30

1. Sep 2013 Verizon to acquire 45% stake in Verizon Wireless for 130bn 2. 49bn bridge loan facility (for 12 mths, but extinguished in 10 days) 3. Largest ever bond issue, USD 49bn; 8 tranche Sep 13 4. Rating downgraded 1 notch by all agencies to Baa1/BBB+/A-. 5. 2x oversubscribed 6. USD 264m in fees; USD 2.2bn in profit to investors on 1st day. Size over price. Premium of 50 - 75bps paid 7. Debt profile then needed adjusting. Jul 14; announced world's biggest liability trade. Pool of 37.4bn existing bonds ffor 12bn in 3 maturities 8. This addressed maturity towers, locked in borrowing rates, extended duration of debt. Investors = +vs NPV, extend duration, pick up yield, additional spread vs existing

Question 31

Brisbane Airports Corp Case STudy

Answer 31

1. 1997 purchased airport from Fed Govt under 50 yr lease for 1.4bn 2. Non listed QLD company, BBB rating 3. 2.5bn planned infrastructure improvements over 10 years 4. Raised debt in US PP market. Also, 200m in local bond mkt