SIM/NYU The Job of the CFO. Hybrid Securities. Prof. Ian Giddy. New York University

Transcription

1 Hybrid Securities-1 SIM/NYU The Job of the CFO Hybrid Securities Prof. Ian Giddy New York University The Agenda What determines the optimal mix of debt and equity for a company? How does altering the mix of debt and equity affect the value of a company? What is the right kind of debt for a company? Hybrid Securities 2

2 Hybrid Securities-2 Corporate Finance CORPORATE FINANCE DECISONS INVESTMENT FINANCING RISK MGT PORTFOLIO CAPITAL M&A DEBT EQUITY MEASUREMENT TOOLS Hybrid Securities 3 Debt? Equity? What kind? DEBT FINANCING ALTERNATIVES AVAILABLE TO MAJOR CORPORATIONS Fixed Floating Long term Short term Dollar Nondollar US CP ARP Euro CP Bank debt Subsidized funds Bank debt Private placement Public offering Project finance Term loan Revolving facility Real estate Leasing Asset backed Unsecured Domestic Eurobond MTN FRN VRN Hybrid Straight EQUITY Callable Index-linked Convertible Stripped Unstripped Equity options With warrants Full rights Restricted Private sale Public offering Domestic International

3 Hybrid Securities-3 When Debt and Equity are Not Enough Assets Liabilities Value of of future cash flows Claims on the cash flows Hybrid Securities 5 When Debt and Equity are Not Enough Assets Value of of future cash flows Liabilities Debt Contractual int. int. & principal No No upside Senior claims Control via via restrictions Equity Residual payments Upside and and downside Residual claims Voting control rights Hybrid Securities 6

4 Hybrid Securities-4 When Debt and Equity are Not Enough Assets Value of of future cash flows Liabilities Debt Contractual int. int. & principal No No upside Senior claims Control via via restrictions Equity Residual payments Upside and and downside Residual claims Voting control rights What if... Claims are inadequate? Returns are inadequate? Hybrid Securities 7 When Debt and Equity are Not Enough Assets Value of of future cash flows Liabilities Debt Contractual int. int. & principal No No upside Senior claims Control via via restrictions Equity Residual payments Upside and and downside Residual claims Voting control rights Alternatives Collateralized Asset-securitized Project financing Preferred Warrants Convertible Hybrid Securities 8

5 Hybrid Securities-5 Managing Hybrid Securities Principles of hybrid instruments Market imperfections as motives for hybrids Hybrids in the Eurobond market: Asset-backed securities Warrant bonds and convertibles Index-linked bonds Application: callable bonds Hybrid Securities 9 A Day in the Life of the Eurobond Market Examine the deals Why were each done in that particular form? What determines the pricing? Can you break the hybrids into their component parts? Hybrid Securities 10

6 Hybrid Securities-6 Why Use a Hybrid? Motivations for Hybrids Linked to business risk Driven by investor needs Linked to market risk Cannot hedge with derivatives Company hedges Company does not hedge Debt or equity are Not good enough Hybrid Securities 11 A Day in the Life... NEW INTERNATIONAL BOND ISSUES Borrower Amount m. Coupon % Price Maturity Fees Book runner Celworks Trust (b) US$ / /8-1 5/8 Credit Suisse Marui Corp* US$500 (4 3/8) /4-1 1/2 Nomura Holderbank (a) US$ / /8-1 CSFB Battle Mountaingold US$ / /2-1 1/2 Merrill Lynch SNCF FFr / /8-1 1/4 CCF Viennische Stadtsbank (a) L100bn / /8-7/8 BNL Eurofima (a) Pta10bn 12 5/ / /8-1 Deutsche Bank Irish Bldg Soc. (a) 15bn / /8-1 1/8 IBJ Bank of Montreal (c) 2.8bn 7 1/ / /8-5/8 Nippon Credit Final terms. *With equity warrants. Private placement. Convertible. (a) Non-callable. (b) Callable at par after 5 years. If call not exercised, bond pays 50bp over Libor in last year. (c) Redemption linked to Nikkei stock index. Hybrid Securities 12

7 Hybrid Securities-7 Equity-Linked Eurobonds Eurobonds with warrants Marui Convertible Eurobonds Battle Mountaingold Index-linked Eurobonds Bank of Montreal Hybrid Securities 13 Warrants V a lu e o f W ar r a nt Market Value Market Premium Theoretical Value ($) 0 Price Per Share of Common Stock ($) Hybrid Securities 14

8 Hybrid Securities-8 Convertibles V a lu e o f C on v e rt i b l e Market Value Market Premium Straight Bond Value Conversion Value B o n d ($) 0 Price Per Share of Common Stock Hybrid Securities 15 Nikkei-Linked PRINCIPAL REPAYMENT 19,000 28,000 Hybrid Securities 16

9 Hybrid Securities-9 Bank of Montreal Nikkei-Linked Note Bankers Trust Bank of Montreal Nippon Credit US pension fund with Japan portfolio Japanese insurance companies Hybrid Securities 17 Structured Notes Bundling and unbundling basic instruments Exploiting market imperfections (sometimes temporary) Creating value added for investor and issuer by tailoring securities to their particular needs Key: For the innovation to work, it must provide value added to both issuer and investor. Hybrid Securities 18

10 Hybrid Securities-10 Carps III 100% CAPITAL-PROTECTED ZERO-COUPON USD EMTN LINKED TO FRANK RUSSELL JAPAN EQUITY FUND Basic Structure a. This is a USD Euro-Medium Term Note with a maturity of 3 years. b. It carries a 100% capital guarantee on maturity (provided by Societe Generale rated Aa3 by Moody s and AA- by S&P) c. Being a zero-coupon Note, the yield is linked to the performance of the Frank Russell Japan Equity Fund. Client Suitability Appropriate for sophisticated investors who: a. require only 100% guarantee on capital on maturity b. believe that Japan is on a recovery path and that the stock market of Japan will see significant gains over the medium term c. believe that the Frank Russell Japan Equity Fund is capable of delivering a consistently above-market return with reduced risks. Hybrid Securities 19 Carps III Client s objectives The Guaranteed Minimum Return product How is this priced? Who else could benefit from it? 60% 50% Profit (Loss) with 100% Principal Protection Profit (Loss) with 90% Principal Protection Profit (Loss) 40% 30% 20% 10% 0% % -20% Index Level at maturity (Initial index level = 100) Hybrid Securities 20

11 Hybrid Securities-11 Medium-Term Notes: Anatomy of a Deal Hybrid Securities 21 Anatomy of a Deal Issuer: Looking for large amounts of floating-rate USD and DEM funding for its loan porfolio. Wants low-cost funds: target CP-.10 Is not too concerned about specific timing of issue, amount or maturity Is willing to consider hybrid structures. Hybrid Securities 22

12 Hybrid Securities-12 Anatomy of a Deal Investor: Has distinctive preference for high grade investments Looking for investments that will improve portfolio returns relative to relevant indexes Invests in both floating rate and fixed rate sterling and dollar securities Can buy options to hedge portfolio but cannot sell options Hybrid Securities 23 Anatomy of a Deal Intermediary: Has experience and technical and legal background in structure finance Has active swap and option trading and positioning capabilities Has clients looking for caps and other forms of interest rate protection. Hybrid Securities 24

13 Hybrid Securities-13 The Deal 1 Initiate medium term note programme for the borrower, allowing for a variety of currencies, maturities and special structures 2 Structuring a MTN in such a way as to meet the investor s needs and constraints 3 Line up all potential counterparties and negociate numbers acceptable to all sides 4 Upon issuer s and investor s approval, place the securities Hybrid Securities 25 The Deal / 2 5 For the issuer, swap and strip the issue into the form of funding that he requires 6 Offer a degree of liquidity to the issuer by standing willing to buy back the securities at a later date. Hybrid Securities 26

14 Hybrid Securities-14 The Issue Issuer: Deutsche Bank AG Amount: US$ 40 Million Coupon: First three years: semi-annual LIBOR + 3/8% p.a., paid semi-annually Last 5 years: 8.35% Price: 100 Maturity: February 10, 2000 Call: Issuer may redeem the notes in full at par on February 10, 1995 Fees: 30 bp Arranger: Credit Swiss First Boston Hybrid Securities 27 The Parties in the Deal DEUTSCHE SCOTTISH LIFE CSFB Hybrid Securities 28

15 Hybrid Securities-15 The Deal in Detail DEUTSCHE Deutsche sells 3-year floating rate note paying LIBOR - 3/8% SCOTTISH LIFE CSFB Hybrid Securities 29 The Deal in Detail DEUTSCHE Deutsche sells 3-year floating rate note paying LIBOR - 3/8% For an additional 3/4% p.a., Deutsche buys threeyear put option on 5-year fixed-rate 8.35% note to SL in 3 years SCOTTISH LIFE CSFB Hybrid Securities 30

16 Hybrid Securities-16 The Deal in Detail DEUTSCHE For 1% p.a., Deutsche sells CSFB a swaption (the right to pay fixed 8.35% for 5 years in 3 years) Deutsche sells 3-year floating rate note paying LIBOR - 3/8% For an additional 3/4% p.a., Deutsche buys threeyear put option on 5-year fixed-rate 8.35% note to SL in 3 years SCOTTISH LIFE CSFB Hybrid Securities 31 The Deal in Detail DEUTSCHE For 1% p.a., Deutsche sells CSFB a swaption (the right to pay fixed 8.35% for 5 years in 3 years) Deutsche sells 3-year floating rate note paying LIBOR - 3/8% For an additional 3/4% p.a., Deutsche buys threeyear put option on 5-year fixed-rate 8.35% note to SL in 3 years SCOTTISH LIFE CSFB CSFB sells the swaption to a corporate client seeking to hedge its funding cost against a rate rise CLIENT Hybrid Securities 32

17 Hybrid Securities-17 What s Really Going On? Note: Issuer has agreed to pay an above-market rate on both the floating rate note and the fixed rate bond segment of the issue FRN portion:.75 % above normal cost Fixed portion:.50% above normal cost Issuer has in effect purchased the right to pay a fixed rate of 8.35% on a five-year bond to be issued in three years time. Hybrid Securities 33 Option Pricing Time Option Price value depends on Time Volatility Distance from the strike price Option Price = Intrinsic value + Time value Underlying Price Hybrid Securities 34

18 Hybrid Securities-18 Option Pricing Model ENTER THESE DATA: ================= -> FUTURES PRICE > STRIKE PRICE > TIME IN DAYS 300 -> INTEREST RATE 7 -> STD DEVIATION CALL PRICE IS PUT PRICE IS CALL OPTION PRICE FUTURES PRICE Hybrid Securities 35 Value of Call Option FUTURES PRICE STRIKE SHADED AREA: Probability distribution of the log of the futures price on the expiration date for values above the strike. INTRINSIC VALUE TIME VALUE EXPECTED VALUE OF PROFIT GIVEN EXERCISE Hybrid Securities 36

19 Hybrid Securities-19 Black-Scholes Option Valuation C o = S o N(d 1 ) - Xe -rt N(d 2 ) d 1 = [ln(s o /X) + (r + σ 2 /2)T] / (σ T 1/2 ) d 2 = d 1 - (σ T 1/2 ) where C o = Current call option value. S o = Current stock price N(d) = probability that a random draw from a normal distribution will be less than d. Hybrid Securities 37 Breaking Down a Convertible: Unisys At the end of 1992, Unisys had a convertible bond, coming due in 2000, which was trading at $1400. It also had straight bonds, with the same maturity, trading in December 1992 at a yield of 8.4%. What s the straight bond component worth? What s the convertible option worth? Hybrid Securities 38

20 Hybrid Securities-20 Breaking Down a Convertible: Unisys Coupon rate on Convertible Bond = 8.25% Market Interest Rate on Straight Bond of same Risk = 8.40% Price of Convertible Bond = 1400 Maturity of Convertible Bond = 8 Value of Straight Bond Portion = $ Value of Conversion Option = $ Hybrid Securities 39 Motivations for Issuing Hybrid Bonds Company has a view There are constraints on what the company can issue The company can arbitrage to save money Always ask: given my goal, is there an alternative way of achieving the same effect (e.g., using derivatives?) Hybrid Securities 40

21 Hybrid Securities-21 Economics of Financial Innovation Certain kinds of market imperfections allow hybrids to flourish But innovation are readily copied; so only certain kinds of firm can profit from innovations. There is a product cycle and profitability cycle of innovations. Hybrid Securities 41 What Conditions Permit Hybrids to Thrive? Government Rules and Regulations Example: Japan Air Lines Yen-linked Eurobond Tax Distortions Example: Money Market Preferred Constraint on Issuers or Investors Example: Nikkei-Linked Eurobond Segmentation-Driven Innovation Example: Collateralized Mortgage Obligations (CMOs) Hybrid Securities 42

22 Hybrid Securities-22 Why Innovations Fail The rationale evaporates It s too costly It s New Coke Hybrid Securities 43 Case Study: Banpu Convertible How did this work? Why did Banpu use this technique? Why did investors buy it? Hybrid Securities 44

23 Hybrid Securities-23 Banpu Convertible Huh? Hybrid Securities 45 Thai Time Hybrid Securities 46

24 Hybrid Securities-24 Leveraged Finance Prof. Ian Giddy New York University M&A and Leverage Company has unused debt capacity Takeover? Leveraged buyout? Leveraged recapitalization? Hybrid Securities 48

25 Hybrid Securities-25 Typical LBO Sequence Company gets bloated or slack and stock price falls IPO or sale of company LBO offer made LBO completed Restructuring Efficiencies Divestiture s Financial? years 3-9 months 5-7 years Hybrid Securities 49 John M Case LBO John Case, owner Company $20 million Managers, buyers Payment: Bank debt $6m Seller note $4m Sub debt with warrants $9.5m Manager s equity $0.5m Hybrid Securities 50

26 Hybrid Securities-26 Simplified Balance Sheet for a restructured J.M.Case Company Cash Assets Other current Fixed & other Good will $ Liabilities Current Liab Bank loan Case loan Plug figure Managers equity $ Total 21,266 Total 21,266 Hybrid Securities 51 John Case Cost of Capital Liabilities Nominal Effective Weight Product Current $1,266 0% 0.00% 5.95% 0.00% Bank loan $6,000 12% 8.40% 28.21% 2.37% Seller note $4,000 4% 8.17% 18.81% 1.54% VC plug $9,500 9% 21.40% 44.67% 9.56% Managers' equity $500 30% 2.35% 0.71% $21, % Hybrid Securities 52

27 Hybrid Securities-27 giddyonline.com Ian Giddy NYU Stern School of Business Tel ; Fax Hybrid Securities 56