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Structured Financing
Prof. Ian GIDDYStern School of Business
New York University
Copyright ©2003 Ian H. Giddy Structured Finance 2
What is Structured Finance?
Tailored financing solutionsFinancing with hybrid securitiesAsset-backed securitizationLeveraged and acquisition finance
FINANCING ALTERNATIVES AVAILABLE TO MAJOR CORPORATIONS
DEBT
EQUITY
Subsidized funds
Privateplacement
Publicoffering
Revolvingfacility
Term loan
Real estate
Leasing
Assetbacked
Unsecured
Domestic
Eurobond
Fixed
Floating
Longterm
Shortterm
US CP
Euro CP
Bank debt
MTN
Dollar
Non-dollar
ARPFRN
VRN
StraightHybrid
Callable
Index-linked
Convertible
With warrants
Restricted
Full rights
Private sale
Public offering
Domestic
International
Equity options
Stripped
Unstripped
Projectfinance
Bankdebt
Debt?
Equity?
What kind?
Debt?
Equity?
What kind?
Copyright ©2003 Ian H. Giddy Structured Finance 4
When Debt and Equity are Not Enough
Value
of future
cash flows
Value
of future
cash flows
Contractual int. & principal
No upside
Senior claims
Control via restrictions
Contractual int. & principal
No upside
Senior claims
Control via restrictions
Assets Liabilities
Debt
Residual payments
Upside and downside
Residual claims
Voting control rights
Residual payments
Upside and downside
Residual claims
Voting control rights
Equity
What if...
Claims
are inadequate?
Returns
are inadequate?
Copyright ©2003 Ian H. Giddy Structured Finance 5
Equity-Linked Eurobonds
Convertible Eurobonds Korea Tobacco
Eurobonds with warrants Keppel
Index-linked Eurobonds Credit Agricole Indosuez
Copyright ©2003 Ian H. Giddy Structured Finance 6
Convertibles
ConversionValue
StraightBond Value
Market ValueMarket Premium
Value
of
Convertible
Bond
($) 0
Price Per Share of Common Stock
Copyright ©2003 Ian H. Giddy Structured Finance 7
Warrants
TheoreticalValue
Market ValueMarket Premium
Value
of
Warrant
($)
0Price Per Share of Common Stock ($)
Copyright ©2003 Ian H. Giddy Structured Finance 8
Index-Linked
PRINCIPAL
REPAYMENT
Copyright ©2003 Ian H. Giddy Structured Finance 9
Breaking Down a Convertible: Unisys
Coupon rate on Convertible Bond = 8.25%Market Interest Rate on Straight Bond of same Risk = 8.40%Price of Convertible Bond = 1400Maturity of Convertible Bond = 8
Value of Straight Bond Portion = 991.51$ Value of Conversion Option = 408.49$
Coupon rate on Convertible Bond = 8.25%Market Interest Rate on Straight Bond of same Risk = 8.40%Price of Convertible Bond = 1400Maturity of Convertible Bond = 8
Value of Straight Bond Portion = 991.51$ Value of Conversion Option = 408.49$
Copyright ©2003 Ian H. Giddy Structured Finance 10
Motivations for Issuing Hybrid Bonds
Company has a viewThere are constraints on what the
company can issueThe company can arbitrage to save
moneyAlways ask: given my goal, is there an
alternative way of achieving the same effect (e.g., using derivatives?)
Copyright ©2003 Ian H. Giddy Structured Finance 11
Case Study:Banpu Convertible
How did this work? Why did Banpu use this technique? Why did investors buy it?
Copyright ©2003 Ian H. Giddy Structured Finance 12
Banpu Convertible
Huh?
Copyright ©2003 Ian H. Giddy Structured Finance 13
Thai Time
1994 1997 1999 2004
Copyright ©2003 Ian H. Giddy Structured Finance 14
Why Use a Hybrid?
Motivations for Hybrids
Linked to business risk
Linked to
market risk
Cannot hedge
with derivatives
Driven by investor needs
Company hedges
Company does not
hedge
Debt or
equity are
Not good enough
Asset-Backed Securities
Copyright ©2003 Ian H. Giddy Structured Finance 16
Asset-Backed Securities:The Typical Structure
FORD (SPONSOR)
SPECIALPURPOSEVEHICLE
LOANS.
ISSUESASSET-BACKEDCERTIFICATES
SALE ORASSIGNMENT
LOANS.
Servicing Agreement
Copyright ©2003 Ian H. Giddy Structured Finance 17
The Alternative: Synthetic ABS
DB (Originator)
SPECIALPURPOSEVEHICLE
REFERENCE
POOL OF LOANS
(Stay on
balance sheet)
ISSUESASSET-BACKEDCERTIFICATES
CREDIT SWAPAGREEMENT
TOP QUALITYINVESTMENTS
Copyright ©2003 Ian H. Giddy Structured Finance 18
Case Study: Finance Company Bhd
Finance company whose growth is constrained
Has pool of automobile receivablesHas track recordPlans to use this as an ongoing source of
financing
Copyright ©2003 Ian H. Giddy Structured Finance 19
Finance Co. Ltd(Seller)
Finance Co.’sCustomers
Hire-PurchaseAgreement
Case Study: Initial Exchanges
Copyright ©2003 Ian H. Giddy Structured Finance 20
Finance Co. Ltd(Seller)
FCL 1997-A(Special Purpose Co.)
InvestorsProceeds Proceeds
Finance Co.’sCustomers
Hire-PurchaseAgreement
Case Study: Initial Exchanges
Copyright ©2003 Ian H. Giddy Structured Finance 21
Finance Co. Ltd(Seller)
FCL 1997-A(Special Purpose Co.)
Investors
Servicing Agreement
Proceeds
Sale of Assets
Proceeds
Asset-BackedSecurities
TrusteeTrust
Agreement
Finance Co.’sCustomers
Hire-PurchaseAgreement
Case Study: Initial Exchanges
Copyright ©2003 Ian H. Giddy Structured Finance 22
Finance Co. Ltd(Seller)
FCL 1997-A(Special Purpose Co.)
Investors
Servicing Agreement
Proceeds
Sale of Assets
Proceeds
Asset-BackedSecurities
Rating Agency
Top Rating
TrusteeTrust
Agreement
Finance Co.’sCustomers
Hire-PurchaseAgreement
Case Study: Initial Exchanges
Copyright ©2003 Ian H. Giddy Structured Finance 23
Finance Co. Ltd(Seller)
FCL 1997-A(Special Purpose Co.)
Investors
Monthly HPPayments
TrusteeTrustee
Responsibilities
Monthly ABSPayments
Servicing Fees
Finance Co.’sCustomers
Hire-PurchasePayments
Case Study: Ongoing Payments
Copyright ©2003 Ian H. Giddy Structured Finance 24
Finance Co. Ltd(Seller)
FCL 1997-A(Special Purpose Co.)
Investors
Financial GuaranteeProvider
(if required)
Servicing Agreement
Proceeds
Sale of Assets
Proceeds
Asset-BackedSecurities
GuaranteeAgreement
Rating Agency
Top Rating
TrusteeTrust
Agreement
Finance Co.’sCustomers
Hire-PurchaseAgreement
Credit Enhancement: Guarantee Method
Copyright ©2003 Ian H. Giddy Structured Finance 25
Finance Co. Ltd(Seller)
FCL 1997-A(Special Purpose Co.)
Senior
Proceeds
Sale of Assets
Rating Agency
Top Rating
Credit Enhancement:An Alternative Approach
Subordinated
More Subordinated
Lower Rating
No Rating
Financial GuaranteeProvider
(if required)GuaranteeAgreement
Copyright ©2003 Ian H. Giddy Structured Finance 26
Example:Ford Credit Owner Trust 1999-A
Copyright ©2003 Ian H. Giddy Structured Finance 27
Ford Structure
Ford Ford Motor Credit
Ford Credit Auto
Rec. Two LP
Ford Credit Auto
Owner Trust
Receivables
Class A-1 to A6
Class B
Class C
Class D
Class D
Sale
Sale
Copyright ©2003 Ian H. Giddy Structured Finance 28
Deal documentation
List information requirementsDue diligence &
Meeting with management
Issuer/BankerRequests rating
Pool credit analysisLegal analysisStress testing
Credit enhancementnegotiation
Rating committeePresale reportFinal report
Rating Process
Surveillance
“Rating CLOs” (Fitch)
on Workshop Website
giddy.org/abs-hypo.htm
“Rating CLOs” (Fitch)
on Workshop Website
giddy.org/abs-hypo.htm
Copyright ©2003 Ian H. Giddy Structured Finance 29
Trade Receivable Backed CP
Over $500 billion outstanding in US alone
Key feature is pooling of different companies’ trade receivables, allowing smaller companies to take advantage of ABS market
Need two-tier legal structure – SPV at level of each company’s receivables pool, and at multi-company program (the “conduit”)
Copyright ©2003 Ian H. Giddy Structured Finance 30
Corporation ACorporation B
Corporation C
SPECIAL PURPOSE VEHICLE“CONDUIT”
Creditenhancement
facilityprovider
Liquidityfacility
provider
Sponsor/administrator
Legal ownerINVESTORS
Trade receivables Trade
receivables Trade receivables
Payments on maturing ABCP
Fees Fees
FeesNominaldividends
Trade Receivable-BackedCommercial Paper (ABCP)
Pool APool B
Pool C
Copyright ©2003 Ian H. Giddy Structured Finance 31
The Process
Is the company
ready?
Is the company
ready?
Are the assets
suitable?
Are the assets
suitable?
What pool?What pool?
What legal
structure?
What legal
structure?
What credit
enhancement?
What credit
enhancement?
Copyright ©2003 Ian H. Giddy Structured Finance 32
Korea Asset Funding
What is the loan portfolio?What is the legal structure of this deal?What are the assets in the SPV? What is the form of credit
enhancement?How does the put option work? Is this a
strength or a weakness of the structure?
What is the “stress testing” done by Fitch?
Copyright ©2003 Ian H. Giddy Structured Finance 33
Korea Asset Funding
Copyright ©2003 Ian H. Giddy Structured Finance 34
Korea Asset Funding
Leveraged Finance
Copyright ©2003 Ian H. Giddy Structured Finance 36
Leveraged Finance
Leveraged buyout?
Company has
unused debt
capacity Leveraged
recapitalization?
Takeover?
Copyright ©2003 Ian H. Giddy Structured Finance 37
Typical LBO Sequence
Company gets bloated or slack and stock price falls
LBO offer made
LBO completed
Restructuring Efficiencies Divestitures Financial
? years 3-9 months 5-7 years
IPO or sale of company
LBO financing lined up
Copyright ©2003 Ian H. Giddy Structured Finance 38
M&A and Leverage
Leveraged buyout?
Company has
unused debt
capacity Leveraged
recapitalization?
Takeover?
Copyright ©2003 Ian H. Giddy Structured Finance 39
LBO: A Temporary Capital Structure
COST
OF
CAPITAL
DEBT
RATIO
Stage 1: Pre-LBO
Stage 4: Debt paydown
Stage 2: LBO financing
Stage 3: LBO refinancing
Copyright ©2003 Ian H. Giddy Structured Finance 40
12-Step Method
Evaluating cost of deal Estimating borrowing capacity Estimating cash costs of funding Estimating growth rates of sales, expenses,
etc Projecting cash flows (FCFF and FCFE) Projecting debt amortization Calculating terminal value of FCFE and FCFF Estimating costs of capital to find PV Making sense of the deal
Copyright ©2003 Ian H. Giddy Structured Finance 41
Cost of the Deal
Estimating cost of deal
Shares 10Price 45$ Premium 15%Equity cost 518$ Debt cost 55$ Fees 5% 29$ Capex & restructuring 10% 57$ Total cost of deal 658$
lbocapacity.xls
Copyright ©2003 Ian H. Giddy Structured Finance 42
Borrowing Capacity
Estimating borrowing capacity
Given:EBIT 95$ Min EBIT int coverage ratio 1.3Interest capacity 73$ Interest rate 16.00%Debt capacity 457$
From table
lbocapacity.xls
Copyright ©2003 Ian H. Giddy Structured Finance 43
Cost of Debt
Estimating the cost of debtEnter the type of firm = 2 (1 if large manufacturing firm, 2 if smaller or riskier firm)EBIT 95$ Current interest expenses = 73$ Current long term government bond rate = 0.06OutputInterest coverage ratio = 1.3Estimated Bond Rating = CCCEstimated Default Spread = 10%Estimated Cost of Debt = 16%
For large manufacturing firms For smaller and risk ier firmsIf interest coverage ratio is If interest coverage ratio is> ≤ Rating is Spread is > ≤ Rating is Spread is
-100000 0.199999 D 0.14 -100000 0.499999 D 0.140.2 0.649999 C 0.127 0.5 0.799999 C 0.127
0.65 0.799999 CC 0.115 0.8 1.249999 CC 0.1150.8 1.249999 CCC 0.1 1.25 1.499999 CCC 0.1
1.25 1.499999 B- 0.08 1.5 1.999999 B- 0.081.5 1.749999 B 0.065 2 2.499999 B 0.065
1.75 1.999999 B+ 0.0475 2.5 2.999999 B+ 0.04752 2.499999 BB 0.035 3 3.499999 BB 0.035
2.5 2.999999 BBB 0.0225 3.5 4.499999 BBB 0.02253 4.249999 A- 0.02 4.5 5.999999 A- 0.02
4.25 5.499999 A 0.018 6 7.499999 A 0.0185.5 6.499999 A+ 0.015 7.5 9.499999 A+ 0.0156.5 8.499999 AA 0.01 9.5 12.5 AA 0.018.5 100000 AAA 0.0075 12.5 100000 AAA 0.0075lbocapacity.xls
Copyright ©2003 Ian H. Giddy Structured Finance 44
Capital Structure
Preliminary capital structure
Debt 457$ Missing 177$ Mgt equity 25$ Total financing 658$
lbocapacity.xls
Copyright ©2003 Ian H. Giddy Structured Finance 45
LBO Financing
NEWCO
Cost of
purchasing
the
business Equity $25
Senior
debt $457 What securities?
What returns?
What investors?Mezzanine
Copyright ©2003 Ian H. Giddy Structured Finance 46
Mezzanine
Asset-backed or cash flow-backed debt Senior debt Subordinated debt with high yield Subordinated debt with upside
participation Subordinated debt with equity option Preferred equity with warrants or
conversion options Restricted shares Common stock
Copyright ©2003 Ian H. Giddy Structured Finance 47
Case Study: Cap des Biches (B)
The LBO ProposalDevise a recommended financing plan
GTI (owner)
Buyers Other Investors
Copyright ©2003 Ian H. Giddy Structured Finance 48
Cap des Biches
Friday: Financial Restructuring
Ashanti-Bogoso
Feng-Shui
Copyright ©2003 Ian H. Giddy Structured Finance 49