Structured Financing Prof. Ian GIDDY Stern School of Business New York University

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?


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?


Equity-Linked Eurobonds

Convertible Eurobonds Korea Tobacco

Eurobonds with warrants Keppel

Index-linked Eurobonds Credit Agricole Indosuez


Convertibles

ConversionValue

StraightBond Value

Market ValueMarket Premium

Value

of

Convertible

Bond

($) 0

Price Per Share of Common Stock


Warrants

TheoreticalValue

Market ValueMarket Premium

Value

of

Warrant

($)

0Price Per Share of Common Stock ($)


Index-Linked

PRINCIPAL

REPAYMENT


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$


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?)


Case Study:Banpu Convertible

How did this work? Why did Banpu use this technique? Why did investors buy it?


Banpu Convertible

Huh?


Thai Time

1994 1997 1999 2004


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


Asset-Backed Securities:The Typical Structure

FORD (SPONSOR)

SPECIALPURPOSEVEHICLE

LOANS.

ISSUESASSET-BACKEDCERTIFICATES

SALE ORASSIGNMENT

LOANS.

Servicing Agreement


The Alternative: Synthetic ABS

DB (Originator)

SPECIALPURPOSEVEHICLE

REFERENCE

POOL OF LOANS

(Stay on

balance sheet)

ISSUESASSET-BACKEDCERTIFICATES

CREDIT SWAPAGREEMENT

TOP QUALITYINVESTMENTS


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


Finance Co. Ltd(Seller)

Finance Co.’sCustomers

Hire-PurchaseAgreement

Case Study: Initial Exchanges



FCL 1997-A(Special Purpose Co.)

InvestorsProceeds Proceeds







Investors

Servicing Agreement

Proceeds

Sale of Assets

Proceeds

Asset-BackedSecurities

TrusteeTrust

Agreement







Investors

Servicing Agreement

Proceeds

Sale of Assets

Proceeds


Rating Agency

Top Rating

TrusteeTrust

Agreement







Investors

Monthly HPPayments

TrusteeTrustee

Responsibilities

Monthly ABSPayments

Servicing Fees


Hire-PurchasePayments

Case Study: Ongoing Payments




Investors

Financial GuaranteeProvider

(if required)

Servicing Agreement

Proceeds

Sale of Assets

Proceeds


GuaranteeAgreement

Rating Agency

Top Rating

TrusteeTrust

Agreement



Credit Enhancement: Guarantee Method




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


Example:Ford Credit Owner Trust 1999-A


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


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


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”)


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


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?


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?


Korea Asset Funding


Korea Asset Funding

Leveraged Finance


Leveraged Finance

Leveraged buyout?

Company has

unused debt

capacity Leveraged

recapitalization?

Takeover?


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


M&A and Leverage

Leveraged buyout?

Company has

unused debt

capacity Leveraged

recapitalization?

Takeover?


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


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


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


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


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


Capital Structure

Preliminary capital structure

Debt 457$ Missing 177$ Mgt equity 25$ Total financing 658$

lbocapacity.xls


LBO Financing

NEWCO

Cost of

purchasing

the

business Equity $25

Senior

debt $457 What securities?

What returns?

What investors?Mezzanine


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


Case Study: Cap des Biches (B)

The LBO ProposalDevise a recommended financing plan

GTI (owner)

Buyers Other Investors


Cap des Biches

Friday: Financial Restructuring

Ashanti-Bogoso

Feng-Shui


Documents

Structured Financing Prof. Ian GIDDY Stern School of Business New York University