Tài chính kế toán - Chapter 10: Medium - To long - term debt

Chapter 10Medium- to long-term debtLearning objectivesIdentify the main types of medium- to long-term debt instruments in the marketTerm loans or fully drawn advances, mortgage finance, bond markets (debentures, unsecured notes and subordinated debt) and lease financingDescribe the main features of these facilitiesIdentify the financial institutions and parties involved in the provision of these facilitiesUndertake calculations related to the pricing of these debt instrumentsDiscuss the availability and appropriateness of these debt instruments for businessChapter organisation10.1 Term loans or fully drawn advances10.2 Mortgage finance10.3 Debentures, unsecured notes and subordinated debt10.4 Calculations: fixed-interest securities10.5 Leasing10.6 Summary10.1 Term loans or fully drawn advancesTerm loanA loan advanced for a specific period (three to 15 years), usually for a known purpose; e.g. purchasing land, premises, plant and equipmentSecured by mortgage over asset purchased or other assets of the firmFully drawn advanceA term loan where the full amount is provided at the start of the loanProvided by:mainly commercial banks and finance companiesto a lesser degree, investment banks, merchant banks, insurance offices and credit unions(cont.)10.1 Term loans or fully drawn advances (cont.)Term loan structuresInterest only during term of loan and principal repayment on maturityAmortised or credit foncier loan Periodic loan instalments consisting of interest due and reduction of principalDeferred repayment loanLoan instalments commence after a specified period related to project cash flows and the debt is amortised over the remaining term of the loan(cont.)10.1 Term loans or fully drawn advances (cont.)Term loan structures (cont.)Interest may be fixed (for a specified period of time; e.g. two years) or variableInterest rate charged on term loan is based on:an indicator rate (e.g. BBSW or a bank’s own prime lending rate) and is also influenced by:credit risk of borrower—risk that borrower may default on loan commitment, giving rise to a risk premiumterm of the loan—usually longer term attracts a higher interest raterepayment schedule—frequency of loan repayments (e.g. monthly or quarterly) and form of the repayment (e.g. amortised or interest-only loan)(cont.)10.1 Term loans or fully drawn advances (cont.)Term loan structures (cont.)Other fees include:establishment feeservice feecommitment feeline feebill option clause fee(cont.)10.1 Term loans or fully drawn advances (cont.)Loan covenantsRestrict the business and financial activities of the borrowing firm Positive covenantRequires borrower to take prescribed actions; e.g. maintain a minimum level of working capitalNegative covenantRestricts the activities and financial structure of borrower; e.g. maximum D/E ratio, minimum working-capital ratio, unaudited periodic financial statementsBreach of covenant results in default of the loan contract, entitling lender to act(cont.)10.1 Term loans or fully drawn advances (cont.)Calculating the loan instalment—ordinary annuity(cont.)10.1 Term loans or fully drawn advances (cont.)Calculating the loan instalment—ordinary annuity (cont.)Example 1: Floppy Software Limited has approached Mega Bank to obtain a term loan to finance the purchase of a new high-speed CD burner. The bank offers a $150 000 loan, amortised over five years at 8% per annum, payable monthly. Calculate the monthly loan instalments.(cont.)10.1 Term loans or fully drawn advances (cont.)Calculating the loan instalment—ordinary annuity (cont.)Example 1 (cont.)(cont.)10.1 Term loans or fully drawn advances (cont.)Calculating the loan instalment—annuity due(cont.)10.1 Term loans or fully drawn advances (cont.)Calculating the loan instalment—annuity due (cont.)Example 2: A business proprietor is purchasing a computer system for the business at a cost of $21 500. A finance company has offered a term loan over seven years at a rate of 12% per annum. The loan will be repaid by equal monthly instalments at the beginning of each month. Calculate the amount of the loan instalments.(cont.)10.1 Term loans or fully drawn advances (cont.)Example 2 (cont.)Chapter organisation10.1 Term loans or fully drawn advances10.2 Mortgage finance10.3 Debentures, unsecured notes and subordinated debt10.4 Calculations: fixed-interest securities10.5 Leasing10.6 Summary10.2 Mortgage financeA mortgage is a form of security for a loanThe borrower (mortgagor) conveys an interest in the land and property to the lender (mortgagee)The mortgage is discharged when the loan is repaidIf the mortgagor defaults on the loan the mortgagee is entitled to foreclose on the property, i.e. take possession of assets and realise any amount owing on the loan(cont.)10.2 Mortgage finance (cont.)Use of mortgage finance Mainly retail home loansUp to 30-year termsTo a lesser degree commercial property loansUp to 10 years as businesses generate cash flows enabling earlier repaymentProviders (lenders) of mortgage financeCommercial banks, building societies, life insurance offices, superannuation funds, trustee institutions, finance companies and mortgage originators(cont.)10.2 Mortgage finance (cont.)Interest ratesBoth variable and fixed interest rate loans are available to borrowersWith fixed interest loans, interest rates reset every five years or lessWith interest-only mortgage loans, interest-only period is normally a maximum of five yearsMortgagee (lender) may reduce their risk exposure to borrower default by:requiring the mortgagor to take out mortgage insurance up to 100% of the mortgage value(cont.)10.2 Mortgage finance (cont.)Calculating the instalment on a mortgage loan(cont.)10.2 Mortgage finance (cont.)Calculating the instalment on a mortgage loan (cont.)Example 3: A company is seeking a fully amortised commercial mortgage loan of $650 000 from its bank. The conditions attached to the loan include an interest rate of 8% per annum, payable over five years by equal end-of-quarter instalments. The company treasurer needs to ascertain the quarterly instalment amount.(cont.)10.2 Mortgage finance (cont.)Calculating the instalment on a mortgage loan (cont.)Example 3 (cont.):(cont.)10.2 Mortgage finance (cont.)Securitisation and mortgage financeMortgage originators, commercial banks and other institutions use securitisation to manage their mortgage loan portfoliosInvolves conversion of non-liquid assets into new asset-backed securities that are serviced with cash flows from the original assetsOriginal lender sells bundled mortgage loans to a special-purpose vehicleThat is, a trust set up to hold securitised assets and issue asset-backed securities like bonds, providing investors with security and payments of interest and principal(cont.)10.2 Mortgage finance (cont.)The securitisation of mortgage finance suffered a large contraction during the GFC.Securitised mortgage assets in 2007: $215 billionSecuritised mortgage assets in 2010: $112 billion These falls were recorded in Australia despite the much lower default rates experienced on mortgages compared to other parts of the world. Chapter organisation10.1 Term loans or fully drawn advances10.2 Mortgage finance10.3 Debentures, unsecured notes and subordinated debt10.4 Calculations: fixed-interest securities10.5 Leasing10.6 Summary10.3 Debentures, unsecured notes and subordinated debtThese securities are issued in the corporate bond marketMarkets for the direct issue of longer term debt securitiesLenders attract higher:risk compared with lending indirectly through intermediariesyield owing to sharing in the profit margin usually taken by intermediaries(cont.)10.3 Debentures, unsecured notes and subordinated debt (cont.)Debentures and unsecured notesAre corporate bondsSpecify that the lender will receive regular interest payments (coupon) during the term of the bond and receive repayment of the face value at maturityUnsecured notes are bonds with no underlying security attachedDebentures:are secured by either a fixed or floating charge over the issuer’s unpledged assetsare listed and traded on the stock exchangehave a higher claim over a company’s assets (e.g. on liquidation) than unsecured note holders(cont.)10.3 Debentures, unsecured notes and subordinated debt (cont.)Issuing debentures and notesThere are three principal issue methods1. Public issue—issued to the public at large, by prospectus2. Family issue—issued to existing shareholders and investors, by prospectus3. Private placement—issued to institutional investors, by information memorandumUsually issued at face value, but may be issued at a discount or with deferred or zero interestA prospectus contains detailed information about the business(cont.)10.3 Debentures, unsecured notes and subordinated debt (cont.)Subordinated debtMore like equity than debt, i.e. quasi-equityClaims of debt holders are ‘subordinated’ to all other company liabilitiesAgreement may specify that the debt not be presented for redemption until after a certain period has elapsedMay be regarded as equity in the balance sheet, improving the credit rating of the issuerChapter organisation10.1 Term loans or fully drawn advances10.2 Mortgage finance10.3 Debentures, unsecured notes and subordinated debt10.4 Calculations: fixed-interest securities10.5 Leasing10.6 Summary10.4 Calculations: fixed-interest securitiesPrice of a fixed-interest bond at coupon dateThe price of a fixed-interest security is the sum of the present value of the face value and the present value of the coupon stream(cont.)10.4 Calculations: fixed-interest securities (cont.)Price of a fixed-interest bond at coupon date (cont.)Example 4: Current AA+ corporate bond yields in the market are 8% per annum. What is the price of an existing AA+ corporate bond with a face value of $100 000, paying 10% per annum half-yearly coupons, and exactly six years to maturity? A = $100 000 C = $100 000 x 0.10/2 = $5000 i = 0.08/2 = 0.04 n = 6 x 2 = 12(cont.)Example 4 (cont.):(cont.)10.4 Calculations: fixed-interest securities (cont.)10.4 Calculations: fixed-interest securities (cont.)Price of a fixed-interest bond between coupon dates(cont.)10.4 Calculations: fixed-interest securities (cont.)Price of a fixed-interest bond between coupon dates (cont.)Example 5: Current AA+ corporate bond yields in the market are 8% per annum. An existing AA+ corporate bond with a face value of $100 000, paying 10% per annum half-yearly coupons, maturing 31 December 2016, would be sold on 20 May 2011 at what price?(cont.)Example 5 (cont.):(cont.)10.4 Calculations: fixed-interest securities (cont.)Example 5 (cont.):10.4 Calculations: fixed-interest securities (cont.)Chapter organisation 10.1 Term loans or fully drawn advances10.2 Mortgage finance10.3 Debentures, unsecured notes and subordinated debt10.4 Calculations: fixed-interest securities10.5 Leasing10.6 Summary10.5 LeasingLeasing definedA lease is a contract where the owner of an asset (lessor) grants another party (lessee) the right to use the asset for an agreed period of time in return for periodic rental paymentsLeasing is the borrowing (renting) of an asset, instead of borrowing the funds to purchase the asset(cont.)10.5 Leasing (cont.)Advantages of leasing for lessee over ‘borrow and purchase’ alternativeConserves capitalProvides 100% financingMatches cash flows (i.e. rental payments with income generated by the asset)Less likely to breach any existing loan covenantsRental payments are tax deductible(cont.)10.5 Leasing (cont.)Advantages of leasing for lessor over a straight loan provided to a lesseeLeasing has relatively low level of overall risk as asset can be repossessed if lessee defaultsLeasing can be administratively cheaper than providing a loanLeasing is an attractive alternative source of finance to both business and government(cont.)10.5 Leasing (cont.)Types of leasesOperating leaseShort-term leaseLessor may lease the asset to successive lessees (e.g. short-term use of equipment)Lessee can lease asset for a short-term projectFull-service lease—maintenance and insurance of the asset is provided by the lessorMinor penalties for lease cancellationObsolescence risk remains with lessor(cont.)10.5 Leasing (cont.)Types of leases (cont.)Finance leaseLonger term financingLessor finances the assetLessor earns a return from a single lease contractNet lease—lessee pays for maintenance and repairs, insurance, taxes and stamp duties associated with leaseResidual amount due at end of lease periodOwnership of the asset passes to lessee on payment of the residual amount(cont.)10.5 Leasing (cont.)Types of leases (cont.)Sale and lease backExisting assets owned by a company or government are sold to raise cash; e.g. government car fleet The assets are then leased back from the new ownerThis removes expensive assets from the lessee’s balance sheetCross-border leaseA lessor in one country leases an asset to a lessee in another country(cont.)10.5 Leasing (cont.)Lease structuresDirect finance leaseInvolves two parties (lessor and lessee)Lessor purchases equipment with own funds and leases asset to lesseeLessor retains legal ownership of asset and takes control or possession of asset if lessee defaultsSecurity of the lessor provided by:lease agreementleasing guarantee—an agreement by a third party to meet commitments of the lessee in the event of default(cont.)10.5 Leasing (cont.)Lease structures (cont.)Leveraged finance leaseLessor contributes limited equity and borrows the majority of funds required to purchase the assetLease managerStructures and negotiates the lease and manages it for its lifeBrings together the lessor (or equity participants), debt parties and lesseeAsset then leased to lesseeLessor gains tax advantages from the depreciation of equipment and the interest paid to the debt parties(cont.)10.5 Leasing (cont.)Lease structures (cont.)Equity leasingSimilar to a leveraged lease, except funds needed to buy asset are provided by the lessorTherefore, it is usually smaller than a leveraged leaseHas many characteristics of a leveraged lease, including the formation of a partnership to purchase the asset, but not the advantage of leverageChapter organisation10.1 Term loans or fully drawn advances10.2 Mortgage finance10.3 Debentures, unsecured notes and subordinated debt10.4 Calculations: fixed-interest securities10.5 Leasing10.6 Summary10.6 SummaryWhen choosing the most appropriate source of medium- to long-term debt, a borrower should consider the following factors:Fixed or variable interest rateTerm of the financing arrangementRepayment scheduleLoan covenantsWhether secured by fixed or floating charge, or unsecuredThe merits of leasing an asset as opposed to buying an asset