Giddy/Asset-Backed Securities
Corporate Financing Choices/1
Case Studies
Asset-Backed Securities
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Asset-Backed Securities
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Prof. Ian Giddy
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Stern School of Business
New York University
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Finance Company Ltd (Malaysia)
Fannie Mae Guaranteed REMIC Pass-Through
Certificates
Sears Credit Account Master Trust II
Ford Credit Auto Owner Trust 1998-B
Trains I PLC
Belenus Securities
Advanta Equipment Receivables
Atherton Franchisee Loan Funding
FILMS (Finance for an Italian Library of Movies plc)
Hong Kong Card Master Trust
Ras Laffan LNG
Copyright ©1999 Ian H. Giddy
Asset Securitization
Example: Formula One Bond
In May1999, Morgan Stanley Dean
Witter and WestLB led a $1.4 billion F1
Eurobond issue.
l The bond was backed by TV rights and
revenues from the exclusive contract
between Bernie Ecclestone’s F1
company and broadcasters for Grand
Prix racing coverage.
CHASE (SPONSOR)
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CREDIT CARD
RECEIVABLES
SALE OR
ASSIGNMENT
Corporate Financing Choices 4
SPECIAL
PURPOSE
VEHICLE
CREDIT CARD
RECEIVABLES
ISSUES
ASSET-BACKED
CERTIFICATES
Copyright ©1999 Ian H. Giddy
Corporate Financing Choices 6
Copyright ©1999 Ian H. Giddy
Corporate Financing Choices 7
Corporate Finance
Asset-Backed Securities
CORPORATE
CORPORATE FINANCE
FINANCE
DECISONS
DECISONS
Corporate Financing
Choices
INVESTMENT
INVESTMENT
FINANCING
FINANCING
PORTFOLIO
Prof. Ian Giddy
Stern School of Business
New York University
RISK
RISKMGT
MGT
MEASUREMENT
CAPITAL
DEBT
M&A
Copyright ©1999 Ian H. Giddy
EQUITY
TOOLS
Corporate Financing Choices 9
Giddy/Asset-Backed Securities
Corporate Financing Choices/2
First Principles
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Invest in projects that yield a return greater than the minimum
acceptable hurdle rate.
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The hurdle rate should be higher for riskier projects and reflect the
financing mix used - owners’ funds (equity) or borrowed money
(debt)
Returns on projects should be measured based on cash flows
generated and the timing of these cash flows; they should also
consider both positive and negative side effects of these projects.
Choose a financing mix that minimizes the hurdle rate and
matches the assets being financed.
If there are not enough investments that earn the hurdle rate,
return the cash to stockholders.
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Corporate Financing Choices
Do financing choices matter?
Debt or equity?
l What kind of debt?
Certain kinds of market imperfections allow
corporations to reduce costs by improving
the financing mix
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The form of returns - dividends and stock buybacks - will depend
upon the stockholders’ characteristics
Minimize unnecessary financial risks.
Objective: Maximize the Value of the Firm
Copyright ©1999 Ian H. Giddy
Corporate Financing Choices 10
Copyright ©1999 Ian H. Giddy
Corporate Financing Choices 11
Is There an Optimal Capital Structure?
Does Capital Structure Matter?
Assets’ value is the
present value of the
cash flows from the
real business of the
firm
Value of the firm
=PV(Cash Flows)
Assets’ value is the
present value of the
cash flows from the
real business of the
firm
Value of the firm
=PV(Cash Flows)
Debt
Equity
Value of the firm
=D+E
Debt
Equity
Value of the firm
=D+E
You cannot change the value of the
real business just by shuffling paper
- Modigliani-Miller
Copyright ©1999 Ian H. Giddy
Corporate Financing Choices 12
Copyright ©1999 Ian H. Giddy
Corporate Financing Choices 13
Does Capital Structure Matter?
The Financing Side:
Is There an Optimal Capital Structure?
Assets’ value is the
Debt
present value of the
cash flows from the
Equity
real business of the
firm
The
The “Conservation
“Conservation of
of Risk”
Risk” argument
argument
Value of the firm
Value of the firm
=D+E
=PV(Cash Flows)
Assets’ value is the
present value of the
cash flows from the
real business of the
firm
Value of the firm
=PV(Cash Flows)
VALUE
OFTHE
FIRM
You cannot change the risk of the
business just by shuffling paper
- Modigliani-Miller
Copyright ©1999 Ian H. Giddy
Corporate Financing Choices 14
Copyright ©1999 Ian H. Giddy
Debt
Equity
Value of the firm
=D+E
Optimal debt ratio?
DEBT
RATIO
Corporate Financing Choices 15
Giddy/Asset-Backed Securities
Corporate Financing Choices/3
When Debt and Equity are Not Enough
Assets
When Debt and Equity are Not Enough
Liabilities
Assets
Claims
Claims on
on
the
the cash
cash flows
flows
Value
Value
of
of future
future
cash
cash flows
flows
Liabilities
Debt
Value
Value
of
of future
future
cash
cash flows
flows
Contractual
Contractualint.
int.&&principal
principal
No
Noupside
upside
Senior
claims
Senior claims
Control
Controlvia
viarestrictions
restrictions
Equity
Residual
Residualpayments
payments
Upside
Upsideand
anddownside
downside
Residual
Residualclaims
claims
Voting
Votingcontrol
controlrights
rights
Copyright ©1999 Ian H. Giddy
Corporate Financing Choices 17
When Debt and Equity are Not Enough
Assets
What if...
Liabilities
Contractual
Contractualint.
int.&&principal
principal
No
Noupside
upside
Senior
Seniorclaims
claims
Control
Controlvia
viarestrictions
restrictions
Returns
are inadequate?
Equity
Assets
Corporate Financing Choices 19
FINANCING ALTERNATIVES
AVAILABLE TO MAJOR CORPORATIONS
Subsidized funds
Project
finance
Bank
debt
Term loan
Revolving
facility
Dollar
Value
Value
of
of future
future
cash
cash flows
flows
DEBT
Contractual
Contractualint.
int.&&principal
principal
No
Noupside
upside
Senior
Seniorclaims
claims
Control
Controlvia
viarestrictions
restrictions
Equity
Copyright ©1999 Ian H. Giddy
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Collateralized
Asset-securitized
Project financing
Preferred
Warrants
Convertible
Corporate Financing Choices 20
What Kind of Debt?
Some Considerations
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Real estate
Private
placement
Alternatives
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Residual
Residualpayments
payments
Upside
Upsideand
anddownside
downside
Residual
claims
Residual claims
Voting
control
Voting controlrights
rights
Copyright ©1999 Ian H. Giddy
Long
term
Liabilities
Debt
Residual
Residualpayments
payments
Upside
Upsideand
anddownside
downside
Residual
claims
Residual claims
Voting
control
Voting controlrights
rights
Fixed
Corporate Financing Choices 18
When Debt and Equity are Not Enough
Claims
are inadequate?
Debt
Value
Value
of
of future
future
cash
cash flows
flows
Copyright ©1999 Ian H. Giddy
Fixed/floating:
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certain are the cash flows? Are operating profits
linked to interest rates or inflation?
Leasing
Asset
backed
Unsecured
Nondollar
Floating
Public
offering
US CP
Domestic
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Eurobond
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the assets short term or long term? Should the
firm assume ease of refinancing, or buy an option on
access to financing?
MTN
ARP
Short
term
FRN
Euro CP
VRN
Bank debt
Hybrid
Straight
Stripped
Callable
EQUITY
Index-linked
Convertible
Equity options
With warrants
Private sale
Full rights
Unstripped
Maturity or availability:
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Currency:
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currency of the assets: currency of location
vs. currency of denomination vs. currency of
determination.
Domestic
Public offering
Restricted
International
Copyright ©1999 Ian H. Giddy
Corporate Financing Choices 22
Giddy/Asset-Backed Securities
Corporate Financing Choices/4
Application
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Guidelines for Financing
How should Spanish oil company Repsol
finance its $13.4 billion acquisition of
Argentina’s YPF? (Fixed/floating; Maturity or
availability; Currency?)
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Originally planned to finance it entirely
with long-term US debt. But the falling
Euro with a lower interest rate led the
company to finance 30%-40% in Euros.
Copyright ©1999 Ian H. Giddy
Corporate Financing Choices 23
Liabilities to match assets: economic
?
exposure of the firm determines
iesbase
rit
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c
financing choices.
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ed
l Decision on whether orcknot to fully
a
t-b
match depends onsecompany's
view
s
a
relative to theuview
implied by market
se
hy
prices.
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financing/hedging techniques that offer
the lowest effective cost.
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Corporate Financing Choices 25
Financing Choices
and Asset-Backed Securities
Corporate Financing Choices 24
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Securitization creates assets with less risk and
greater liquidity, hence a lower cost of financing
But can the higher quality be achieved without a
commensurate decrease in the quality of the
remainder of the company?
Yes -- if securitization sweetens a lemon!
Reason: when a company faces uncertainties,
investors demand a premium. But investor concerns
about receivables can be dispelled at far lower cost
than other concerns about the company and its
overall performance.
Copyright ©1999 Ian H. Giddy
Corporate Financing Choices 26
Information-Based Value Added
ABS are complex and expensive to
structure. Hence in a perfect market
with no informational inefficiencies, no
need for ABS
l Use of ABS may make sense when
there are
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uSubsidies,
guarantees or regulatory
incentives
uInformation-based value added
Copyright ©1999 Ian H. Giddy
Copyright ©1999 Ian H. Giddy
Beyond Modigliani-Miller’s
“Conservation of Risk” Argument
Guidelines for Financing
Copyright ©1999 Ian H. Giddy
Liabilities to match assets: economic
exposure of the firm determines base
financing choices.
l Decision on whether or not to fully
match depends on company's view
relative to the view implied by market
prices.
l When strategy is chosen, use the
financing/hedging techniques that offer
the lowest effective cost.
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Corporate Financing Choices 27
Information about a company’s
receivables is improved
l Specialization in risk-bearing is
achieved
l ABS has positive “signalling effect,”
especially when residual rights retained
by company
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Copyright ©1999 Ian H. Giddy
Corporate Financing Choices 28
Giddy/Asset-Backed Securities
Corporate Financing Choices/5
Asset-Backed Securities: Summary
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Asset-backed securities can create
value for investors and issuers if:
uThe
assets are for some reason worth
more off the balance sheet than on
uThe right legal framework is in place
uThe costs do not exceed the benefits
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Sometimes they do not work...because
you cannot make money by cutting up a
dog
Copyright ©1999 Ian H. Giddy
Corporate Financing Choices 29
www.giddy.org
Ian H. Giddy
Stern School of Business
New York University
44 West 4th Street, New York, NY 10012, USA
Tel 212-998-0332; Fax 630-604-7413
ian.giddy@nyu.edu
http://giddy.org
Copyright ©1999 Ian H. Giddy
Corporate Financing Choices 31