ShortTerm Financing STCM Chapter 16 ETM Chapter 13

1
Short-Term FinancingSTCM Chapter 16ETM Chapter
13
Order Order Sale
Cash Placed Received
Received

Accounts Collection lt
Inventory gt lt Receivable gt lt Float
gt

Time gt Accounts Disbursement
lt Payable gt lt
Float gt Invoice
Payment Cash
Received Sent
Paid
2
Financing and the Cash Flow Timeline

• A deficit cash position may result from the
  iteration of inefficient or inappropriate working
  capital policies
• Management should first evaluate its working
  capital policies to ensure the most efficient
  stream of cash flow from operations
• Strategic Plans can also cause a need for
  financing
• Balance Sheet Management will help dictate the
  financing strategies

3
Overall Borrowing Strategy

• Access to Capital
• Benefits of Using Financial Leverage
• Coordination with Capital Budgeting

4
Financing Strategies
Short-Term
Excess
Liquidity
Financing

Temporary Current Assets
Permanent Current Assets
Long-Term
Financing
Fixed Assets
Time
5
Decisions/Issues to Consider in Borrowing
Strategy

• Source - Debt vs Equity
• Maturity - Short or Long
• Interest Rate Characteristics
• Secured vs Unsecured
• On-and Off-Balance Sheet Financing

6
Short-Term Borrowing Objectives

• Maintaining Availability of Credit
• Optimizing the Cost of Funds
• Minimizing Risk
• Maintaining Flexibility

7
Factors Influencing Financing Costs
8
Loan Pricing

• All-in-RateBase Rate Spread
• Spread and Creditworthiness
• Common Base Rates
• LIBOR
• Prime Rate
• T - Bill

9
Credit Ratings

• Ratings are issue-specific
• Useful tool in evaluating overall
  creditworthiness
• Incorporates business risk and financial risk
  factors
• A company pays for the rating service

10
Short-Term Funding Alternatives

• Trade credit
• Internal borrowing
• Asset sales
• Commercial bank credit
• Single payment notes
• Reverse repurchase agreement
• Line of credit
• Revolving credit agreement

• Commercial paper (CP)
• Asset-based borrowing
• Bankers acceptance (BA)

11
Asset Based Loans

• Receivable financing
• Inventory financing

12
Line of Credit

• An agreement between a lender and a borrower in
  which the borrower has access to funds up to a
  specific amount during a specific period of time.

13
Line of Credit Key Characteristics

• Lender gives access to funds up to a maximum
  amount over a specified period
• May be committed or uncommitted lines
• Committed obligate the buyer to provide funding
  as long as the buyer is not in default
• Uncommitted can be cancelled by the lender at any
  time
• Usually revolving
• May be secured or unsecured
• Usually have a 30- to 60-day cleanup period

14
Effective Rate for Lines of credit

• Out of pocket costs
• Interest expense
• Commitment fee
• Usable funds
• Compensating balance

15
Effective Annual Borrowing Ratefor a Line of
Credit Formula

• Where
• Total interest paid is the all-in rate times the
  average loan amount outstanding.
• Total fees paid include all commitment fees,
  placement fees and any issuance costs.
• Average useable loan is the net amount of
  borrowed funds available after any compensating
  balances are deducted.

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Effective Annual Borrowing Rate for a Line of
Credit
Example A company wants a 30 million line of
credit with average borrowing to be 20 million.
The bank charges a commitment fee of 0.2 on the
unused portion. Advances bear interest at prime
(currently 7) plus 2. A possible compensating
balance requirement is also shown below.
17
Revolving Credit Agreement

• A facility which allows the borrower to borrow,
  repay, and reborrow up to a defined amount.
• It is a contractual commitment which includes
  covenants, commitment fees, and facilities fees.

18
Commercial Paper

• An unsecured promissory note issued by companies
  for a specific amount with maturities ranging
  from overnight to 270 days.

19
Commercial Paper (CP) Issuance
20
Commercial Paper Pricing

• Out of pocket costs
• Interest expense
• Line of credit fee
• Dealer underwriting fee
• Remarketing fee
• Usable funds
• Discounted price (Face value less interest)
• Dealer spread

21
Effective Annual Interest Cost for Commercial
Paper (CP)
Example A company wants 10 million commercial
paper issue . The dealer charges a fee of 0.1 .
The bank providing a letter of credit wants a
fee of .2.The Commercial Paper is utilized for
60 days. The Commercial Paper is sold at a
discount rate of 4.2.
Part 1 of 2
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Effective Annual Interest Cost for Commercial
Paper (CP)
Example A company wants 10 million commercial
paper issue . The dealer charges a fee of 0.1 .
The bank providing a letter of credit wants a
fee of .2.The Commercial Paper is utilized for
60 days. The Commercial Paper is sold at a
discount rate of 4.2.
Part 2 of 2
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Letter of Credit

• Substitutes the credit of a financial institution
  for that of the borrower
• Financial institution guarantees payment to the
  seller and then collects from the borrower

24
Bankers Acceptance (BA)

• A negotiated short-term instrument used primarily
  to finance the import, export or domestic
  shipment of goods or the storage of readily
  marketable staples.

25
Key Characteristic of BAs

• It is a time draft accepted by a bank.
• The BA is the direct obligation of the accepting
  bank.
• The credit rating of the accepting bank backs the
  BA.
• A BA is a marketable instrument.
• A BA is a discount instrument.

26
Asset-Backed Borrowing

• A secured form of lending based on the pledging
  of A/R or inventory as collateral for the loan.

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Types of Asset-Backed Borrowing

• A/R
• Inventory
• Floor Planning
• Factoring

28
Accounts Receivable

• Collateralized over 100
• Payments by customers made directly to lender
• Lender does not own the receivables

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Inventory

• Collateralized over 100
• Finished Goods or Raw Materials

30
Floor Planning

• High Cost Goods (Autos, Appliances)
• Lender takes title to the goods
• Loans are repaid when the goods are sold

31
Securitization

• Financing technique in which a company issues
  debt securities backed by a pool of selected
  financial assets.

32
Key Characteristics of Securitization

• Off-balance sheet financing
• Helps improve the balance sheet by reducing
  leverage
• Issues are credit enhanced

33
Credit Enhancement Methods for Securitization

• Over-collateralization
• Letter of Credit
• Spread Accounts

34
Securitization
Acme Corp
Auto Loans 8 5 years 10M
Subsidiary (off balance sheet) 9.5M
35
Securitization
Acme Corp
Cash
Investors
Auto Loans 8 5 years 10M
Subsidiary (off balance sheet) 9.5M
Asset backed securities
4 3yr 4M
2 1yr 2.3M
6 5yr 3.2M
36
Acme Corp
Securitization
Cash
Investors
Auto Loans 8 5 years 10M
Borrowers 11.5M
Subsidiary (off balance sheet) 9.5M
Asset backed securities
Repay loans
4 3yr 4M
2 1yr 2.3M
6 5yr 3.2M
37
Securitization
Acme Corp
Cash
Investors
Auto Loans 8 5 years 10M
Borrowers 11.5M
Subsidiary (off balance sheet) 9.5M
Asset backed securities
Repay loans
Acme Corp 1M
4 3yr 4M
2 1yr 2.3M
6 5yr 3.2M
Residuals
38
Medium and Long-Term Borrowing Alternatives

• Medium Term Notes
• Bonds
• Debt-Equity Hybrids
• Term Loans
• Leasing
• Private Placement

39
Private Placement

• Is a direct sale of securities by a company to
  institutional investors.
• Securities are not registered with the SEC.
• May offer longer or more flexible terms than term
  loans.
• Less costly to arrange than for public debt
  issues.

40
Reasons Private Placement is Preferred Over
Public Issuance

• Less restrictive covenants
• The size of the issue
• The reduced time and number of parties involved
• The complexity of the securities
• A desire for minimal reporting, agency ratings or
  public disclosure
• Lower costs
• Control over who holds the debt

41
Debt (Bond) Capital Markets

• Use of short- and long-term debt usually results
  in lower overall cost of capital and an increase
  in cash flows per dollar of equity due to
• Generally lower cost of debt (vs. equity)
• Tax deductibility of interest payments
• Fixed nature of debt payments
• Profitable companies favor debt
• Payments limited to principal/interest
• Risk of insufficient cash flows
• Additional borrowing or possible default or
  bankruptcy

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Long-Term Bonds (1 of 2)
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Long-Term Bonds (2 of 2)
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Key Characteristics of Bonds

• Bonds are administered through a trustee.
• Bonds can be secured versus unsecured.
• Bonds can be classified as senior or subordinate.
• Bonds have call features.
• Secured bondholders have priority claim in
  liquidation.
• Ratings

45
Issuance of Bonds

• Competetive or Negotiated
• Hire a Financial Advisor or Underwriter(s).
• Hire Bond Counsel.
• Create Documents including Official Statement
  (OS).
• Apply for Ratings.
• Finalize Structure and issuance date.
• Marketing and Order Period.
• Sale.
• Closing.

46
Leasing

• An alternative to term lending for financing
  equipment purchases.
• Typically 100 of the equipment cost can be
  financed.
• A capital lease is an on-balance sheet
  transaction.
• An operating lease is an off-balance sheet
  transaction.
• Tax advantages exists for the lessor and the
  lessee

47
Types of Leases

• Sale and leaseback
• Operating or service leases
• Lessor maintains, retains asset at end
• Often OBSA
• Shorter duration than life of asset
• Capital or financial leases
• gt 1 yr., not cancelable, fully depreciate list
  on balance sheet as a capitalized lease
• Lessor does not maintain
• Lease runs for life of asset lessee can purchase
  or renew contract at end