DEBT CAPITAL MARKETS

SESSION 1.
With Fixed Income we mean a type of investing or budgeting style for which real return
rates or periodic income is received at regular intervals and at reasonably predictable levels.
Therefore, a fixed income security, is a type of asset class which promises you returns. We
have two kinds of returns:
- Coupon
- Face value: fixed return that you will get at the end
The repayment is not guaranteed due to a concept called credit risk. Which is one of the
various risks you heard in the finance world. For instance, we have the systematic risk which
cannot be eliminated. Or Inflationary risk, legislative risk, currency risk.

To make people in the market understand how much risk they are getting when they invest
in a debt instrument, there are the so-called ratings. Ratings are grades given by rating
agencies. They go from AAA to D, that stands for default. There is an inverse relationship
between YIELDS, so returns and Risks. Indeed, High Ratings (AAA) get low YIELDS.

You can be downgraded in terms of ratings, indeed a company that has been downgraded
from high grade to high yield is called a fallen angel. But what is a bond?
A bond is a debt investment in which an investor loans (gives) money to an entity which
borrows the funds for a defined period of time at a variable or fixed interest rate.

There are some terms we need to know:

- Issuer: in the contract he would have a nick name represented by a ticker
- ISIN: is a serial number that are like a bar code of the product
- Date of issuance
- Interest payment date: the frequency of coupon payments
- Maturity: the redemption of the bond
- Denomination: is the minimum you can trade.

Fixed income securities fall into two general categories:

Debt Obligations
- Corporate Bonds
- Sovereign Bonds
- Mortgage-backed securities
- Banks Loans
Preferred Stock
- Class of ownership in a corporation that has a higher claim on its assets and earnings
than common stock
- Preferred shares generally have a dividend that must be paid out before dividends to
common shareholders, and the shares usually do not carry rights

The agreement between the issuer of a bond and the bondholders is called the bond
indenture, and it contains basically the terms and conditions, like basic terms of the bond or
the description of the security, call provisions, covenants.
Focusing on the last concepts, the debt covenants, they are like conditional terms in lending
agreements to ensure the borrower’s financial performance remains steady and
management continues to be responsible when making corporate decisions.
They can be affirmative covenants or negative.
Affirmative covenants set forth what the borrower has promised to do
- To pay interest and principal on a timely basis
- To pay all taxes and other claims when due
- To submit periodic reports to the trustee stating that the borrower is in compliance
with the loan agreements
Negative covenants set forth certain limitations and restrictions on the borrower’s activities.
- A limitation on the borrower’s ability to incur future debt obligations – To meet
certain financial coverage ratios
- To not sell assets without notification to the trustee and/or lender

An important concept is when they say secured or non-secured bonds. Secured means that
if I go bankrupt the bondholder would be still able to claim specific assets with which I
secured the bond. This also means that your company doesn’t have that much trust,
because you need to give incentives, so investors trust you more.
How does the market work when there is a bond issuing?

The coupon can be of different types, like Zero-Coupon Bonds are bonds that do not make
periodic coupon payments, interest is paid at the maturity date. They are traded at discount
an investor who buys the bond will earn a return both from receiving the coupons and from
receiving a face value that exceeds the price paid for the bond. As a result, if a bond trades
at a discount, its yield to maturity will exceed its coupon rate. Given the relationship
between bond prices and yields, the reverse is clearly also true: If a coupon bond’s yield to
maturity exceeds its coupon rate, the present value of its cash flows at the yield to maturity
will be less than its face value, and the bond will trade at a discount.

Then we have Step-up Coupon Notes that are bonds with a coupon rate that increases over
time. They are different from Floating Coupon Bonds, which are bonds that have a coupon
rate which resets periodically based on a formula and so considering something variable like
a quoted margin.

Let’s start distinguishing different kind of Debt Instruments.

Sovereign Debt.
They are obligations of a country’s central government. They can be issued in their own
national markets or in the foreign sector. T Bills are issued by US government and they have
maturity of maximum 1 year. T notes are coupon securities with original maturity between 2
and 10 years, while T-bonds over 10 years.
Corporate Debt.
Corporation have two sources of debt financing: bank borrowings or issuance of debt
securities. They can be Senior or Subordinated. Subordinated means that they have a lower
priority claim to the firm’s assets in the event of a bankruptcy. Corporate Bonds can also be
Secured or Unsecured. In the first case they have a collateral backing. When you are
secured by a specific property then we are talking about a Backed Security. The typical case
is the Mortgage Backed Security. How do they work?
I am a bank an di give a lot of mortgages and I put all this loans into a one asset. This pool of
mortgages will be keep yoghurt by an external entity, called SPV (special purpose vehicle)
and trough a process called securitisation the product will become liquid and then can be
issued to the market. The ones that buy it from the market will receive a coupon which is
coming from the people paying the mortgages back.

Reasons for 2008 crisis.

In this pool you can’t have only prime mortgages (AAA), but we have also people that we
didn’t even check if they had income to pay it back. Also, the rate at the beginning is quite
low but hone when interests rate go higher the mortgage rate starts to go higher people
couldn’t afford them anymore.

As stocks, there are also debt with options. Remember that a call gives to its owner the right
to buy an asset and the put to sell it.
An issuer would issue a callable bond because he thinks that potentially interest rates can
go lower and so he will call back the bond and reface itself at a cheaper cost. If the issuer
calls back the bond, for me that I am an investor means that I have to reinvest my money at
a lower interest rate. Therefore callable coupons are higher because of that.

To figure out how much a bond is liquid, you take into account the Bid-Ask Spread. -->
Narrow spread = More liquid asset.
Market makers = triggers that decide the market on specif asset side treasures. Traders on
utility bonds.
Market maker will give you a BID = the price he is willing to buy (dealers point of view --- not
customers). Bid offer from dear point of view. Ask who wants to sell from the seller
The difference between the bid and the offer – 100 bid / 101 ask – spread of 1% Bid/Ask
This is how you can make money. In US treasury the Bid/Ask(offer) price is very narrow..
very liquid instruments it trades in huge sizes. The bigger is the Issue the more is the liquid.
The less is the issue the lower the liquidity.. Lower than 500 median is less
Valuation and Bond Pricing.
The way you do it is calculating the present value and so considering the five keys (Coupon;
Maturity; Face Value; PV; Yield) . As the market moves the discount will be different.
The yield to maturity is the expected return if you hold the bond until maturity. The
assumption we made is that you reinvest the coupons at the same rate, but it is very
unlikely because interests moves. This risk is called reinvestment risk.

But be aware that you should not use only one discount interest or factor because it could
be not in accordance with reality, but we will see it later.
Furthermore, if the Yield is higher than the coupon rate, it means you sold it at a discount.
(Denominator greater than numerator). It is important to understand that the value of the
same bond change with time. The price of a bond will change during time because the
maturity changes therefore the YIELD changes because an 8 Year YIELD is not the same of
the one of a 1 year.
When a bond is purchased between coupon periods, the buyer pays a price that includes
accrued interest, called the full price or dirty price.
Accrued Interest = Interest Payment x (Number of Days since last payment/ Number of
days between payments) - > try do to exercise pag. 48

Yield Curve.
The Yield to maturity is the interest rate that will make the present value of the cash flows
from a bond equal to the price plus accrued interest.
Instead, the IRR is the Yield to maturity that gives NPV = 0 if you hold the bond until
maturity.
The biggest limitation of the Yield is that it considers that the coupon payments from a
bond a reinvested at an interest rate equal to the Yield, but due to something called
reinvestment risk is not possible.

YIELD CURVE SHAPES:

It is very important to understand the shape of the YIELD CURVE
• Normal (positively shaped) = NORMAL economic situation.
The LOWEST the maturity, the LOWEST the yield. The HIGHER the maturity the HIGHER the
yield
• Flat = if we see the yield curve flattening, Example the return on 2Y bond = to the return of
the 5Y bond, this means that something is happening in the economy. Usually this is a
PHASE OF TRANSICTION! --> if you see flattening (short maturity rising or long maturity
decreasing), it is very likely that in the short term you are going to have an INVERTED
CURVE --> that reflects a recession
• Inverted (negatively sloped) = usually sign of a recession in the economy. The short term
maturity yield is HIGHER, so in the short term the RISK is high --> in the LONG term it
becomes less RISKY. The STRESS in the market
• Many other forms of yield curve. Example: HUMPED yield curve
--> in HUMPED yield curve there is stress in the SHORT - MEDIUM term, but not in the LONG
term

Example if you understood:

- The FED has said that they are going to hike (increase) the rates --> RATES are going
HIGER.

If you are a PORTFOLIO MANAGER, would you buy short-dated bond or long-dated bond?
• You should buy a SHORT-DATED bond if you thing that RATES ARE GOING HIGHER
• You should not buy the LONG TERM of the curve --> if you thing rates are going to be
higher tomorrow (or few months), why would you lock in a bond at a LOWER rate for 10Y,
wait a little bit more until the rates are higher. So if you have to put the money somewhere
but the short-end of the curve. Do not lock yourself in a bond with lower rate that you can
get just by waiting a little bit more
If everyone buys the SHORT-END of the curve, what happens to the PRICE of those BONDS?
- Prices will go UP and yield (short term) will go DOWN --> so the curve will STEPEN even
more. With rate hikes, the market will exasperate this movement (steep curve between
short-end yield and long-end yield) --> because nobody is buying the long term bonds

The opposite will happen with LOWERING interests rate --> You will buy the LONG-END of
the curve

SESSION 2.
The YTM is the interest rate that will make the present value of the cash flows from a bond
equal to the price plus accrued interests.
We said before that we might need to use different interests’ rate to discount a bond
because using one is unrealistic.
Therefore, we introduce the concept of Spot Rates & Forward Rates.

Spot Rates
It is a rate (IRR) of interest that can be earned on a default-free investment made today
which would be repaid with interest on a specific date in the future with no coupons.

You should use this interest rate to discount a default free cash flow

S1 = 8.75% (from 0 to year1)

S2 = 9.15% (from 0 to year 2)
S3…

They are extrapolated because since we have a limited number of those zero-coupon
securities traded in the market so you need to calculate rates for interim maturities. Spot
Rates can be derived by a method called bootstrapping with which you can derive the spot
rate curve. It is important to have bonds with the same credit qualities and different
maturities otherwise you compare apple to oranges. Therefore same issuer or same rating
(like BBB in the energy sector)

FIND A WAY TO DO SPOTS RATE IN EXCEL FAST!! IF YOU USE NORMAL BONDS

Forward Rates
These rates are used to calculate spot rates in an easier way, they are implied in the yield
curve.
1F1 represents the forward rate between year 1 and 2
2F1 represents the forward rate between year 1 and 3
1F2 represents the forward rate between year 2 and 3

One period forward rate -> r(0,2) = r(0,1)*1F1

1F1 = r(0,2)/r(0,1)

The formula to Find F(2,3) = ((1+R3)^(3))/((1+R2)^(2)) – 1

The difference between forward rates and spot rates is in the execution, spot are executed
today, forward will be executed in the future. The securities that have spot rates are ZCB,
Currencies and commodities.

We have to approach to value a bond’s cash flow: The traditional approach and the
Arbitrage-free approach.
Traditional Approach:
A benchmark or similar investment’s discount rate is used to value the bond’s cash flows.
The flaw is that it views each security as the same package of cash flows and discounts all of
them by the same interest rate.
Arbitrage-free pricing approach:
Assumes that no arbitrage profits are possible in the pricing of the bond
– Each of the bond’s cash flow (coupons and principal) is priced and discounted separately
– The spot rate is used to discount a default-free cash flow with the same maturity
– The value of a bond based on spot rates is called the arbitrage- free value

There are different types of bonds.

Entering in the market is very different if we are talking about US or Europe.
But the concept of primary market stays the same in both countries. The bond market of a
country consists of:
• an internal bond market - also called the national bond market
• an external bond market - also called the international bond market. Eurobonds are bond
denominated usually in a G7 Currency that is underwritten by an international syndicate, or
more syndicates and DCM departments. They come to the market at the same time.
A Yankee bond is created by non-USA Company but sold in USA
Samurai Bond, same concept but in Japan
Panda Bond, same concept but in China

Bond Issuing Process

Everything starts with the issuer that can be a corporate or a sovereign. When they come to
the market for the first time they will enter the primary market. The first party they
interface with is the DCM Origination Departments. Indeed, the origination team will knock
at the door of the corporate saying: “Hey, I know you need some funding, and we can help
you”. They will suggest the structure of the bond which will be then issued to investors. The
Banks will pitch their ideas and get back to the issuer that will choose which bank they want
that will become the Lead Bank or Lead Manager. This bank will be mandated and all the
information exchanged in this frame of time are very private and can not be spread withing
other departments of the company and so it is build a Chinese wall.
Once they have originated, pitched the deal and be chosen under lead managers, they will
start looking for clients. Firstly, they go to someone that works in the front office and say:
“Hey, I know you cover the account of this client that has bought a log of debt from the
issuer. I am going to give you some sensitive information which could move the market and
so you are not allowed to say anything”. This person will repeat a phrase to swear under
registration. Then they will call the client like a robot.
Then the Lead Manager will underwrite the deal. Underwriting comes from an old
procedure. In the past the issuer that wanted to raise bonds, will go to a room full of banks
and ask for 1 million. A company agrees to give him a part and so he underwrites the name
of the company under the sum. Then the deal becomes public, the Lead bank is going to live
the deal. Once the deal is live, everyone in the public side will receive a message: “Company
X has issued a 7year bond with initial price of Y, if you want to place orders, please reflect to
person x”. Then the middle managers will call directly some clients and ask if they want to
make orders and so they will build the book. All this process is done by only the lead
manager and not the other banks. These other banks will operate in the Grey Market. They
will put a price on the bond that will be free of trade the day after, depending on the
demand of the security. If the lead bank receive too many orders then the bond is
oversubscribed, therefore they gather more than they needed. What happens is the price
going up, and therefore whoever bought it in the primary market can re-sell it in the grey
market.
Once the book has been ri-coincide, meaning that the syndicate verified who booked it and
for how much, the issuer will decide the allocation. The distribution phase involves road
shows, so when the lead managers and the senior manager of the issuer will actually go on
the road and travel city to city to give update on their business.

SESSION 3
Recap:
- How do we price a bond? 5 keys, but remember to see if you need to use YTM or
Spot rates
- The pricing convention: we price the bond at 90, means = 90% of 1000
- If a company is selling a bond at 3 points discount means it is selling at 97%
- What is the bid/offer spread? Think about the bid shop in a horse race, the bid is the
price at which the dealer buy and the ask is the price the dealer would sell it.
- The lower the spread the more liquid is the security, so a Bid/offer of 99/100 means
that 99 is the price the dealer would buy and 100 would sell it, so the spread is 1
- If you expect interest rates to increase, what do you? Long- or Short-term bond?
Short-term bond à and we will purchase later the bond when will be higher. If
everyone buy short term bond, the yield curve is going down more because everyone
is stepping in, so the yield curve will steeper.

The relationship between prices and yields is convex. There is indeed a positive convexity,
when the yield goes down the price increase. Long Term bonds are more sensitive to
change sin interests.
When interest rates go up the price go down but the variation from P0 is less than the
variation occurred when interests go down, because of the positive convexity which is
investor’s friendly.
The Duration, instead, is the first tangent to the convexity, therefore is the first derivative of
the relationship between price and yield. With the duration you can get the new price after
a change of 1% in yield. Basically, the duration is a formula to get the price chage of a bond
whenever yields move 1%. If a bond has a Duration of 4% it means that a1% change in Yield
will lead to a 4% change in price. But also, a Duration of 4 means that the bond is going to
take 4 years to repay the initial investment.
Therefore, when I want to get the price of a bond for a change in Yield:
- Calculate the duration
- Calculate the convexity, cause it gives you P-YTM relationship
 - Just get the new price

Very important to understand that for a very small change in Yield the price decreases or
increases in the same way because the curve is symmetric.
Features that affect interests and therefore prices are:
- Maturity: the longer the more sensitive. Because time gives value to money
- Coupon rate: the quicker you get coupon the shorter the duration

Let’s see some Bond Proprieties.

Property 1.
- In response to a given change in Yields, bond prices do not change equally cause:
o The convexity of bonds is not the same
o Longer maturity means bigger convexities
o Lower coupon increases convexity too.

This means that bonds that have a greater convexity will be paid more because when yields
go down the price appreciation is higher for convex bond.
The other properties we have already talked about.

If we said that the Duration is the tangent it means that if Yield goes up also the Duration
Increases, the slope becomes steeper.
To Sum it up.
What is Duration?
• Duration is a measure of the average life of a security
• Duration is the weighted average term to maturity of the security’s cash flow
• Duration measures the approximate price sensitivity of a bond to interest rate changes.

The formula should be-> Macaulay Duration =

n = number of cash flows; t = time to maturity

C = cash flow; i = required yield; M = maturity (par) value P = bond price
We can also calculate the Modified Duration = Macaulay Duration / (1+YTM/k) . and it gives
you the volatility or sensitivity of the bond. Where K is the number of coupon periods per
year.

If a bond A and Bond B have the same duration it means that they have the same interest
rate.
Duration decreases as time moves closer to maturity, but duration also increases
momentarily on the day a coupon is paid and removed from the series of future cash flows.
Indeed, if you have bonds. One that pays quarterly and the other one semi-annually, the
one with lower duration is the quarterly one because you get the coupon quicker.
For Bonds with Call option I can’t use the modified duration formula, because of the call
feature, meaning that some coupons may not be paid because of the possibility for the
bond to being called., therefore we use the effective duration

Because it calculates how duration will change when interest increases by 100 basis points,
the modified duration will always be lower than the Macaulay duration.
Bond Price Change = Yield Change × Modified Duration × Bond Price

Convexity.
Duration does a good job of estimating the percentage price change for a small change in
interest rates but no when it comes with big changes.
To solve this we need to adjust the duration with convexity, that is the second derivative of
the relationship Yield - Prices.
Convexity = slope of the price/ Yield curve. It is usually greater on the upside than on the
downside. It increases as yield to maturity decreases.
The higher the coupon rate, the lower the convexity. ZCB have the highest convexity and
callable bonds have negative convexity at certain price-yield combination, when the bond
will be called basically.
Convexity measure =

Look at the formula on the slides 44-47

- When interest rate goes up, the price of the bond goes down. This trend is weakend
the more the bond is convex.
- When interest rate goes down, the price of the bond goes up. This trend is strengten
the more the bond is convex.
- Suppose bond A and bond B have the same duration but bond B has a higher
convexity then bond A
- Investor will always prefer bond B:
o When interest rate are going up, the price of bond B decreases less then the
one of Bond A
o When interest rate are going down, the price of bond B increases more then
the one of Bond A
- Generally, market prices take this into account in their pricing
SESSION 4.
 BERLIN
LONDON
MADRID
c PARIS
TURIN
WARSAW

Debt Capital Markets course:

Debt Capital Markets in practise I
Dr Andrea Simoni
[email protected]

1
DCM in practice: overview
c

2
Exam: multiple choice questions + gap filling
c

3
About me

[email protected]

linkedin.com/in/simoniandrea/

+44 7709 246407

Master in Management
Class 2020

Business administration
Class 2017

Leveraged Finance
Analyst 2

Former president

4
 BERLIN
LONDON
MADRID
c PARIS
TURIN
WARSAW

Section 1.1

- Actors in Debt Capital Markets

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Who are the main players in DCM?
Main actors in debt capital markets (DCM)
c
• Debt capital markets (DCM) are a component of
the international financial markets in which
corporates and governments raise funds

• DCM is a higher-volume, lower-margin business

compared to ECM as credit markets are bigger
than equity markets. At the end of FY19 global
market issuance reached $21 trillion (+20% YoY)
vs $0.54 trillion (+1% YoY) of global equity
issuance

• The terms refers to all the international markets Source: SIFMA

in which debt is traded
Top 10 banks worldwide by fees generated in FY21 (Bonds)
• Debt products mainly include corporate and
government bonds, loans, treasury bills,
commercial papers, credit default swaps
• Similarly to equity markets, DCM can be divided
into:
• Primary market – where a borrower
issue a new debt product in order to
raise cash directly from the market
• Secondary market – where existing debt
instruments can be traded between the
various market investors
• Main actors in the market are
• Investment banks
• Investors (investment managers,
pension funds, hedge funds, market
makers)
• Rating agencies, law firms and auditors
Source: Financial Times (Refinitiv, 29th December 2021)

• BoFa and Morgan Stanley = KING of IG

• Credit Suisse, Deutche Bank, Barclays = more focused on High Yield bonds 6
Who is more cyclical Equity issuance or Debt issuance?
EQUITY despite the fact that there are interest rates, the market is more stable in Equity. You always need cash,
when there is market breakdown, a bear market it is easer to find big companies (oil, automotive) trying to get
money to get founding. The IPO market tends to be hindered by shocks in the markets.
DCM = used to raise funds. It is characterized by HIGHER volumes and LOWER fees compared to capital
markets. Why? There is much more DEBT than EQUITY.
----> 20trillion debt vs 0.54 trillion of equity (it's 40x more)
--------> DCM is also a growing sectors it's growing at 1% year of year
What are the products of DCM? Basically everything = bonds, loans, treasury bills, CDS (Credit Default Swap)
What is the main difference between a BOND and a LOAN.
= Bond is negotiable and transferable. Highly tradable, you have a liquid market --> liquidity always a concern
for investor.
Another similarity between DCM and ECM is the conception of PRIMARY and SECONDARY market:
• Primary = company issue a bond,and they get cash from investors. I am a buyer and get cash from investors
to use it for acquisition
• Secondary market = the names on Bloomberg. Secondary investors buying and selling = making liquidity for
everybody.
The 3 main actors of DCM:
1) IB
2) Investors (the most important one)
3) Ancillary functions = rating agencies, law firms
GRAPH
The difference between Investment Grade (IG) and High Yield is only the RATING.
Below BBB- you get to the junk bond high yield level --> this makes a difference because there are different
teams in a bank depending on the rating of the debt instrument
---> DCM = they only do IG
---> Leverage Finance = they do High Yield
Investment banks (Origination team)
DCM Origination
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• DCM origination teams advice corporates, financial institutions and SSA
• Direct relationship with clients to bring new issues to (Sovereigns, Supranationals and Agencies) entities:
the primary market • SSA: (i) sovereigns indicate central government (e.g. Italy, France); (ii)
supranational borrowers are institutions that operate across national
• Fee-based business model where the client pays a borders and are owned/governed by a number of countries (e.g. EIB,
percentage of the amount issued IBRD); (iii) agency is a broad term that applies to institution that performs
a task on behalf of sovereigns entities (e.g. KfW, CADES, ICO)
• Additionally, banks usually tend to involve multiple • Financial Institutions (FIG): include investment banks, companies that
teams in order to cross sell additional products that may provide financial services and insurance companies (e.g. Unicredit)
be useful for the borrower. Main examples are: pre- • Corporates: non-financial corporations (e.g. Vodafone, Enel, Bayer)
hedging, cross currency swaps or treasury investment
products. Key interactions with liability management, Total global bond issuance 2010-2020
corporate banking and rates teams Why the 2Q of 2020 was that high?
• Originators may also decide to be involved in a -- Covid impact was the best year for IG issuance
transaction with limited fees for two main reasons: in the last years. Because companies struggled
• “League table trade”: the marketing value of a to find cash!
bank is directly correlated with its league table
ranking as it will enhance its credentials in a
specific sector. The main providers of league
tables in the DCM sector are Bloomberg,
Dealogic, IFR and Euroweek
• Relationship management: each client
maintains a special relationship with a
restricted group of investment banks. This
relationship may derive from personal
relationship (e.g. former managing directors
becoming executives at the corporate),
historical partnerships (e.g. BNP
Paribas/Société Générale in France or
Deutsche Bank in Germany) or specific
technical skills (e.g. one-stop shops for different
services)
Source: ICMA analysis using Bloomberg Data (August 2020)

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There are mainly 2 FUNCTIONS in DCM:
• Originator = are the true bankers. They maintain the relationship and they prepare the documents. They have a
stable relationship with the client and a deep understanding of the business model. This is a fee based business
model ---> like in M&A you get paid by a percentage of the deal. This percentage is based on the deal that you
make and usually goes 1.5% - 2% for HY (high yield)
---> What bankers do? They create relationship with people in other teams. Basic market strategy. 1 STOP SHOP
= they try to CROSS SELL I help you to issue this bond + I help the client to diversify the portfolio!
• Syndicator = ??? SLIDE 9

A part from the fees there are other 2 main reasons to do HY:
1) • Lead Table Trade = Marketing is very important --> you need to have a proof that you are better than the
others. M&A is standardized, what makes difference is the marketing, (I lead 10 of the biggest M&A last year,
you can build some credibility and you can use it for pitching and getting mandates)
---> Lead Table = the tables that say who is the first, the second, the third .... the RANKINGS.
2) • Relationship Management = more shady. You have to manage some relationship with clients. The problem?
Sometimes you get stuck with a deal that you do not want to execute, because it is not convenient BUT you still
go trough with it. Why? Because you want to keep the relationship with the client for the next deal

DCM Origination TEAM is divided in 3 categories:

1) SSA = Sovereign Supernationals Agencies --> in terms of share is the biggest one! Government are of course
the biggest ones and they issue much more and more regularly. Sovereign basically means countries.
Supernational borrowers --> operates across national borders. Agencies works specifically for a certain
government
2) FIG = Financial Institutions ---> Like in M&A is always different. They have different ways of looking at cash
generation. FIG = IB, Insurance companies.
3) Corporates = non-financial corporations
Every bank will be First for something! Passive Bookrunners = they have a lot of cash
invest. They try to be in every deal
Global league tables (Bloomberg and Dealogic)
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Source: https://www.globalcapital.com/data/all-league-tables (Dealogic, 16th January 2021)

http://data.bloomberglp.com/professional/sites/10/Bloomberg-Global-Capital-Markets-League-tables-FY-2019.pdf (Bloomberg, FY 2019)
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 Investment banks (syndication desk)
c
Syndication desk

• Syndicate is the interface between the primary and secondary market

• By interacting with Origination (in contact with the sell-side, i.e. the issuer) and Sales (in contact with the buy-side, i.e. the investors),
the syndicate desk can ensure that the demand and supply of capital markets products are matched

• Once a transaction is announced, Syndicate, Sales and Origination work together to support investors’ analysis on the issue through
the organisation of extensive deal and non-deal roadshows involving:

• Group presentations

• One-to-ones investor meetings

• Investor conference calls

• Sales, split by region, work closely with Syndicate to ensure investor concerns are addressed and takes advantage of credit research
and secondary trading to add colours to transactions

• During the book-building process, Syndicate collates all the orders from investors. Once the book is closed, with the agreement of the
issuer, Syndicate will allocate, launch and price the deal

Issuers Investors
Origination Syndicate Sales
(sell-side) (buy side)

Investment
bank

9
SYNDICATE:
Syndication desk is a weird spot in IB --> between markets and corporate finance.
More markets than corporate finance, nut they sit in between!
Syndicate = the interface between primary and secondary market

- Relationship between Syndicates, Sales and Origination:

There are SALES on one side = so PUBLIC SIDE and talking with investors (Pimko, Blackrock) and they report
this reports to the syndicate
On the other side there are the origination side, that are tying to get the best price of issuance. So between
them there is a little bit of conflict of interest
• The Syndicate ROLE is to match DEMAND and OFFER: so it is a market MAKER
---> What you need to do is to convince investors about your presentation.
There are DEAL and NO DEAL roadshow
The final goal of SYNDICATE is the BOOK BULDING. So when there is an issuance, you need to collect the
order and make the best price possible.
 Investment banks (ancillary functions)
c Support all the contracts that are signed in IB
They are needed for Non disclosure agreements

• Sales and Trading (S&T) consists of salespeople, who call • Internal lawyers support the IB by providing legal, policy,
institutional investors with trading ideas, and traders, who reputational, and commercial advice and transactional
execute the related orders expertise on all aspects of the IB business to protect the firm

• In DCM origination and syndication bankers interact mainly • In DCM internal lawyers represent a fundamental resource in
with rates (government bonds) and credit (investment grade order to support negotiations of financing terms and
bonds, high yield bonds, loans) discussions with external law firms

Debt Capital Markets

• Compliance is a “middle office” function that ensures that a bank adheres to external rules imposed by regulators in order to
guarantee investor protection and market transparency

• Since financial crisis in 2008, investment banks have invested heavily on compliance (BNP Paribas increased the numbers of
compliance officers from 1,732 in 2014 to 3,770 in 2017)

• KYC (Know Your Customer) is a mandatory process in order to deal with financial crime and money laundering through the customer
identification. Penalties for non-compliance with AML (Anti-Money Laundering) reached $26bn worldwide between 2008 and 2018

Compliance = the internal police for IB --> after 2008 controllers wanted to put some barriers of what banks
could do! --> they cost a lot of money because they check everything in the bank. Cost 26bn for anti money
laudery

What are the most dangerous sectors for bank? Oil, problem of gaming (slot machines)
ethical problems! 10
 What do investors buy? Investors mainly buy SSA bond --> 68% bonds and corporate
bonds. Why are investors buying those product?
The YIELD --> The same as investing in equity with a dividend yield
Investors
c
Other strategies = Reserve Management --> the use of Central Banks to achieve
monetary targets --> Quantitative easing.
Investors overview Cumulative global bond issuance 2010-2020 (incl. matured bonds)
• As of August 2020, ICMA estimates that the overall size of the
global bond markets in terms of USD equivalent notional
outstanding, is approximately $128.3tn. This consists of $87.5tn
SSA bonds (68%) and $40.9tn corporate bonds (32%)
• Investors are mainly looking for:
• Reserve management: use of CBs cash reserves to
achieve monetary policy targets
• ALM (Asset Liability Management): mechanism to
address the risk linked to a mismatch between assets
and liabilities either due to liquidity or changes in
interest rates
• Speculation: mainly related to hedge funds focusing on
generating income through arbitrage and total return Source: ICMA analysis using Bloomberg Data (August 2020)

Investor type Examples Investment rationale

Banks DB, SG, JPM, Citi ALM, yield, relationship

Central banks ECB, BoE, Norges Bank Reserve management, yield

Asset managers DWS, Fidelity, Blackrock Asset allocation, yield

Insurance companies Aviva, Generali, Allianz ALM

Pension funds OTPP, Norway Government Pension Fund Security, ALM

Hedge funds Man GLG, AQR, Citadel Rel Val, Arb, Total Return

Money Market Funds Western AM, Federated Investors, Dreyfus Low risk-return

Retail households Saving management

ALM = more related to pension funds --> you have investments in long term to generate yield
Speculation = hedge funds - not many in IG 11
There are 3 important External Actors: 1) Rating Agencies 2) Auditors 3) Law firms

Other actors : rating agencies, auditors and law firms

c
Rating both for debt products they issue and corporate. Also there are different rating if you have a Senior or
a Junior bond
• Role: rating agencies provide an independent evaluation of creditworthiness by evaluating the credit
risk of both specific debt products and the related borrowing entities
• Ratings are used by investment banks to identify the appropriate risk premium to be charged on loans
and bonds of both corporates and governments entities. A higher rating represents a lower probability
of default
• Actors: The “Big Three” credit rating agencies are S&P Global Ratings, Moody's, and Fitch Group and
they collectively account for ~92% of EU market share in 2019 Only 3 players for 92% of the Market
• Even though the Big Three were accused as enablers of the 2008 global financial crisis, the other
players are well below 3% of market share and only DBRS is recognized by ECB with the ECAI status

In needs to help building a good story to get a good credit rating

• Role: accounting firms provide a wide scope of different audits on private and public companies. The
main contribution in debt capital markets is represented by a comfort letter to confirm that there has
been no material adverse change in the issuer's financial condition since the last audited account
• Actors: the “Big Four” accounting firms refer to Deloitte, PricewaterhouseCoopers (PwC), KPMG, and
Ernst & Young
This guys are mainly taking care of DUE DILIGENCE --> auditing the
accounts, no material adverse change = you need to prove that the
company did not have any material change between the last auditing account and the time of the bond

• Role: lawyers advice debt and equity issuers as well as investment banks. The main responsibilities
comprise (i) advisory on legal and regulatory matters (particularly first-time borrowers), (ii) drafting of
documents (e.g., prospectus and term sheets) and negotiation of contracts between banks and issuers
• Other responsibilities include the conduct of due diligence on the issuer to make disclosure of the
associated risks and the provision of legal opinion and disclosure letter at deal closing
• Actors: the main law firms in the UK DCM market Allen & Overy LLP, Clifford Chance LLP, Linklaters
LLP, White & Case LLP

Lawyers are different --> advisory on legal and regulatory matters. Memorandum + important for the negotiation process
Nothing is really standard you can decide what terms you can use etc...
12
 BERLIN
LONDON
MADRID
c PARIS
TURIN
WARSAW

Section 1.2

- Credit ratings and rating agencies

13
Rating agencies = they tried to express the likelihood that you receive the money back… they need to be independent (you decide
which credit agency you want) --> and you PAY for your grade! At the end of the day, the ISSUER is your CLIENT!

Credit ratings and rating agencies 90% of Eurozone debt is rated by at least 1 agency

c
• Credit ratings provide an opinion on the relative ability of an entity to meet its financial commitments, such as interest, preferred
dividends, repayment of principal, insurance claims or counterparty obligations

• Investors use credit ratings as indication of the likelihood of receiving their money back in accordance with the terms on which they
invested. Therefore they are a key component in their investment decision

• Credit ratings cover the global spectrum of corporate, sovereign, bank, insurance, municipal bonds, as well as structured finance
securities backed by receivables or other financial assets

• Rating agencies provide independent credit assessment on a case-by-case for either a specific company or a specific issue
They have a lot of internal adjustments
• Over 90% of the volume of the Eurobond market carries at least one rating from a major agency

• Credit ratings are of a prime importance when investors/lenders make an investment decision

• An adequate rating significantly increases the company’s visibility, its access to capital markets and reduces its funding cost without
impairing its capacity to implement its strategy

• The three leading global agencies are Standard and Poor’s (S&P), Moody’s and Fitch. The presence of a conflict of interests, as ratings
are requested and paid by the issuer (for both initial rating and yearly coverage), has determined a general lack of credibility after the
financial crisis in 2008

2008 2011 2020

14
Rating agencies look at 2 things: BUSINESS PROFILE and FINANCIAL PROFILE over a 3-5 year period!
BUSINESS PROFILE, they look at:
Rating agencies’ methodology 1) Competitive Position = are you the leader in the market?

c 2) Diversification = always diversify! No mono product company

3) Margins = mature sector, so nobody cares about Revenues
they only care about MARGINS

Business profile Financial profile

Business risk Industry risk Financial risk Strategy

• Competitive position • Industry growth • Financial ratios • Development strategy

• Diversification • Cyclicality • Financial flexibility • Financial target ratios
• Margins • Barriers to entry • Funding structure • Appetite for leverage

Corporate rating

• The rating methodology combines perception of business profile and financial profile over a 3 to 5 years period

• Corporate creditworthiness, which determines corporate rating is also based on a peer group comparative analysis and on country risk
(economic risk, legal risk and institutional stability)

• Rating agencies are also responsible to provide a rating valuation of the debt issued by the company. In the investment grade
environment, corporate ratings are usually the same of the IG issuance. As a rule of thumb, the lower the seniority of the debt
instrument the higher the probability of a downgrade from the corporate rating and vice versa

• Ratings agencies also assign a rating outlook to assess the potential long-term credit horizon (time horizon 6 months to 2 years).
Outlook opinions can be (i) positive; (ii) negative: (iii) stable/developing

15
Financial Profile:
- Financial Ratios = the main one for credit agencies is GROSS LEVERAGE/ EBITDA
----> Not very used metric in the market, in private debt you usually use Net Debt/EBITDA.
Why EBITDA can be used? Because it eliminates the differences between different companies. Also EBITDA is a
proxy for cash flow generation!
- Financial flexibility = not all the debt is all the same. There are some covenants = legal obligations to do or not
to do some stuff --> you may have a non pay back period. You can't pay back the bond for a certain period
Being blocked is bad in case of necessity!
- Funding structure = Equity % / Debt % --> The more equity you have the better it is

STRATEGY(probably the most marketing part of this exercise). Sell the fact that you are developing, that you are
growing. Rating agencies don't like M&A --> M&A is risky and it costs a lot of money
- Financial Target Ratios = growth, EBITDA in the future. You will show your business strategy, look at the CF
- Appetite for leverage = you will say that your aim will be just to repay your debt... You need to build your track
record. Rating agencies and investors are important!
 •- = Bankruptcy filling
To be above IG you need to have at least FAIR business profile • SD = when you don't pay 1 obligation
(Ex: if you don't pay 1 installment)
Rating agencies’ methodology – S&P focus • D = default. when you are not able to
repay any obligation

Financial risk profile

c LT rating Description

1 2 3 4 5 6 AAA Extremely Strong

Minimal Modest Intermediate Significant Aggressive Leveraged
AA (+/-) Very Strong
1
AAA/AA+ AA A+/A A- BBB BBB-/BB+ A (+/-) Strong
Excellent

2 BBB (+/-) Adequate

Business risk profile

AA/AA- A+/A A-/BBB+ BBB BB+ BB

Strong
BB (+/-) Less Vulnerable
3
B/A- BBB+ BBB/BBB- BBB-/BB+ BB B+ B (+/-) More Vulnerable
Satisfactory
CCC (+/-) Currently Vulnerable
4
BBB/BBB- BBB- BB+ BB BB- B
Fair CC Currently High Vulnerable
5 - Bankruptcy filling
BB+ BB+ BB BB- B+ B/B-
Weak
SD Selective default
6
BB- BB- BB-/B+ B+ B B-
Vulnerable D Default

Typically for LBOs

Source: Corporate Ratings Methodology – Standards & Poor’s Ratings Services (2014)

16
From business risk and financial risks (anchors) you need to focus on other factors:
1) Liquidity = Cash + unused revolving credit facility -- like a credit line (card for business)
2) Comparable ratings analysis = everything in finance. Comps in rating are very important. If there is a business
that is doing a similar job as you (but you do it 10x better), there is a RISK that you are going to get the same
rating --> rating agencies think of companies from a comparable perspective. Difficult to get a different rating
compared to similar business in the industry
3) Management governance = not 100% sure that your bond is rated at the same time as the corporate. This is
because there are term conditions, there are specific basket of assets where you can get your money from.
Depends on the capital structure that you have in place. To simplify: you have Senior debt and Junior debt,
Mezaning debt and Equity --> the ratigns would be the same for Senior and Junior would be 1 level below.
---> In ratings we know that there is the ISSUER and the ISSUE (so Corporate rating and Bond rating) + there is
an other important metric for S&P (That is not for Moody's) = the RECOVER RATING (that goes from 1 to 6)
Recover Rating tells you what are the changes to get your money back in case some of the obligations are not
met! ( 1 = 100% ; 6 = 0%)
IG = DCM The rating determines the cost of debt
Junk Bonds / High yield = Leverage Finance The spread between BBB- (last IG) and BB+ (first HY) --> it's 8 bips of difference (0.8% more)
The change in SPREAD is the highest between these two IG and HY
Rating scales If you see a number in the rating it's Moody's

•
c
Depending on the different combinations of business/financial factor, the credit rating of an
Rating scales (long term debt)

issuer will fall in a determined rating class S&P Moody’s Fitch

AAA Aaa AAA

• Rating agencies provide credit rating scales in order to measure different credit risks. There
are close correspondences between agencies’ rating scales AA+ Aa1 AA+

AA Aa2 AA
• Credit ratings correlate negatively with the cost of debt, meaning cost usually rises as ratings
decline. Ratings are benchmarks in determining the margins over risk-free bonds that debt AA- Aa3 AA-
issuers pay to access the capital markets A+ A1 A+

• Between 2009 and 2019, spreads on BBB- (lowest IG rating for S&P) have averaged 284bps A A2 A
compared to 360bps for BB+ (~80bps of difference as per the chart below). As highlighted by A- A3 A- IG
the chart, the largest gaps in percentage terms is between IG and HY DCM
BBB+ Baa1 BBB+
• The sharp gap in terms of cost of debt between IG and HY is mainly due to demand and BBB Baa2 BBB
investor appetite. Indeed, several investors such as Central banks (until recently) and some
pension funds are restricted by fund’s bylaws to invest in high-risk products BBB- Baa3 BBB-

BB+ Ba1 BB+

• Fallen angels are issuers/issuances that were once in in the investment grade territory but
they were downgrade. Rising stars, on the contrary, are issuers/issuances that were BB Ba2 BB
previously rated below BBB- and they are now included in the IG due to better fundamentals BB- Ba3 BB- HY
LF
Changes in spreads on different rating notches B+ B1 B+

B B2 B

B- B3 B-

CCC+ Caa1 CCC+

CCC Caa2 CCC

CCC- Caa3 CCC-

On top of the rating, companies are given also an

OUTLOOK. Ex: AA- with POSITIVE outlook
---> it means that is expected to increase in the
rating in the next years.
OUTLOOKS: Positive; Stable; Negative

An other important difference between IG and HY in the PRICE is due to the fact that some banks CANNOT buy HY bonds
They can only buy IG 17
The RATINGS are very important especially during a market SELL-OFF: When the markets are booming the gap between 1 notch and another is very
SMALL ----> but during difficult markets (market uncertainty), High Yield bonds tend to SCALE

Rating scales: the cost of a notch

c
The change between A stable and A negative outlook = 400 bps it's HUGE!
Same rating but with different Outlook, you pay almost 3% more!

Source: S&P Global Ratings “Credit Trends: The Cost of a Notch” (Mar-19)
18
Rating report: Evonik example (1/2)
c

Source: Moody’s
19
Rating report: Evonik example (2/2)
c

Source: Moody’s
20
 BERLIN
LONDON
MADRID
c PARIS
TURIN
WARSAW

Section 1.3

- Funding alternatives: public vs private

markets

21
Benchmark = the standard amount or the minimum amount of the debt ticket that you can issue in the market. If you do something sub-benchmark there is
the risk of illiquid

Public markets: US market

Characteristics
c • Pros:
✓ Deepest capital market (high volumes)
• Tenors: 3-30 years (average at 10 years) Also active in summer
✓ Low seasonality (high liquidity) --> Not the case in EU
✓ No financial covenants
• Benchmark size: $300m
• Cons:
• Largest trade: $49bn Verizon (2013) × Fairly rigid tenors (standardisation)
× High transaction costs
• Documentation: rule 144A / Reg S (exemptions from
× Documentation required For a Public market
registration with SEC – see below)
US Bond market overview (source: SIFMA)
• No financial covenants required, but additional
disclosure/provisions are needed

• Average costs for a transaction: ~£500,000

• Marketing: 3-4 days for physical plus netroadshow

• Rating: 2 public ratings required

For US you need 2 public rating to be in the market
Difference between USA vs European market

Securities Act (1933): a borrower must register securities with the SEC before selling to the public to guarantee high protection and transparency. Moreover,
investments cannot be sold before a mandatory holding period of two years

Reg S = is for outside USA. For US issuer outside of USA

Rule 144A (exclusion from the Section 5 of the “Securities Act”) Reg S (exclusion from the Section 5 of the “Securities Act”)

• Rule 144A (1990) was introduced to increase market efficiency by • A securities offering, whether private or public, made by an US issuer
reducing protections for qualified institutional buyers (QIBs). outside of the United States in reliance on Reg S need not be registered
Minimum holding period was reduced to 6 months, while the sale of under the Securities Act
privately placed securities was possible without SEC registration
• Conditions: (i) the offer/sale is made as part of an “offshore transaction”;
• Conditions: (i) US and foreign issuers that are not listed on a US (ii) none of the parties make any “directed selling efforts” in the US
securities exchange or inter-dealer quotation system (ex. Nasdaq
Corporate Bond Exchange); (ii) reoffer/resale is made only to QIBs • Non-exclusive regulation: a combined Regulation S offering outside the
US and Rule 144A offering inside the US is a common structure

On Bloomberg you will see the same BOND with two different names: One will end with 144A; the other will end with Reg S
---> Those bonds are for 2 different entities. You must register to the SEC + you need to have a minimum holding period of 2 years
22
 Between USA and Europe: Tenors are much more different, Europe are more flexible!

Public markets: EUR And GBP market You need UK based investors and even liquidity is not the best

Characteristics (EUR market)

c Compared to US market
Characteristics (GBP market)
• Tenors: usually up to 10 years (high flexibility) • Tenors: 4-30 years
• Benchmark size: €500m • Benchmark size: £250m
• Largest trade: ~$15bn AB InBev (2016) • Largest trade: $3bn National Grid (2016)
• Documentation: EMTN (Euro Medium Term Note) docs • Documentation: EMTN (Euro Medium Term Note) docs
1/2 costs • No financial covenants required • No financial covenants required
of US • Average costs for a transaction: ~£230,000 (EMTN update & drawdown) • Average costs for a transaction: ~£230,000 (EMTN update & drawdown)
• Marketing: 3-4 days for physical plus netroadshow • Marketing: 3-4 days for physical plus netroadshow
• Rating: not required (one rating is optimal) Difference compared to • Rating: not required (one rating is optimal)
USA
• Pros: • Pros:
✓ Satisfying depth and diversified investor base ✓ Better for domestic companies
✓ Flexibility of tenors ✓ Flexibility of tenors
✓ No financial covenants ✓ No financial covenants
• Cons: • Cons:
× Seasonal trends: market slows sensibly during summer and × UK-based core investors are fundamental
end of year × Less compelling pricing (£ exposure after Brexit)
× Lack of longer tenor (< 10 years)

EMTN programme (regulated by the Prospectus Directive 2003/71/EC) EMTN = Medium term for UNSECURED debt (not collateral)
• EMTN is a medium/long-term (< 5 years) and generally unsecured debt instrument. On the other hand, a EMTN programme is a standardized issuance
platform for Euro Medium Term Notes in the public European market. This enables both US and European companies to enter foreign markets more
easily and to take advantage of favourable market conditions by reducing the process for the issue

• EMTN issuers must maintain a standardized document known as “EMTN programme”, which require:
• Base prospectus: a disclosure document which contains the master terms and conditions of the notes
• Program agreement between the issuer and the dealers at the establishment
• Procedures memorandum: set the procedures for issue and settlement of the notes
• Pro forma final terms: commercial terms of a particular notes being issued (to be read together with the “master terms and conditions)
• Agency agreement and deed of covenant
• Legal opinions, auditor’s comfort letter, issuer’s board resolutions

23
Public markets: the gap between US and UK/EU
Bank lending vs capital markets
c
• US market was almost three times deeper than EU average in 2016, with US capital markets growing in line with GDP, while 80% of EU countries
reduced their depths between 2013 and 2016

• EU shows a wide range in depth across countries. The UK, the Netherlands and Nordics have highly developed capital markets while some
important economies such as Germany, Italy and Spain still rely heavily on bank lending compared to European average

• Direct bank lending still represent the main funding source in the EU, accounting for ~80% in 2016 (vs ~25% in US and ~55% in UK). However, while
US bank lending remained stable as % of total corporate debt, EU is showing an increased interest for corporate bonds which gained almost 7% vs
bank lending in just 10 years (UK corporate bonds gained ~9% in the same period)

• The lack of long-term capital in Europe may also explain the sharp differences between the two systems and it is due to the lack of large pension
funds (except for few exceptions such as the Government Pension Fund of Norway). Pension assets in the EU are just ¼ of the US ones (as
percentage of total GDP)

• Regulations and different policies across different EU jurisdictions tend to hinder the development of capital markets

High proportion of European bank lending compared to US. Bank debt can be more expensive and much risker
It is better to be on capital markets because you can have bigger sizes + you can avoid systematic risks! 24
There are 2 types of private placement: USPP and SSD

Private markets: US Private Placement (USPP)

Private market = people that buy directly from you

Characteristics
c
Process
Not standardized. We are in
• Tenors: up to 12 years the private. More tailored to • Usually takes between 8 and 12 weeks
the need of the issuer
• Size: $100m to $1,500m • Issuer appoints a banks as Placement Agent

• Documentation: Model Form 2 Note Purchase • The agent prepares the Offering Memorandum (OM) plus the Road
Agreement You better have more covenants because Show presentation (if needed)
you are not doing something standardized
• Financial covenants: required and in line with the • Legal counsel is also chosen and takes care of the Note Purchase
existing RCF RCF = highly secured type of debt, Agreement (NPA), discussing with both the agent and the issuer
it has a lot of grantees
• Marketing: investors meeting / calls • Both OM and NPA are distributed to investors before the launch and
road show is organised before receiving bids
• Rating: not required despite being in the US, because
PRIVATE!
• Currency: mainly USD, but also EUR, GBP, CAD

• Investors: mainly US (~50 active companies) and

Canadian life insurance companies

• Early redemption: MWC (make-whole calls)

• Pros: USPP market overview

✓ Alternative source of liquidity from traditional

bank/bond market
✓ No rating required
✓ Flexibility in terms of size
✓ Usually more resilient than public markets in
volatile periods (ex. in 2008/2009)
• Cons:
× Small premium to public bond market
× Stringent covenants (similar to credit
facilities)
Source: Private Placement Monitor (H1 2020)

Private Market = alternative source of liquidity. Ex: If you have problems in the bond market, for example in 2008 the bond market shut down.
So if you don't have other alternatives and you need cash --> you go to the private market!
25
European / German agreement

Private markets: Schuldschein (SSD)

Characteristics
c
Process

• Tenors: 5/7 years (up to 10 years, but more rare) • Usually takes between 8 and 10 weeks. It is governed by German law

• Size: €20m to €500m • Issuer appoints a banks as Arranger plus Affiliate agents (lawyers),
which are in charge of preparation of documents and terms
• Documentation: Schuldschein agreement
• It includes a loan agreement (Schuldscheindarlehen - SSD) and a
• Financial covenants: required and in line with the certificate of indebtedness evidencing such loan agreement (a
existing RCF Schuldschein)
• Marketing: investor calls and 1 day roadshow in • SSD are not considered securities according to EU or German Law so
Frankfurt there is less regulation involved
• Rating: not required Schulds
Borrower SSD Arranger cheine Investors
• Currency: EUR and USD
Evolution of the Schuldschein market: Transaction volume in EUR billion (left axis, bars)
• Investors: mainly commercial banks (German, Swiss and total number of deals (line, right axis)
and Asian) as well as Insurance companies

• Early redemption: MWC (make-whole calls)

• Pros:
✓ High flexibility in terms of size and maturity
✓ No rating required
✓ Quicker process compared to bonds
✓ Less documentation compared to bonds
✓ Low transactions costs
• Cons:
× Higher pricing due to illiquidity and
unsecured status
× Stringent covenants (similar to credit
facilities) compared to bonds
Source: Finbridge (2019)

26
 BERLIN
LONDON
MADRID
c PARIS
TURIN
WARSAW

Section 1.4

- Issuance process in bonds

27
 Key stages of bond issue
c
Pre-launch Announcement Roadshow Book-building Pricing Signing Closing

Design who
is doing what - Appointment - Issuance
- Approval on
in the NDA of parties and listing of
the
the bonds
prospectus
- Drafting of
documents - Payment of
- Release of
the issue
auditors’
- Due proceeds to
Comfort letter
diligence call the issuer
- Timeline: 3
- Timeline: 3/4 - Timeline: 2
days
weeks days

Offering Memorandum

Source: Thomson Reuters Practical Law

28
1. Pre launch and announcement
c
Pre launch If you are the lead bookrunner, you are the one in contact with the client

1. Appointment of parties: (i) financial institutions, that will arrange the deal (lead bookrunner vs joint bookrunner); (ii) legal advisers,
that will draft documents and provide legal opinions; (iii) auditors that will provide comfort letters at signing/closing for the banks; (iv)
listing agents, that will advise regarding the procedure for listing and will submit the appropriate documentation; (v) rating agencies,
that will assess the financial position and creditworthiness of the issuer by providing a rating to the bond issuance

2. Drafting of documentation: (i) mandate letter, to appoint the financial institutions in charge of the new issuance; (ii) prospectus,
which is a regulatory disclosure designed to prevent investors for claiming that they were not given all the material information and it
includes: a description of the issuer’s business and operations, financial data, risk factors related to the business/industry and a
summary of the selling restrictions and tax provisions

3. Due Diligence call: enable advisor’s protection against potential claims by investors by confirming that (i) the prospectus contains
accurate information; (ii) no material facts are omitted from the prospectus and that (iii) no material changes are present between the
signing of the prospectus and the DD call
Due diligence calls concern 2 things: 1) The prospectus contains accurate information
2) No materials factor omitted --> everything that needs to be done is there!
3) No material changes from the auditing financials

Announcement on Bloomberg

• Once the issuer is comfortable with all terms and conditions proposed by the banks, they will mandate one or more financial
intermediaries as bookrunners

• The mandate will usually detail several factors such as agreed currency, size, tenor, target spread, fees, expenses, announcement
date and syndicate structure.

• The banks announce the issue through Bloomberg or other financial data providers to gather interest from investors in the credit.
Usually maturity, size and spread are not disclosed at this stage to increase focus on the company instead of the issuance itself

29
 The key element is to create the hype! There are 3 main centers: London, Paris, Frankfurt
From Italy and Spain you need to go abroad because ---> you have better capital there!
2. Roadshow
c
• A roadshow broadens the investors pool and is an Aviva, L&G, Schroders +
opportunity to market the credit to new investors American asset managers

• Typical roadshow comprises (i) group presentations, (ii)

one to one meeting and (iii) conference calls

• The level of questioning put to management during

conference calls is much lower than during one on one
meetings Allianz, DWS,
DekaBank
• The roadshow process is important in driving the
momentum of the transaction

• A group conference call can be arranged to reach out to

investors who can not be visited during the European
roadshow

• The group conference call is followed by one-on-one

calls with selected investors in order to give accounts the
possibility to ask “one-off” questions Amundi,
Natixis, Axa,
• The issuer team usually includers the CEO (excluding
large companies), CFO and Investor Relations

• European roadshow schedule usually includes 2/3 cities

depending on the issuer and on the size of the offering.
First-time issuer from a peripheral European country
would require more marketing than a well-known UK
based multinational company

• Main hub to approach the fixed-income investor

community are London, Paris, Frankfurt and Amsterdam
(additionally Milan and Madrid for domestic issuances)

30
Diversification important: who are you selling to? Not the same AM or Hedge Funds
Hedge Funds = usually the next day they do +1% and sell everything (and the bond collapse) ---> if the bond collapse the next time the issuer goes to
market he will pay MUCH MORE. The price needs to be STABLE!!

3. Book-building process In this way you can: • Increase the demand at the beginning • Than you can
reduce the spread (make less costly for the issuer) + you can also increase

c
the size ---> (sometimes you have books that are 6x 7x oversubscribed) and
you can reduce the pricing

• “Book- building” can be defined as the process of generating/recording investor demands for financial products (applicable to both
shares and bonds) and guarantees:
Reducing the interest of the bond.
• Full transparency and quality of the order book via a pot system If you get more demand: equation demand/offer
• Possible tightening of the re-offer spread during the order book building process --> so you push down the yield (so it's less attractive
to investors), you move a little bit of demand,, but you
• Optimization of size, duration and cost of funding reduce the cost of the issuance
• Significant diversification of the placement during the allocation process [this is a bullish case]

• The banks will open the book and collect the investors intention to subscribe the bonds. The initial pricing will be determined on the
basis of the feedback received from potential investors

• Over-subscription will allow bookrunners to have some momentum in the market to support the transaction. Moreover, it will help
spreads to perform immediately post-launch

The book building process (pre-placement and final placement) You don't want volatility!

Total book orders

Potential size increase
200%
Spread tightens
150%
Spread & size tuning

100% Initial placement target

After the Roadshow you start to collect the orders form your clients

50% You create the Hype + present

Roadshow to the investors

31
When you have a book, most of the times it is oversubscribed --> You have 100m but you have 200 - 300m of demand. What happens? You need to decide
who takes what, You need to decide how to allocate. MIFID II regulation! Before you could decide whatever you wanted
Now there is the DUTY OF CARES --> You need to keep in mind every issuer and give a motivation to why you are
4. Allocation choosing him. There is the tendency to allocate PRO-RATA = 100m book with 200m orders ---> everybody 50%
Not so true! You need to make some adjustments --> 1) You need to be diversified in terms of Geography
c
2) Investor engagement is also remunerated (if you are one of the first to place an order) you are creating a
momentum --> push the market (so you tend to remunerate the people that creates this momentum)
3) Long-term vs Short-term = you prefer people that stay for the long run (hedge funds usually don't get anything)
Allocation

• The DCM Syndicate desk (not Origination) is responsible for the pricing and allocation process and has a duty of care to issuers in
terms of fair treatment, transparency and appropriate advisory

• When the order book is sufficiently full of orders and at a time announced in advance by the lead-managers, the book will be close

• No further orders are accepted after closing

• After the confirmation of all the orders in the book, lead managers will coordinate the allocation of the available issued amount

• The majority of orders are allocated pro-rata; e.g. if the bond size is €1bn with an order book of ~€2bn, every investor will receive 50%
of their initial order

• With the introduction of MiFID II, which enhances transparency and fairness in EU financial markets, bankers are required to provide a
justification for the final allocation of bonds. The ratio behind the decision was that investment banks were accused of favouring the
largest AMs instead of small accounts in order to benefit from cross-selling opportunities with other financial products

• Main factors in allocation process includes:

• Diversification: both in geographical and investor type (ex. retail, asset managers, hedge fund)

• Investor engagement: early commitment to the deal (for example in roadshow) is seen positively as it helps creating
momentum

• Long-term investment vs short-term investment: a buy-and-hold account is preferable as there will cause less volatility
resulting in stability for the issuance

• Syndicate has to record a line-by-line written commentary in relation to any investors that have received a final allocation in the top
20% of the total allocation (as per ICMA guidelines)

32
After you have allocated everything you decide the price based on the relationship between demand/offer --> you get the FIXED PRICE RE-OFFER
FPR = is a SPREAD ---> When you are selling a bond you don't say that the bond is at 3.5%
5. Launch and pricing you are saying that the bond is at 50 bps above the Mid Swap or Government bond US

c
Launch

• After the closing of order books, the lead managers have to confirm the final spread on the issuance

• A public announcement through dedicated platforms is required

Pricing

• When the final allocation is confirmed to investors, the lead managers will price the deal and determine the Fixed Price re-offer (FPR)

• Fixed Price re-offer (FPR) is the price at which all participants in the transaction will pay for their bonds and it is equal to the spread
agreed when books are closed

• The pricing of a bond is primarily a function of the credit quality of the borrower. The higher the probability of default the higher the yield
investors will require. Main factors that needs to be considered to release a pricing guidance for a new corporate bond includes: credit
quality, comparables, current market conditions, regulatory risk, new issue premium (NIP)

• Moreover, the structure of the new issue will have an impact on the price depending on: (i) size, (ii) maturity, (iii) covenants, (iv)
subordination

• There are two main measures to price a credit in the market:

= cash flows
• Spread over Swap curve: a swap is a contract in which two counterparties agree to exchange interest rate flows. The Swap
curve is an array of swap rates for each relevant maturity. The mid-swap is the average of bid and ask swap rates and it is the
main benchmark for € issuances (“Mid what and why?” https://www.ifre.com/story/1311297/mid-what-and-why-ngmjbjbdh1)

• Spread over Government curve: built by compiling the outstanding government outstanding benchmarks. Prices are available
on major platforms such as Bloomberg and Reuters

• The pricing of the bonds is usually determined through a process called price discovery. There are three main steps in the discovery:
(i) Initial Price Thoughts (IPTs); (ii) guidance; (iii) final terms. If final terms come “inside” the IPTs the spread is tightening, while if
the final spread is higher than IPTs the bond is widening
5) New issue Premium = I have 10 bonds, 1 is maturing in 10 years, 1 in 7 years
I issue a new 7 years bond --> what happen? My new 7 year bond has the same
price of the one already in the market, otherwise nobody would buy that bond
The price depends on several conditions:
1) Credit Quality = good company you will pay less 3) Current market conditions = A company that is exposed to Russia & Ukraine
2) COMPS = comparables --> people use comps 33 country
4) Regulatory risks = you have to price in what could change in a specific
We have the PRICE, we have the INVESTORS --> just now Signing and Closing.
Signatures need to be kept in ESCROW: --> you sign before and then lawyers ask you for the permission to realise the signature.
You need to sign:
6. Signing and closing • Prospectus = like ID card of bond
• Subscription agreement = between the company and the banks. Allows the bank to sell the bond

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• Comfort letter = document provided by auditors and certifies that the information in the
prospectus is fine

Signing

• It takes place between 2 days and one week before the closing

• Documentation to be signed and dated (or held in escrow) includes:

• Prospectus: legal document that provides all the fundamental information to potential investors regarding the issuer and the
issuance = like the ID card of the BOND

• Subscription agreement: conditional contract between the company and the banks, under which the company agrees to issue
and the banks jointly and severally agree to underwrite the issue providing certain conditions precedent are satisfied

• Comfort Letter: legal document provided by auditors regarding to certify the financial information provided in the prospectus

Closing There are some conditions in CLOSING:

• Prior to the confirmation of the payment to the issuer ,the lead manager has to confirm that all the conditions of closing have been
satisfied. Those includes:

• Legal opinion from the Issuer’s legal adviser

• Legal opinion from the IBs’ legal adviser

• Rating confirmation letter (if needed)

• Bring-down comfort letter

• Issuer closing certificate

• Confirmation of listing of the bonds (if needed)

• The issuer will then receive the net proceeds after paying for fees and expenses. Expenses cover certain costs which are incurred by
the lead managers and paid by the issuer afterwards. Those costs typically include legal costs accrued by the banks and listing costs
for listing transaction

In closing there is wire transfer of clash but is NET PROCEEDS--> Ex: you issue 400m bonds you will not get 400m in your bank account
You need to pay lawyers, you need to pay the banks + other transaction costs. There are a lot of expenses!
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• Comfort Letter = confirms that the information contained in the offering is ACCURATE and FAIRLY presented + no material adverse changes.
There is a specific form, called ICMA form: you confirm that everything is accurate.• Tick and Tie = a document of 400 pages, If you report revenues for 1bn
and revenues were 1.1bn you can get sued --> you need to tick and tie between financial statements
7. Relevant documentation • Comfort letter doesn't cover things that are NOT in the FINANCIAL STATEMENTS
= everything that is outside FS is not responsibility of an auditor

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Comfort Letter Prospectus
• Provided by the issuer’s auditors • Provided by lawyers
• Comfort letter confirms that the information contained in • Legal document that highlights the main information
the offering documentation is accurate and fairly regarding the issuer and the issue in a bond issuance
presented and that there are no material adverse
changes to the financial condition of the issuer between • The document mainly includes a summary of the
the date of the last audited accounts and the date of the corporate and of the financing structure. Main sections
letter are: (i) summary of financial information; (ii) risk factors;
(iii) use of proceeds; (iv) capitalization; (v) industry
• ICMA form of comfort letter is the market standard overview and (vi) offering information (e.g. maturity, call
across main European jurisdictions excluding specific provisions, credit rating, interest)
countries such as France and Italy
• Also known as Offering Memorandum (OM)
• 3 levels of comfort are provided in the letter:
• In most jurisdictions the issue of a prospectus ahead of a
• Confirmation that the interim/annual financial
bond launch is required by law (such as EU’s
statements have been reviewed
“Prospectus Directive” and UK’s “Prospectus Rules”) in
• Indication of any changes in several line items order to protect investors, guaranteeing transparency
(including debt, cash and equity) since the last
reporting • Issuer usually provide both a preliminary and a final
prospectus. The former is the initial offering document
• Confirmation that the prospectus and accurate which provides details about the proposed transaction
by way of tick & tie every number related to while the latter is offered when the offering has been
accounting records finalized
• NB. Auditor’s comfort letters do not cover financial or
other data that cannot be traced to the issuer’s reporting

• Prospectus = ID card of the bond. Provided by lawyers in combination with bankers. Contains a summary of: 1) What is the business;
2) Financial info = costumer free reporting + quarter reporting LTM; 3) Capitalization ...... 6) Other information like covenants
The OM is required by LAW 35
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Section 1.5

- Covenants and redemption events (bond)

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Covenants = legally binding terms of agreement between a bodn issuers and investors --> the aim is to PROTECTinvestors

Selected bond covenants

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Bond covenants: legally binding terms of agreement between a bond issuer and the acquiror. The main aim is to protect the interests of the parties
through contractual terms. The main type of covenants are:

1. Restrictive/Negative covenants: specific activities that needs to be avoided by the issuer

2. Affirmative/Positive covenants: specific requirements that needs to be met by the issuer

In case the issuer violates one of the covenants → technical default, which may result in a rating downgrade or default procedure after a certain time

• Negative Pledge Clause Prevent the user to use the same type of assets as a guarantee for other bonds
A
• Prevents the issuer from creating any mortgage, charge, lien, pledge or other security interest, except for a permitted security interest

• Permitted security interest are dependent on the documentation and can often allow the issuer to create liens against a specific basket of
assets. Therefore, the clause prevents the issuer from using the same assets to secure another debt obligation

• This clause increases the safety of the bond resulting in lower interest rates for the issuer

• Cross Default Clause

Famous for the domino effect. Incentive to avoid breaking any covenant. If you break 1 covenant you break all
B the others and you are technically in deafaul
• Bond indenture that puts places the borrower in default if the borrower defaults on another obligation. Main causes of default on a specific
instrument includes (i) failure to pay interests, (ii) failure to repay principal on time and (iii) violation of affirmative/restrictive covenants

• Cross default clause includes provisions to avoid a “domino effect” by allowing the issuer to obtain a waiver

• Limitation on Sale and Leaseback Clause

C
• Restricts the issuer from entering into a sale or leaseback transaction on certain assets, although several exemptions apply

• The issuer is permitted to enter sale and leaseback transactions if they use the proceeds to repay debt or purchase new property or
qualifying assets

• Merger, Consolidation or Sale of Assets Clause

D Merger can take place under certain condition: 1) Obligations are the same for the issuer

• Presents the conditions under which a merger is permitted to take place. This usually includes:

• The acquirer or resulting corporation in the event of a merger, will assume the obligations of the issuer

• After giving effect to such transaction, no event of default will have occurred or be continuing

37
Redemption events are crucial for both investors and issuers: They are used to repay earlier the principal in case of specific and predetermined conditions
Ex: interest rates are dropping, so i can pay less for my bond (as an issuer) --> in order to recall the bond you need to meet certain conditions

Selected redemption events

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A redemption event is a specific situation that allows the issuer to repay (usually at premium) earlier the principal in case of specific and pre-
determined conditions

•A Make Whole Call If you call the bond (it's a call option) before the maturity you have to pay the future value of all the CF that you promise

• Type of call provision that allows the issuer to call the bond (i.e. repay the debt earlier) at the greater of the make whole price or par

• The make whole spread is usually set at 15% of the benchmark spread, making it prohibitive to the issuer to call the bond early

•B Issuer Par Call useless (3m prior to maturity) --> nobody tends to leave bonds to expire. Usually with bonds you refinance 2 years before maturity

• Provides flexibility to the issuer to call the bond at par at a prespecified time prior to redemption

• Typically, the par call is 3 months prior to the maturity date, but it can be 1 month for shorter notes or 6 months for 20/30 years notes

•C Clean Up Call (“calamity call”)

• Allows the issuer to redeem the outstanding notes, if the outstanding amount of the notes is 20% or less

• This call provides flexibility for issuers and it is a type of extraordinary redemption mainly used for municipal bonds and CMOs

•D Change of Control Clause

• Enables bondholders to redeem the bonds (usually at 101) if a change of control event is triggered

• Change of control event is defined as:

• Change in ownership of the issuer

• Issuer is downgraded from investment grade to non investment grade (e.g. from BBB- to BB+)

•E Special Mandatory Redemption Clause

• The issuer is required to buyback the notes at premium (usually at 101), if the merger is not completed on or prior to the mandatory
redemption date

Fundamental. If you are doing an acquisition in PE and you want to buy a company that is listed and has outstanding bonds (Ex. KKR trying to buy
Telecom recently) --> they have 20bn of bonds in the market. If they have a change of control, it means somebody is trying to acquire them, they
need to PAY BACK ALL the DEBT of the previous investors with a PREMIUM of 1% --> Crazy 1% premium on 20bn... so this gives additional security
to investors!

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Q&A

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Debt Capital Markets course:

Debt Capital Markets in practise II
Dr Andrea Simoni
[email protected]

1
Short-term (ST) and long-term (LT) financing
c
ST financing characteristics • Pros of LT debt:
Enables Long-Term strategy by aligning capital
• ST financing is in line with firm s operational needs structure to strategic objectives
Helps to match the duration of the asset size
• Tenor: between 3 and 5 year
with the duration of liabilities (i.e. ALM)
• Use: to match fluctuations in working capital and other operational Creates LT engagement and relationship with
cash outflows investors
Reduces exposure to interest rate risk due to the
• Rate: floating rate as default but the can be artificially fixed through fixed rate nature of LT financing
the use of swaps (i.e. interest rate swap) To sum up, it allows to diversify capital portfolio by
spreading debt maturities, decreasing the dependence on a
• Provider: it is usually provided by banks (e.g. BNP, DB, CS) single source of capital and fixing interest rates
• Firms tend to use short-term, asset-based financing generally at the • Cons of LT debt:
early stage of the business cycle in order to cope with working × Usually collateralised (e.g. shares and PPE)
capital needs × Fixed maturity date for repayment
× Interest on debt may result in a permanent
• Secondly, firms move to short-term, cash-flow based bank loans
burden for the firm
LT financing characteristics × Difficulties to obtain at early stage
× Vulnerability in case of adverse market
• LT financing is useful for firms which are looking to extend their conditions
refinancing terms beyond the ST bank tenors
Overview of ST and LT financing
• Tenor: between 5 and 25 years. Long maturities enable to
customize amortization (limited, delayed or absence of amortization) ST financing LT financing

• Use: (i) acquisitions, (ii) share repurchase, (iii) debt refinancing, (iv) Tenor Typically 3-5y Usually 5-25y+
acquisition of LT assets, (v) debt diversification, (vi) exceptional
Rate Floating rate Mainly fixed rate
activities (e.g. take private of a public company)
Provider Banks and FI Institutional Investor
• Rate: mainly fixed rate but also floating rate is really common
Use Working capital and ST LT initiatives and BS
• Provider: Institutional investors (e.g. insurance, AM) through
needs risk management
syndication or direct lending

2
Main public debt markets products
c
Short-term financing Long-term financing

Money Markets instruments (<1y) Bond Markets instruments (>1y)

Treasury Bill: zero coupon, short-term government debt issuance Treasury Notes (1-10y), Bonds (10-30y) & TIPS (Treasury
(UK and US) Inflation-Protected Security): medium-long term government bonds

Commercial Paper (CP): unsecured, short-term debt instrument

Straight Corporate Bonds: pays interests at a regular interval
issued by corporations

Certificate of Deposit (CD): bank certificate to confirm a deposit for Callable / Putable Bonds: optional repayment by issuer / optional
a specified length of time at a specified rate of interest redemption by investor

Repurchase agreements (Repo): Short-term loans (normally for

less than one week and frequently for one day) arranged by selling Convertible Bonds: bond with an option to convert it into a new
securities (usually low risk) to an investor with an agreement to company shares at fixed price (issued by corporations)
repurchase them at a fixed price on a fixed date

Municipal notes: in the U.S., short-term notes issued by Exchangeable Bonds: bond plus an option to convert it into another
municipalities in anticipation of tax receipts or other revenues investor s equity holding (issued by investors)

Securitized Bonds: debt security where both coupon and interest

payments come from a collection of other underlying assets (ex.
MBS mortgage backed securities)

NB. RCF and loans are not included in this table as they are not public!

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Section 1.1

- Short-term financing

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 1. Revolving Credit Facilities
Characteristics
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RCF: reusability cycle
• A revolving credit facility (RCF), also known as revolver, is a line of credit that is arranged by a bank. It
comes with a defined maximum amount and the firm may access the funds whenever it needs them

• Use: operating purposes, especially for any firm experiencing sharp volatility in its cash flows and some
unexpected large expenses. It is mainly needed for firms that have low cash balances to support their
working capital requirements. Hence, it is considered short-term financing and is usually repaid quickly
Withdrawing Spending
• Useful for seasonal businesses with high receivables (i.e. sales made on credit) where the firm needs to wait
for cash inflows in order to make expenses

• RCF in IG companies is usually a backup instrument (i.e. not drawn in normal conduct of business) as this is
a condition from rating agencies to maintain a good credit rating. Hence, revolver should be used when the
access to capital markets is difficult (e.g. market turmoil, business specific issues) Repaying

• In terms of fees, RCF can be considered as relationship management product as it is usually offered as part
of a bigger package (e.g. supporting a bond issuance) and does not provide a substantial remuneration to
the lender. On the other hand, banks have to set aside part of their balance sheet to guarantee the liquidity
also in difficult times (hence the definition of balance sheet banks )
Physical financial tombstone
• Different vs term loan because of the ability for the borrower to pay down the loan or take it out again.
Different vs credit cards because money is transferred in advance in the bank account.

• Main features of the revolver includes:

• Interest Expense: calculated on the amount of the principal balance outstanding for the prior month.
It is a floating interest rate linked to Euribor/SOFR/SONIA (depending on the currency)
• Covenants: mainly secured with high level of covenants, including cash sweep provision
• Maximum Amount: banks set a maximum amount of borrowing but they may review the revolver
annually. If revenues and cash flows tend to fall dramatically year on year, there is an high risk that
banks will lower the RCF availability to avoid default risk
• Commitment Fee: it compensates the lender for keeping open access to a potential loan. It is
usually a one-off fixed percentage of the unused portion (undrawn) of the RCF (usually between
0.25% and 1%)
• Reusability: the name revolver refers to the fact that when the outstanding amount is paid off, the
borrower can use it over and over again

5
 Cash sweep provision
•
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Cash sweep refers to the use of excess cash to pay down debt, which will result in a reduction in outstanding debt and a consequent decrease of default
risk for borrowers

• Cash Sweep provision: any excess free cash flow generated by a company will be used to pay down the outstanding debt of the revolver ahead of
schedule. This is done to force companies to make repayments instead of using cash to distribute dividends or use the cash to generate additional wealth
(e.g. by buying expensive assets or financing new projects)

• Beginning cash represents the cash on balance sheet from the previous year reporting

• Estimated minimum cash balance is the minimum level of liquidity required to run the company and it is linked with working capital requirements

• Excess cash is the difference between the beginning amount of cash on balance sheet and the estimated minimum cash requirements

• Unlevered Free Cash flow (UFCF) is a metric that defines the firm s capability of generating cash flows before taking into account interest
payments. It can be calculated as EBITDA Capital Expenditure Working Capital Taxes

• Cash flow for debt repayments is the sum of excess cash and unlevered FCF

• Total debt repayments is the sum of various line items (e.g. interests and principal repayments)

• Cash available for sweep is the residual value after making the scheduled debt repayments. The amount can be used to pay down the revolver

Cash sweep benefits for a firm (LHS) / debt schedule (RHS) £m 2020A 2021E 2022E 2023E

Beginning cash £100 £120 £140 £160

A Lower leverage (D/E)
(Estimated minimum cash balance) £(20) £(20) £(20) £(20)

Excess cash £80 £100 £120 £140

B Reduced interest expense Unlevered FCF £50 £60 £70 £80

Cash flow for debt repayment £130 £160 £190 £220

(Senior notes) £(5) £(5) £(5) £(5)

C Better refinancing position
(Subordinated notes) £(10) £(10) £(10) £(10)

Cash available for sweep £115 £145 £175 £205

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2. Commercial papers
Characteristics
c
Process Commercial paper rates

• Commercial papers (CP) are money market • A typical commercial

instruments, with maturities of less than 270 days paper program is based
on a continuous rollover
• Unsecured (i.e. not backed by collateral) and short term
of the existing
debt issued by a corporate and can be sold directly to
commercial papers
investors or through intermediary
• Firms are hence
• Issued at a discount with maturities between 1 and 6
refinancing their existing
months and rarely as an interest-bearing note
CPs with additional CPs,
• Use: short term liabilities including financing of payrolls, without violating the 270
accounts payables, inventories days threshold, which
guarantees the
• Registration: no registration with SEC required exemption from
registration under the
• Denomination: $100,000 (mainly for institutional Securities Act
investors) Source: Federal Reserve

• Rating: same rating methodology used for corporate

Outstanding levels (seasonally adjusted, $bn)
bonds. However, only offered by investment grade firms
(i.e. no sub-investment grade market)

• Pros:
Quick and cheap way to raise money
No registration and low amount of
documentation required
No collateral required
• Cons:
× Liquidity (as secondary markets are quite small)
× Only available for blue-chip firms with good
credit rating
× Slightly higher interest rate compared to RCF
and short-term loans from banks Source: Federal Reserve

7
2. Commercial papers: example
c

Can you spot the 2 main differences between what is generally true about CPs and the Starbucks case?

• Section 4(a)(2) exemption guarantees benefits, but each resale of CP must be private placement

Source: Starbucks 2015 Form 10-K

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Section 1.2

- Long term financing

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Main long-term financing products in IG
Bond
c ABS (asset-backed security)
Term loan
• Definition: debt security issued • Definition: security collateralized
• Definition: form of financing
and sold to investors by a pool of assets such as
offered by a group of several
loans, leases, receivables
• Plain or hybrid (combining both lenders
equity and debt characteristics) • Comprise multi-tranches,
• Typically senior in the debt
including class A, B, C, D Notes
• Fixed rate Notes (%) or Floating capital structure
(based on rating)
Rate Notes (E/S + bps)
• Term loans bullet/amortising or
Why ABS?
Why bonds? bridge facilities
Favourable accounting
Secondary market liquidity Why syndicated loans?
treatment (more complicated
Cost efficient form of financing with new International
Diversification of sources of
when close relationship with Accounting Standards - IAS)
funding
banks is maintained
It might be a competitive way of
Ability to secure long-term
Easier to execute than a bond or financing
financing
an ABS issue
Alternative source of funding
Free-up banks capital
Available to a wider range of (i.e. different investor pool)
(complementary to RCF)
corporates

Bonds or loans?

• Generally, loan market pricing is structurally higher as banks need to maintain higher capital requirements
• European corporates tend to use loan instead of bonds when financial institutions can guarantee liquidity (bullish market). Otherwise,
firms tend to increase their capital markets issuance to diversify the source of financing when there are major issues with banks (e.g.
global financial crisis in 2008 or European debt crisis in 2012)
• In Q3 2007, the total EMEA loan volume reached ~ 300bn vs ~ 50bn in the bond market. However, in Q1 2009 corporate bonds
volumes came close to matching syndicated loan volumes at ~ 125bn each

10
1. Term loans
Term loan characteristics
c
Investment Grade loans in US
• Term loans are secured (= collateral backing) instalment loans
provided by banks or institutional investors • US IG loans are mainly for Healthcare, Technology,
Finance, Oil & Gas and Telecom companies
• Tenor: between 5 and 10 years
• Jumbo loans, indicating deals of $5bn or larger,
• Use: financing acquisitions, R&D and GCP (general corporate accounted for 92.5% of the top 4 sectors volume
purposes)
• By 2025 ~$513bn of US IG loans will be coming due with
• Interest expense: fixed rate or floating rate based on EURIBOR, the Real Estate, Utility & Energy and Technology
SONIA and SOFR sectors holding ~17%, ~15% and ~14% respectively of
the total debt amount
• Covenants: mainly maintenance of a minimum level assets and
provisions to avoid additional loans/debt
US Investment Grade Loans by sector (as of Oct-19)
• Amortizing term loan (TL A): term loan facility with a progressive
repayment schedule which typically matures in six years. The
syndication process mainly include banks with are already offering
the revolving credit facility to the borrower

• Institutional term loan (TL B, TL C): term loan facility that targets
institutional investors and they usually don t have amortization as
they benefit from bullet repayment

• Pros:
Cheap source of financing
Flexible terms based on negotiations with lenders
Interest payments are tax deductible
Low amount of documentation required
• Cons:
× Presence of restrictive covenants
× Less liquid than public instruments
× Principal repayment which may hinder cash flow generation Source: Dealogic

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2. Syndicated term loans
c
Syndicated loans characteristics Types of syndication
• A syndicated loan is a specific type of loan which is provided by a • Underwritten deal: arrangers guarantee the whole
group of several lenders and it is structured by one or more commitment. This may lead to sell at discount (i.e.
arrangers (usually investment or commercial banks) generating a loss for the bank) if investors perception on
• The use of this financial product is linked with the development of the credit is negative. On the other hand, underwritten
the LBO (leveraged buyout) market in the second part of the 80s deals may help to win mandates and to increase fees

• Main factor of success for the product is that they are less • Best-efforts syndication: arrangers do not underwrite the
expensive and more efficient than traditional bilateral/individual issuance, but they guarantee commercially reasonable
credit lines efforts . In case the loan is not fully subscribed, there are
changes in terms of pricing or size. It represents the
• Investment-grade loans are less used compared to leveraged loans most common type in the investment-grade world
(sub-investment grade) as they carry lower yields
• Club deal: smaller loans ($25m to $150m) which are pre-
• Arrangers will test investors appetite and will launch the credit with marketed to a specific group of lenders. Hence, the
a spread plus a fee arranger is a primus inter pares (first among equals)
and fees are shared between the participants
• Pricing (i.e. spread) is not fixed but arrangers use a market-flex
language, which enables them to change the pricing based on
investor demand. The process is similar to book-building in bonds Global syndicated loans volume (both IG and sub-IG)

• Main types of syndicated loan facilities include:

• Term loans: both amortizing and institutional TLs

• Line of Credit (LOC): guarantee provided by banks to pay

off debt in case the borrower is not able to

• Acquisition or equipment lines (e.g. capex lines): credits

which can be drawn to purchase specific assets or to make
acquisitions during a specific period

• Bridge loans: loans intended to provide interim financing

Source: Dealogic
before a bond/stock offering

12
3. Bonds
Characteristics
c
Type of bonds
• A bond is a loan that the bondholder makes to the
issuer. Bonds usually pay interest periodically and • Zero-coupon bonds: debt security that is traded at discount instead of
repays the principal at maturity providing an interest. The return on the investment is the difference
between the face value and the price of the bond
• Bond prices on the secondary market and prevailing
interest rates shows a negative correlation. If interest • Inflation-linked bonds: issued by government and periodically adjusted
rates fall, investors will buy more bonds due to the to the rate of inflation (e.g. TIPS in US). Due to the protection against
attractive rate pushing prices higher inflation, the interest rate offered is usually lower
• Face value (or principal) is the amount that the • Perpetual bonds: bond characterised by the absence of a maturity
bondholder will receive at maturity (usually $1,000) date (e.g. consols issued in UK and US or subordinated issuances
by FIG). The price can be determined as coupon divided by discount
• On the secondary market, a bond can be traded at:
rate. Those bonds can be considered similar to equity
• Par: price is equal to the bond s face value
• Above par (at premium): price is trading • Subordinated (junior) bonds: bond which ranks below other securities
above the face value in the capital structure. In case of default, creditors of junior tranches
• Below par (at discount): current price is will be paid after senior bondholders. Due to their lower protection to
below face value. default risk, subordinated issues guarantee higher remuneration
• NB. price will always go towards par when compared to the senior counterparts
maturity is approaching
• Hybrid bonds: bond that combines both equity and debt features. Main
• Main factors affecting bond s secondary trading examples are convertible bonds
levels are: (i) interest rates; (ii) financial
performance; (iii) credit ratings; (iv) supply and • Bearer bonds: bond that does not carry the name of the bondholder.
demand (similar to stocks); (v) geo-political factors Conversely, all the other bonds have a registered owner. Eurobonds
(= bonds denominated in a foreign currency compared to the market
• Size: on which they are issued) are an example of a bearer bond
• Minimal amount: 300m (sub-benchmark)
• Average amount: from 500m to 1bn • Sustainability bonds: bond that aims to target identified social issues.
• Larger sizes: achievable through multi- ICMA provides the Sustainability Bond Guidelines (SBG) which aims
tranche and multi-currency issues to finance a combination of both Green and Social projects

• Tenor: 5y, 7y and 10y are the most liquid maturities

13
Fixed vs Floating Rate Notes
c
Fixed Rate Notes (SSNs) Floating Rate Notes (FRNs)

• A fixed rate note pays the same amount of interest • A floating rate note pays a variable interest rate to
(coupon) over the duration of the issue investors depending on the underlying benchmark

• Interest rate risk: probability that prevailing interest rates • Interest rates are linked with a ST benchmark rate, such
will increase, determining a decrease in the bond s value as EURIBOR, SOFR and SONIA, plus the spread
determined at issuance
• The longer the tenor, the higher is usually the interest
paid (due to default risk) • Reset period is defined in the bond prospectus and
highlights how often the rate adjusts
• Pros:
Higher yield to investors • Pros:
Predictable coupon payments Partial removal of interest rate risk
Benefit from a rise in interest rates
• Cons:
× Presence of interest rate risk • Cons:
× Prices are more volatile × Lower yield to investors
× Unpredictable coupon payments

Floating Rate Notes mechanism

Prevailing interest
Coupon rate is
rate increase, FRN s duration is Secondary levels
adjusted, based on
following CB s going towards zero are not affected
the reset period
decision

Duration is a measure of the sensitivity of the price of a

bond or other debt instrument to a change in interest rates

14
SONIA vs LIBOR (UK market)
c
LIBOR (London Interbank Offered Rate) SONIA (Sterling Overnight Index Average)

• Administered by the Intercontinental Exchange (ICE) • Administrated by the Bank of England (i.e. governance
and publication on every business day)
• Introduced in the 1980s
• Introduced in March 1997 and main £ benchmark since
• Average interest rate at which major global banks borrow 31st December 2021
from one another. It is based on five currencies including
the U.S. dollar, the euro, the British pound, the Japanese • Average of the interest rates that banks pay to borrow
yen, and the Swiss franc, and serves seven different sterling overnight from other financial institutions and
maturities (overnight/spot next, one week, and one, two, other institutional investors
three, six, and 12 months)
• SONIA is used to value around £30 trillion of assets each

Unlike LIBOR which is a forward-looking rate, SONIA is backwards-looking, reflecting interest rates that banks pay to borrow sterling
overnight from other banks. The key differentiator from LIBOR is that SONIA is based on real market transaction data, and thus perceived
to be risk free and more robust following the LIBOR scandal that came to light in 2012 (ongoing since as early as 2003)

Source: Bank of England, WSJ

15
Libor curve (12-month)
c

Source: https://www.macrotrends.net/1433/historical-libor-rates-chart
16
SONIA curve (daily)
c

Source: Bank of England

17
Euribor curve (3-months vs 12-month)
c

Source: https://www.euribor-rates.eu/en/euribor-charts/
18
EURIBOR and SONIA Forward Curves
c
Forward curves are used for forecasting and underwriting floating-rate debt

Guess which is EURIBOR at 3-month and SONIA at 3-month and why

Source: https://www.euribor-rates.eu/en/euribor-charts/
19
Sample vs real Term Sheet
c

Source: Kaleidoscope Capital Partners and Scatec Solar

20
 Green bonds
•
c
Green bonds enable capital-raising and investment for new and existing projects with Tombstones of Green Bond deals

environmental benefits

• The Green Bond Principles (GBP) are voluntary process guidelines that recommend
transparency and disclosure and promote integrity in the development of the Green Bond
market by clarifying the approach for issuance of a Green Bond

• The GBP include guidelines for:

• Use of Proceeds
• Process for Project Evaluation and Selection
• Management of Proceeds
• Reporting
• The GBP recommend issuers to communicate their Use of Proceeds categories clearly so
that investors can determine the bond s consistency with their investment strategy

• The transparency and disclosure recommended by the GBP are intended to provide the
informational basis for the market to increase capital allocation to environmentally beneficial
purposes without any single authority or gate keeper

• Green bonds are instruments in which the proceeds will be exclusively applied towards new
and existing Green Projects

• Green projects are activities that promote climate or other environmental sustainability
purposes

• Investors include mainstream institutional investors such as Amundi, Aviva, Blackrock and
specialised ESG players such as Mirova and ACTIAM

• Pros:
Diversification of investor base (= higher demand), including ESG focused funds
Signalling to capital markets regarding company s long term objectives
• Cons:
× Not actually cheaper in terms of yield
× Difficult to define KPIs and environmental/social impact

Source: Green Bond Principles Voluntary Process Guidelines for Issuing Green Bonds (2014)
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Main types of Green bonds
c
Green bond type Use of proceeds Debt recourse Example

Green Use of
Green projects Issuer Enel Green Bond
Proceeds Bond
Green Use of Hawaii State (backed by fee on
Green projects or refinancing of green Revenue streams from the
Proceeds Revenue electricity bills of the state
projects issuers through fees or taxes
Bond utilities)
Ring-fenced for a specific project or a Project (only cashflows Peruvian project bond for the
Green Project Bond
specific set of projects generated) Lima Metro Line
Green Securitized Refinance portfolios of green projects or Tesla Energy (backed by
Portfolio of projects
Bond proceeds residential solar leases)
For eligible projects included in the Berlin Hyp green Pfandbrief
Green Covered Bond Issuer
covered pool green covered bond

Definitions

• Project Bond: debt security to finance a project (usually infrastructures), which will be paid back exclusively by the flows generated by
the project

• Securitized bonds: debt security where both coupon and interest payments come from a collection of other underlying assets (ex.
MBS)

• Covered Bond: debt security that is created from public sector loans or mortgage loans that are backed by a separate group of assets

• Debt recourse: legal agreement that gives the lender the right to pledged collateral if the borrower is unable to satisfy the debt
obligation protection for the lender (consequently, lower cost of debt)

22
 Green bond principles (I/II)
c
Use of proceeds Process for Project Evaluation and Selection

• For a Green Use of Proceeds Bond or a Green Use of Proceeds • Issuer of a Green Bond should outline the investment decision
Revenue Bond, the issuer should declare the eligible Green making process it follows to determine the eligibility of an
Project categories (including types of investments made individual investment using Green Bond proceeds
indirectly through financial intermediaries) in the Use of
Proceeds section of the legal documentation for the security • It should establish a well-defined process for determining how
the investments fit within the eligible Green Project categories
• The GBP recommend that all designated Green Project identified in the Use of Proceeds disclosure
categories provide clear environmental benefits that can be
described and, where feasible, quantified and assessed (KPIs) • A process of review should determine and document an
investment s eligibility within the issuers stated eligible Green
• GBP recognize several broad categories of potential eligible Project categories. If possible, issuers should work to establish
Green Projects for the Use of Proceeds including but not limited impact objectives from the projects selected
to :
• Multilateral and bilateral agencies and other International
• Renewable energy Finance Institutions have established processes to ensure that
environmental criteria are considered for each project to which
• Energy efficiency (including efficient buildings) they allocate funds, independent of whether they qualify for use
of Green Bond proceeds. These reviews are carried out with
• Sustainable waste management
resident teams of environmental experts
• Sustainable land use (including sustainable forestry and
• GBP recommend all issuers to engage in similar environmental
agriculture)
reviews of the projects they are financing
• Biodiversity conservation
• In addition to the Green Bond process, criteria and assurances
• Clean transportation that an issuer provides, many Green Bond investors may also
take into consideration an issuer s overall environmental and
• Clean water social and governance framework

Source: Green Bond Principles Voluntary Process Guidelines for Issuing Green Bonds (2014)
23
 Green bond principles (II/II)
c
Management of proceeds Reporting
• Net proceeds of Green Bonds should be moved to a sub- • In addition to reporting on the Use of Proceeds and the eligible
portfolio or otherwise tracked by the issuer and attested to by a investments for unallocated proceeds, issuers should report at
formal internal process that will be linked to the issuer s lending least annually, if not semi-annually, via newsletters, website
and investment operations for projects updates or filled financial reports on the specific investments
made from the Green Bond proceeds, detailing wherever
• As long as the Green Bonds are outstanding, the balance of the
possible the specific project and the dollars invested in the
tracked proceeds should be periodically reduced by amounts
project
matching investments made during that period
• GBP recommend the use of quantitative and/or qualitative
• Pending such investments, it is recommended that the issuer
performance indicators which measure, where feasible, the
make known to investors the intended types of eligible
impact of the specific investments (i.e. reductions in greenhouse
instruments for the balance of unallocated proceeds
gas emissions, number of people provided with access to clean
• The management process to be followed by the issuer for power or clean water)
tracking the proceeds should be clearly and publicly disclosed
• While there is variability in impact measurement systems, much
• The environmental integrity of Green Bond instruments will be progress towards standardization has been made in the past
enhanced if an external auditor, or other third party, verifies the several years
internal tracking method for the flow of funds from the Green
• Issuers are recommended to familiarize themselves with impact
Bond proceeds
reporting standards and, where feasible, to report on the
• Depending on issuers and investors expectations, outside positive environmental impact of the investments funded by
review of the internal tracking method may or may not be Green bond proceeds
necessary

Source: Green Bond Principles Voluntary Process Guidelines for Issuing Green Bonds (2014)
24