SWAPS

Bankers Trust operates a network of swaps cenEes in New

York, [-ondon, Tokyo, Hong Kong and Toronto and has
been a substantial market player since the beginnrng of this
funding revolution.
The frrst unit was established in New York by Allen
Wheat and Tim Lindberg in l9B2' and was the acom
Fom which the bank's capital markets oak would ultimately
grow. Indeed, most BT swaps e.\perts today are also
skilled capital markets generalists whose careers have
evolved out of this partcular discipline. Wheat's recent
appoinhnent as head of capital markets illustrates the point'
In 1983, Wheat and Lindberg migated to London to
extend the swaps empire and, later, to develop other
aspects of the capitai markets group. Consequendy,
Wheat's New York leadership slot was assumed by
Jon
Berg, who is a BT managing director and deputy head of
capital markets.
The next link to.be forged was in Tokyo, where BT set
up its swaps shop in l9B2 under the aegis of Brady
Dougan, a vice president in the capital markets group.
BenWeston and Tim Lindbetg at Banhers
Trust uith ( centre) Bernt Ljunggten ftom SEK
This was followed in 1984 by Hong Kong, which is
headed by BT associate Trevor Price. Earlier this year,
vice president Brian Walsh
-
one of a four-man team of
defectors to BT Fom Canada's Wood Gnrndy merchant
bank- founded the New York bank's Toronto swaps unit.
While Wheat may now be de
facto
head of capital
markets and, ipso
facto,
of swaps, most BT gmgraphical '
operations are highly decentalized and have become
quintessential capital marker entities wtth pronounced
swaps skills. According to Berg in New York, BT today
54 Special sponsored supplement
offers the full gamut of swaps services and
-
based on
Federal Reserve Bank statistics
-
ranl's number three in
the dollar interest rate league after Citibank and Salomon
Brothers with deals in l9B5 worth $24 billion rising to
more than $30 billion in the current year. And, while no
reliable figures are available for currency swaps, BT claims
to be a leading player, ranking, overall, among the top five
swaps operations worldwide.
The pro6le of BT's strengths and related atkibutes
highlights a sound trading balance bet'ween interest rate and
curency swaps with particular eminence in two to
three-year interest rate swaps, swaps combined with
options and US dollars as well as yen and Swiss franc
swaps. It also claims the distinction of being the frst market
maker in interest rate swaps in Tokyo'
In the market-making context, BT takes sizeable
positions, although typically not longer than two weeks. In
recent months, business has been 507o sourced in the US,
25Vo n Europe, and 25Vo in Tokyo. It is also heavily
linked to new issues and investment swaps'
Berg uiso points to BTs innovative qualities and cites
last year's yen option bond issues for l.ongterm Credit
Bank of
Japan
and British Peuoleum. A more recent
example, he adds, was the swap-driven bond issue for
Swedish Export Credit, whic} was described in the
l,ondon financiai media as the lowest cost-swap ever
adueved from a Eurobond. "Our capital markets group
has virtually grown up around swaps," explained Berg,
"which has resulted in many of our capital markets products
having swaps feahres."
L"ookins to the future, Berg foresees a world of
ever-bigger swaps. Outstanding issues still to be resolved,
however, are those of documentation and credit risk.
"At
some point," he said, "the markei may experience a major
default which could negatively impact business and volume.
Nbtrvitirstanding, my prognosis for the future is onwards
and upwards with the real value-added coming from new
arbitrages. What is innovative today will become generic
tomorrow."
This is the $25 billion-plus swaps operation that
pales any comparison. Citibank is reputed to be the
creator and the nurturer of the swap, a market which
kicked off in the early 1980s. Since then, the world's
largest bank has also become the world's largest swap
business. All this activity, however, poses a major and
THE
BIG PLAYERS
IN
THE
SWAPS
GAME
Although the swaps revolution took off only a!-the s:tart of this decade,
the maj-or banks *"".
quick to take up the challenge, md business is
booming
SWAPS
';Lrh;3
problem for the bank's swaps department
-
6+*
itself fully staffed. Citibank's swaps employees
fvc
migrated
en masse from their training ground to
Chemical
Bank'
But such
problems do not daunt Yves de Balmann,
who heads the interest rate and currency risk unit for the
bank in Nerv York. An I l-year veteran of Citibank, de
Balmann
started out his career as a scientist after
receiving
a MSc from Stanford, but soon ended up in
6nance.
He held positions for Citibank in the Middle
East, London, and, most recently, his native France
before returning to New York in 1984. Swaps were
nothing new to de Balmann, though, who headed the
bank's leasing business in France.
"You
learn by osmosis
and by doing," he explained.
Furthermore, there is always the strength of the
Citibank business itself. "Part of our strength is our
distribution network and our relationship managers,"
said de Balmann. We cover more corporate names than
anyone."
Citibank, unlike some of its competitors, keeps all of
its staff involved in swaps business on its huge trading
floor on Wall Street. The New York desk currently
numbers 20 professionals, all of whom have been trained
within the bank.
There are about 50 professionals globally who deal
exclusively with swaps.
Twelve of them are in London headed by Mark
Blundell. The office, which is separated from the
dealing room by a glass wall, has been particularly busy.
In one week alone this year, it arranged 35 swap deals.
Recently, it became the 6rst house to launch sterling caps
and collars.
Blundell has split his team into three parts.
Marketing of US dollar and sterling caps and collars
employs two people, a further four are taken up
arranging "old
fashioned" counterparty matching:
litibank make a speciality of non-reserve currencies in
this 6eld, such as Ecu, Dutch guilders, Saudi riyals and
Belgian francs. The third group, of frve, is occupied
The team at the mighty Citibank. The banh b
c r edite d. uith pio neerhg sut aps
with the warehouse positioning books in sterling,
Deutschemarks, Swiss francs and US dollars. The Far
East team also positions Australian do[ars. To satisfu
in-house restrictions, virtually all positions are hedged.
"We
can handle any size of transaction," said
Blundell.
"From only $ I million to practically no upper
limit." Uke many in his 6eld, Blundell is excited by
technicalities.
"The more complicated a transaction, the
better we like it," he said.
All this new activity, however, is not straining the
current staff, said de Balmann. "We
don't have a large
need to increase our size substantially," he said, although
he anticipates a fairly large amount of turnover. But,
then again, the promise of such career advancement
makes swaps a hot area for the swarm of bright young
professionals at Citibank. "'We see the best resum6s
around," he said. "This business tends to attract very
smart people."
Staffmembers say the competitive atmosphere, which
Citibank is renowned for in financial circles, does not
mean they cannot be team players. "We have a lot of
fun," asserted Citibank vice president, Alan Schealy,
one of the desk's three traders. "There's a clear idea of
your responsibility here and we work productive hours."
Additionally, Citibank's large capital base of $ l6
billion more than adequately allows the bank to book
swaps, a record that shifts so frequently that a thick
computer print-out list is updated constantly and handed
out every morning.
"This is a risk-oriented environment.
'lVe
can structure complex transactions, the esoteric
swaps that are the vogue right now," noted de Balmann.
"To
us, there's no deal that can't be done."
For Morgan Guaranty's small group of swaps
professionals, a team approach is without question the
only viable one. At the bank, becoming a swaps
specialist is not a lifetime career commitment, but one
more rotation through a department in the bank. "This
bank does not identify its business with superstar
individuals," explained Mark Brickell, who
just
recently
took over the management of the five-member New
York team. As a result, he will not be putting any
personal stamp on the bank's swaps effort.
"lt's
not a
question of change: we'll continue to be good at this
business. I'd say there are some small corrections in the
course, but no change in the direction," he remarked.
This new assignment does not mean a seat on the
trading floor.either, since swaps are considered more a
function of corporate 6nance. As a result, the swaps
group, complete with their blinking sets of computers,
are nestled in one corner of an open room of desks.
"W'e're not
just
reacting to the market's activities, but
working with capital markets people and the corporate
finance professionals who deal directly with our clients,"
said Brickell.
Swaps are nothing new to Brickell, a Harvard
MBA whose past assignment was working for the
bank's treasury group, where swaps are used to create
fixed-rate funding for the bank. To prepare for this next
step, Brickell overlapped for a few weeks with his
predecessor, Peter Bernard, who has moved ur to
trading options within the bank. All the same, the
33-year-old Brickell says he has done a lot of reading up
on swaps.
"This job
takes a sense of discipline and
Special sponsored supplement 55
SWAPS
analyzing down to the last detail," he pointed out.
Aside from Brickell, there are four other swaps
professionals in New York, four in Tokyo and six in
London, none of whom have been recruited from
outside. But their training in swaps is as intense as
possible since the bank is a market leader, with
$2 I
billion in interest rate swaps outstanding, with a risk of
$1.2 billion, at year end I985. And those numbers do
not include currency swaps where the bank handles
nearly 20 curiencies and specializer in exotics, such as
swapping the hrst Yankee bond in New Zealand dollars
issue by Sallie NIae this year. Furthermore, the New
York team has its hands full simply keeping pace with
the demands of Morgan Guaranty's global customer
base, as well as the growing presence of Morganl
Guaranty Ltd, its London merchant banking arm, as a
Eurobond underwriter.
Morgan Guaranty's teann, their reputation is
based on their strengthin zero coupon sl.;r,aps
in all curtencies
Recently, there has been a trend for many houses to
do more business in London than in New York) At
Morgan Cuaranty, this is reflected by staff numbers.-
The London office, run by Conrad Volstad, outmans
New York with a crew of seven. There are a further
three people in place in Tokyo where Nick Rohatyn is
chief. The London office sees much room for expansion,
particularly in the areas of currency swaps and complex
deals.
"Business
is so varied we like to think we can do
anything," commented Volstad.
"lt's
a great area to work in the bank because it's so
busy all the time," said one young professional on the
desk.
Morgan Guaranty has been in the relatively young
swaps market for a long time, acting as an agent for,
currency swaps in the late 1970s, and taking on an
interest rate swap dollar book in 1982. But, not until
early l9B4 was a group of swap specialists formed to
handle the growing volume. Highly innovative, Morgan
Cuaranty made its reputation in the swaps market based
on its dominance of zero coupon swaps in all currencies.
Business is booming for First Boston's swaps team,
mostly as a result of the Credit SwissiFirst Boston
dominance of the new issues market. So much so that
swap volume should rise to $25 billion plus this year,
58 Special sponsored supplement
said Carol Einiger, a First Boston m.anaging
directot
;f*ne,*othe
firm,s short_term finun.ing
."pit.l
However, bigger is not always better.
This fast pace
of growth does not come without-some
cost,
unj
fo.
CSFB's New York office-, it has followed
a period
of
retrenchment. "For a brief period of time last year.
we
were less active in the market." said Einiger. "'We
toor
a
step back and looked at our business. Whar
sacrificed wasn't dollars, but market presence.
During that time, the firm evaluated the mechanrcs
oi
how things worked for its swaps team, from the physrcal
placement of its swaps professionals
in its bustling
trading room to its computer software system
and
various hedging techniques. The most visible change
to
any onlooker is the separation of swaps traders
and
marketers in the trading room, who sit diagonallv
opposite each other, while the currency s*ups t.am ,iis
amidst CSFB representatives and the foreign exchange
desk. The rest, however, is proprietary information,
but
the result, said Einiger, is "part of what gives us an edge
in the market.
'We're
comfortable with the financial
sophistication of our people, our software and ou.
hedging techniques."
Fbst Boston's grouting team, one of the most
innooatil.te in the marhet
The number of employees of the swaps desk has been
expanding as well, with new recruits coming from such
firms as Marine Midland, Citibank, Manufacturers
Hanover and Bankers Trust. Now, there are nine
professionals in New York as well as seven on the
marketing side.
.There
are also other employees who
deal exclusively in swaps for the 6rm around the world:
one professional in London, three in Tokyo, one in
Sydney, and three in Zurich. However, if support staff
are included the global team numbers around 40.
With these sweeping numbers of employees,
impersonal relations can result; But, everyone is
required to put in some time in the competitive New
York office. Part of their expertise, however, is the
result of First Boston's ability to attract some of the best
talent in the business at some of the highest salaries
around. This bevy of technical wizards has launched the
6rm's reputation as one of the most innovative. But, as
one trader explained: "There
are no books to teach you
how to do swaps. It's seat of the pants learning."
Einiger, 36, is the first female managing director at
First Boston. Right out of college, Einiger started out at
Goldman Sachs and after deciding frnance was in her
blood, went on to attend Columbia Business School.
i-U*n graduation, she
joined
First Boston
-
initially in
li. invatrnent
banking
-
before moving to the capital
.l markets
group, which has seen its business explode.
SWAPS
"We're forced to be opportunistic so we've become
the biggest agent in the business," said Walthur. One
way to beat the competition is by shaving some basis
points off the arrangement. Another is simply being
there at the right time, particularly since the swap desk is
integrated with instruments which play off each other
-
currency swaps, interest rate caps and synthetic
securities.
Of course, a lot of the unit's business springs right out
of Goldman itself, which is submerged in new issues,
particularly "heaven and heil" bonds.
International issues and time clock differences
recently forced one young trader to stay at Goldman all
night to tie up the counterparty for the swap transaction,
part of a recent Australian dollar issue by Ford Motor
Company, underwritten by Goldman.
Walthur, at 37, is a sage of this relatively young
business. A West Cerman by birth, he graduated from
Harvard Business School and conducted his first swaps
deals for First Boston Corp. Coldman lured him away
when Sears, Roebuck and Co., one of Goldman's
biggest clients, started doing its swap business at the
rival frrm. Walthur brought some of his old team with
him and has built the rest of his group largely from the
outsids including Citibank and First Chicago,
integrating them into Goldman's team player
atmosphere. Growth will continue, said Walthur,
noting the increasing standardization of swaps. "W'e've
come a long way from the days of sitting in corporate
finance without screens."
The Goldman SacAs surap s dealers, utho are
noted for their d.edication
Not that screens full of quotes are always necessary to
piece together a swap. One devoted young trader, who
recently suffered a back injury; came into work all the
same, lay down on the foor of a conference room and
started ringing up parties on the telephone.
"lt's an
intense place," said one competitor.
Morgan Stanley's swap team has gone through a bit of
an evolution in the last year. For one thing, it has
loosened up
(not something Morgan Stanley is known
for), and boosted the bottom line in the process. "We're
defrnitely more risk oriented," explained Bidyut Sen,
who came to Morgan Stanley from Citibank a year ago.
The Morgan Stanley method, in the past, was to
Special sponsored supplement 59
].
--rti; "g"ri."
early on recognized the growing
Upon
graduation, she
joined
First Boston
-
initially in
investment
banking
-
before moving to the capital
markets
group, which has seen its business explode.
First Boston early on recognized the growing
application
of swaps as a financing technique and moved
its swaps desk to the trading floor in 1983. The frrm has
also been on the cutting edge of developing a liquid
secondary market for traders of swaps by seeking
methods of making swaps more homogenous, by, for
example, requiring collateral from weaker credits like
thrifts.
"What
makes us different is that we're in the
forefront of the market. Not many 6rms are as far along
as we are in managing risk," Einiger noted.
Artur Walthur, Goldman Sach's co-head of capital
markets, begins his average workday by telephoning the
Tokyo of6ce from his car at about 6.30am to get a
reading on the market. He then calls London. But this is
just
the first round. When he arrives at Goldman's Wall
Street headquarters, he is on a conference call to both
cities at 8am. "That's
the time of day we all intersect."
he remarked with a grin. But, by 9pm the same day,
Walthur is still at work, making a'good morning'call to
Tokyo before he goes home for a quick nap.
Walthur's boundless energy is
just
one reason, albeit a
very important one, why Goldman was able to set a new
house record for swaps volume in April
-
about $2.4
billion in two weeks and a record $ I 2 billion for the first
third of 1986. With this intense pace, the name of the
game for Walthur and his I 7-member swaps unit is
hustle. Goldman, unlike some o[ its competitors, does
not put its own capital on the line by buying swaps
outright when counterparties cannot be found. So,
Walthur and his associates sweat it out like Hollywood
agents looking for the right press event in their
minute-by-minute searches for the appropriate
counterparties.
Paul Efron, at the six-strong London office,
explained the policy of not running a large book.
"You
have to ask if the capital is sufficient to
justifu
the risk,"
he said. "We think it's generally better to take positions
on the bond markets. I see the profitability of running a
large swaps book declining." However, Goldman Sachs
will take a short-term position to accommodate a
counterparty.
Efron moved in to lead the London offrce in
September from the New York team, before which he
worked for First Boston. Goldman Sachs has always
been a predominantly US house, and it was only last
year that currency swaps were introduced in a major
capacity. Already, currency swaps account for slightly
more business than do interest rate swaps.
This business mix is also represented in Tokyo, which
is staffed by a team of four.
"Yet, they differ in that they
tend to be more investment driven," noted Efron.
SWAPS
WHY S\ryAPS MAKE
SOME
CURRENCIES
POPULAR
Currency swaps have driven the Eurobond market.
In 1985 an estimatedTo%o of all issues \rere swapped. Why should
some currency sectors be more swap driven than others?
-
Up to 907o of yennew issues are swapped, according to
Japanese
banks, with an increasing number involving
three or more counterparties. Most borrowers need
dollars more than yen, and, like any low coupon
currency, the yen market offers attractive low-cost
funding opportunities to gain leverage in the yer/dollar
swap market.
"Like any new market, the yen sector suffers from
bouts of indigestion. It is less deep than traditional
European currencies," said
Jerry
Langley, treasurer of
McDonald Corporation. McDonald has regularly
tapped the yen sector, either to obtain working capital
for its chain of some 500 restaurants in
Japan
or for
lucrative swaps. In
January
I 985, it made its first foray
into the newly liberalized market with a straight Y25
billion bond, a portion of which was used for lending on
to the company's joint
venture. Another portion was
swapped into floating rate dollars at an all-in cost of
Libor minus 80-
Swaps triggered by yen obligations tend to be better
.
priced than European alternatives, explaining the
popularity of the sector among borrowers. "A
number
ofJapanese houses are pricing deals very competitively
.
to establish their market share," said Langley. "They
are willing to drive swap terms really fine."
Uberalization of
Japanese
financial markets in April
I 985 permitted the introduction of yen zero coupons,
FRNs, convertibles and dual currencies. "Dual
currencies in the yen sector are the single most important
development in the
Japanese
capital markets during
I 985," said Hiroshi Toda, executive director at
Nomura International. Nomura lead managed the first
ever yen dual currency in the shape of a Y I 5 billion
issue, redeemable in US dollars at $4000 per bond, for
Farm Credit Corporation of Canada, as well as around
20 of the subsequent deals.
The spate of dual currency issues, for names like
IBM, Credit National, Phibro Salomon, Honeywell
and Fannie Mae, were all swap driven, and resulted in
cheap dollars for the borrowers. IBM achieved
sub-commercial paper rates using the structure.
Swaps off yen dual currencies relied upon locating
investor appetite in order to drive borrowing costs
down. Investors were offered a higher than average
coupon
-
around 87o
-
rn return for accepting a foreign
exchange risk dependent on the dollar/yen rate on
maturity. For the borrower, the subsequent swap into
floating dollars only involved a spot foreign exchange
transaction of the principal and forward coupon swap,
since the principal repays in dollars.
Yen dual currency issues are a prime example of
"the
further opening up of the yen market, making it much
more sophisticated and easier to deal in", according to
Tam Robertson, Farm Credit treasurer. The issue
resulted in a final cost of funds of l0.02Vo after two
swaps into US, then Canadian dollars, or 28 basis
points under Canadian teasuries.
Euro-yen new issuance volume increased fivefold
during 1985, boosting the total market share of
yen-denominated international bonds to the equivalent
of $6,463 million, or 9Vo of thetotal Eurobond market.
In fact, the yen sector was the third largest in terms of
new issue activity during 1985. Much of the surge in
volume can be accounted for by swap driven issues.
"The
Euro-yen market is trying to follow the
Eurodollar," Toda concluded. "Borrowers
who
previously relied on the Eurodollar can now diversifu
their investor base and, through the swap market,
achieve any currency they want."
Since last October/November, *h.n ih" y.n',
meteoric rise began, the yen swap market has tended to
be all one way
-
borrowers anxious to tap investor
demand for yen-denominated securities with new issues,
and swap into dollars, while yen payers have been in
short supply. 'Japanese
companies have been keen to
sell yen forwartand buy dollars because of interest rate
differential between the currencies," said Shinsuka
Amiya of Yamaichi International. "With
the dollar at a
Special sponsored supplement 27
SWAPS
forward discount, they have been unwilling to accept
expensive yen debt in return for dollar debt."
Amiya argued that, given. the scarcity of natural
counterparties to yenldollar swaps,
Japanese
banks
have been hard at work creating synthetic
counterparties. This has been achieved through the
invention of dual currencies and heaven and hell issues,
which off-load the hedging of the final redemption
amount to the investors, making it possible for the
arranging banks to offer preferential swap rates to
borrowers willing to assume yen debt. Dollar equity
warrant issues for
Japanese
borrowers have also created
a pool of yen payers to supply the other side of the
equation.
"ln order to protect our market, it is necessary to keep
making innovations," Amiya summed up. "Only then
$/ill the yen market rival the Swiss franc or
Deutschemark in terms of volume.
'We
must seek new
schemes for swaps while the yen continues to be so
strong."
The Swiss franc capital market has always been
relatively free from regulation, a fact which early on
fostered a flourishing swap market. For sophisticated
international borrowers, accustomed to borrowing
Swiss francs, it was a natural progression to return to the
market to launch issues intended for swapping into
another currency. It was no coincidence that the first ever
crrrency swap between the World Bank and IBM
involved Swiss francs. "lt's a symptom rather than a
cause," was the opinion of one Swiss banker commenting
on the .*..6.y swap market developed out of
Switzerland.
Because retail investors
-
the mainstay of the Swiss
franc investor base
-
prefer debt from household names,
well-known US corporations have carved a lucrative
niche in the new issue related swap market. During
I 985, as the Swiss franc appreciated against the dollar
or interest rates fell, windows opened for North
American borrowers which were quickly seized upon.
Names like ITT, McDonnell Douglas, American
Fletcher, Textron and Goodyear Tyre and Rubber all
.
featured in the swap market.
Such borrowers
-
in response to investor appetite
-
were able to lower issue costs, then swap their debt for
sub-Libor funds with counterparties willing to assume
the Swiss franc liability. ITT's Sv',frl00 million issue
over l0 years in October, for example, was swapped
into 6red US dollars at 34 basis points over teasuries.
Tlie-best the company could have achieved in the
domestic market, at that time, was 60 to 80 over
Treasuries.
McDonnell Douglas's savings were equally large.
The final cost of funds, after swapping out of a Swfr I 00
million l0-year issue, was
just
44 basis points over
Treasuries, some 30 points less than a Eurodollar or US
debt market issue.
"'We like the Swiss market and they
like us," said Robert Owsley, treasurer and vice
30 Speciar sponsored rroo,.rnlJ,*t'ent
at McDonnell Douglas'
"The Swiss franc market is sometimes receptive to
some types of borrower who don't get the same relative
reception elsewhere," said Stephen Mahony, swaps
specialist at Swiss Bank Corporation International in
London.
In price terms, less than AAA credits 6nd Swiss
franc swaps favourable because yield differentials are
narrower in Switzerland than in the dollar market. A
US name is therefore able to contain cheap terms in the
Swiss market and exchange its debt for dollars at a
better rate than would be available to it in the dollar
sector, where lower ratings count more heavily.
Take for example the notional case of a BBB
company which is able to issue a l0-year Swiss franc
bond at an all-in cost of.5.5Vo. A swap into fixed-rate
dollars would result in a cost of around I 25 over
Tieasuries. In the Eurodollar or domestic market, the
same borrower would probably pay nearer Tieasuries
plus 140. The swap would save I5 basis points.
For an AAA rated borrower, however, the coupon
on.a Swiss franc fixed-rate debt issue might be nearer
43/+7o with an all-in cost of 5t/c%o. A currency swap
would result in cost of funds at around Treasuries plus
100, while a dollar issue would cost the same borrower
Treasuries plus 50, proving the relative value of the type
of swap to a lesser rate borrower.
Dawn Lomas of Shearson Lehman pointed out the
recent restrictibns imposed by the Swiss authorities,
which aim to curb what was seen as an alarming
tendency for the Swiss franc bond market to become a
'dumping' ground for lesser rated credits. Public debt
issues
-
or those longer than eight years
-
must be BBB
rated or better, according to the ruling. According to
Lomas, the Swiss market was at one time associated
with prestige borrowers, a psychological factor which is
no longer relevant since obtaining cheap cost of funds has
become the main priority.
Lomas predicted Swiss franc swaps will 'become
more competitive in future, as US investment banLs
slowly start to erode the domination of the big-th
Swiss banks
-
UBS, SBC and Cr6dit Suisse
-
in the
Swiss capital markets as a whole. "But it's going to take
a long time," she added.
Last October, a number of US and Canadian banks
made their presence felt in the Swiss market, winning
lead manager positions for big US name. like R
J
Reynolds, ITT and McDonnell Douglas. The trend
was continued in February with names such as Morgan
Griaranty and Royal Bank of Canada
.rn
in,ing
mandates for issues on behalf of Coastal Corporation,
Del,Webb and Humana. Other names to encroach on
the once hallowed ground include Chase Manhattan,
Citicorp, Banque Paribas and Coldman Sachs.
US banks, with their expertis'e in the swap market
and a worldwide network of swap counterparties, are
now in a strong position to establish themselves in the
Swiss market. Often, the all-in package, including
underwriting fee and swap, which they are able to quote
to borrowers, lures new issue business away from the big
three Swiss banks.
Swiss franc swaps have no basis interest rate over
which they are priced like Treasuries to the dollar
market, Schuldschein to Deutschemarks and gilts to
sterling. Shorter dated swaps, from two to four years,
i
tend to follow domestic interest rates, while the longer
end is priced off a hypothetical level of where new issues
would be brought.
The new issue related swap market in Swiss francs
6nds an abundance of counterparties in sovereigns and
supranationals, who need to mainthin a currency spread
in their debt portfolios, and may find a price advantage
in swapping into Swiss franc debt as opposed to a public
debt market offering of their own. Other entities seeking
to swap into Swiss francs are those wishing not to spoil
their reception for repeated financing through over-
borrowing.
Falling rates in Switzerland, in early 1986, enabled
swaps to be written off old debt, where borrowers
swapped out of relatively expensive foreign debt into
Swiss francs. The steady rise of the yen against the Swfr
also meant that
Japanese
borrowers, who have been
-favourites
in the Swiss market for a long time, provided
ready supply of Swiss payers.
Up to Bl?a of Ecu new issues are swapped,
according to Philippe Gautier, head of swaps at Chase
Manhattan. The high percentaSe is due mainly to the
fact that spreads between Treasuries and Eurodollars
are at their widest for two years, making swaps off
Eurodollars uncompetitive for all but the best names.
Instead, borrowers are turning to the Ecu market which
now offers some of the best opportunities for swaps into
cheap floating dollars.
On the large number of swap driven new issues,
Gautier remarked: "l think it's an advantage to the
market. Investors in the Ecu are getting access to a wider
variety of credits, such as borrowers from the US, the
-^
Pacific or Canada for example, which they would
,therwise
not have. From the investor's point of view,
the Ecu offers a strong currency with virtually the same
interest rate as the dollar."
The recent currency re-alignment within the
European Monetary System (EMS) has further
enhanced the Ecu swap market. Prior to the currency
adjustment potential, Ecu payers were deterred because
of uncertainty over the future exchange rate. "The
re-alignment cleared the air for swap counterparties,"
said Cautier, "which
has greatly enhanced possibilities."
Chase Manhattan has Iead managed a number of
swap driven Ecu issues over the last six months, for
names like Colgate-Palmolive, Modt Hennessy and Elf
Aquitaine. Although still very much a name market,
relying on the recognition of household entities among
retail investors. Gautier noted that recent issues for
EDC and Sweden have offered investors top-rated
credits in addition to well known names.
Because the Ecu swap market is name-conscious,
swap opportunities arise on a case-by-case basis,
depending on the names issuing and the demand for Ecu
paper. During
July
and August 1985, for instance,
there was a fantastic demand for Ecu paper from
good-quality US names like R
J
Reynolds, Chrysler
and Xerox which created swap windows for
SWAPS
corporations to win cheap dollars through a swap.
Walt Disney is a typical US company to have used
Ecu swaps as a cost-saving exercise. It tapped the Ecu
market twice in l9B5 to raise fixed yen rather than
dollars, achieving a competitive cost of funds compared
with a straight Euro-yen issue.
'Walt
Disney treasurer,
Don Tucker, claimed he likes the opportunities offered
in the Ecu market because
"the
Ecu is a well accepted
vehicle and there are always plenty of swaps available.
We always welcome more European investors."
The open and closed nature of the market is also due
to the counterparty-driven nature of the swaps, with
most banks preferring to match transactions rather than
warehouse positions. "The
market is still relatively
illiquid," commented one trader. "Not
many banks will
make an active Ecu market."
Counterparties to new issue Ecu swaps are typically
European companies which are unable to launch an issue
in the market directly because of insufficient credit
standing, or agencies and corporations with huge dollar
liabilities seeking to hedge their currency exposure.
Given the drop in the dollar, many borrowers are scared
of an upward correction, and want to lock into a
different currency at today's favourable rates.
"A good proportion of Ecu swaps takes place in the
quasi-secondary market," said Alec de Lezardiire of
Banque Paribas Capital Markets. "Around 75Vo to
80Vo of all Ecu swaps are companies managing existing
debt." The Ecu provides an ideal mechanism for
diversifuing risk, he argued, and, as the underlying Ecu
market gains depth and liquidity, more swaps will take
place
-
both into and out of the currency.
De Lezardiire estimated that the percentage of Ecu
issues subsequently swapped is nearer 757o for 1985,
and only 50Vo during the 6rst quarter of 1986. He
maintained that the trend is towards a decreasing
number of swapped new issues, as borrowers retain the
currency as a valid hedging medium against dollar debt.
"The
market is absorbing a huge volume of paper at the
moment, proving its liquidity. The differential berween
the real cost of borrowing in Ecu and the theoretical
yield, or borrowing in each of the separate component
currencies, has narrowed to around 50 basis points. It's
becoming more popular for non-swappers as well."
Ecu swaps are cyclical. "Every time the dollar
weakens, there's a food of European companies seeking
to lock in profits by swapping into Ecu or other
currencies," he maintained.. Italian and Spanish
companies are particularly active.
De Lezardidre predicts the next major development
for the Ecu swap market will be an increasing number of
banks prepared to warehouse swaps
-
something
Paribas is already doing. This will enhance volume in
the number of swaps off existing debt, enabling
companies to swap into Ecu when it suits them, rather
than when a new issue creates an Ecu receiver.
Swaps from Ecu new issues are facilitated by the fact
that credit differentials in the Ecu market are narrower
in the Ecu than in the Eurodollar market. This means a
single A credit, for example, is able to obtain frner terms
in Ecu than might be possible in Eurodollars, where its
lower credit rating wou[d count more. With the
relatively cheap Ecu debt, the company might then gain
leverage into cheaper dollars via a swap.
Special sponsored supplement 31
SWAPS
The development of the Euro-Australian bond
market has been given a tremendous boost by parallel
growth in the swap market. New issue volume in
Australian dollar denominated Eurobonds reached
nearly A$4.5 billion in 1985, compared with
just
4,$361 million in 1984
-
a twelvefold increase. The
number of issues also increased dramatically to 89 last
year from l0 in 1984.
The surge in new issue volume has been largely swap
driven, with up to 90Vo of new issues swapped, mainly
into floating rate dollars. The Euro-Australian dollar
market has become accustomed to a host of European
and US names, including prime corporations and
banks. Although they do not have any natural need for
the currency, they are unable to resist the opportunity to
raise cheap dollars. German borrowers have figured
prominently: names like BMW blazed a trail in August
l9B5 when it achieved Libor minus 50, while Deutsche
Bank and Commerzbank, more recently, are reported to
have.obtained floating dollars at
just
Libor minus 75.
"The
Australian dollar sector of the Euromarket
offered the best swap rates in the market to many
Cerman entities and US household names last year,"
said
John
Kerr, executive director at Orion Royal
Bank. "At the same time as the Deutsche Bank swap,
the yen, Ecu or Deutschemark could only off.er 25 to 40
basis points under Libor." Orion has established a
Comparison of costs of selected Euro-Australian
dollar bond issues with five year domestic
Commonwealth Bond yield
-
s-year domestic Commonwealth Bond
a lssues lead managed by ORB (book running position)
o Issues colead managed by ORB
a
AVCB
l{* t990
aut
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13r,t* 1990 14 5
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13,lX 1992
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BHiH','o'
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14* 1988
l3i/r* 1988
At{z
l3r,t* 1992
a
13!i 1992
a cB.0P EUt X HAt{ot-ratc
al3rix
1992
crTtconP lAusT.)
. MOMAI' 6UAMI{TY AIJSI
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MY I{YP{)SAXX
13* 1990
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.
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12,iI 1990
SouEi Orio Foyal 8!nk Umhqd
1986-
34 Special sponsored supplement
SWAPS
strong market share in Iead managing Euro-Australian
dollar issues, bookrunning 39 of a total I I 9 issues
between 1983 and
January
1986, or nearly 3370.
Orion brought the first ever Euro-Australian dollar zero
coupon bond for the Commonwealth Bank of Australia,
which was also swapped.
Swap driven new issues in Australian dollars enjoyed
a freld day during the summer of 1985, and the market
once again sprang to life in the first quarter of I 986. A
flood of German bank borro*ers exploited the open
window to get cheap floating dollars, including
Badische Kommunale Landesbanke, DC Finance and
IKB Finance. Fiat and Pepsico quickly followed suit.
Pepsico achieved a 6nal cost of funds of around 80
basis points below Libor, or significantly below US
commercial paper rates, after swapping its A$75
million issue over three years
-
a very competitive rate
-
qompared with the company's outstanding debt
rrtfolio, according to an assistant treasurer at the
company. The cheaper floating rate dollars are being
used to replace Pepsico's existing commercial paper
borrowing.
Pepsico's
January
Australian dollar swap was only
its second venture into the market. "Our centralized
borrowing operation means our costs are averaged out,
making the whole debt portfolio more attractive," the
treasurer noted. However,
"it's
fringe market", he
added. "Opportunities
come and go. The other
detraction can be the small issue size you are limited to
-
A$75 million in only around $50 million."
The reason that so many non-Australian borrowers
are able to achieve such competitive dollar costs is
largely historic. The Australian domestic bond market
is underdeveloped, and Australian banks only lend on a
floating rate basis. The only way for many Australian
companies to obtain fixed Australian dollars, then, is
either to issue through a parent in the Euromarkets or
enter into a swap with a non-Australian counterparty.
--.
"Swaps
developed because Australian borrowers,
,ch as public sector entities, took out large US dollar
syndicated credits during the I 970s and early I 980s to
finance capital expenditure projects," explained Kerr.
"Typically, the borrowers only had income in
Australian dollars. So, when the currency collapsed in
early 1985, they suffered huge forex losses." Such
borrowers, with their need to pay Australian dollars
and receive US dollars, form the counterparties to the
swapped new issues abundant in the Euromarkets.
From an Australian borrower's point of view, only
the most highly rated company is able to tap the
Euromarket. The majority of borrowers end up paying
over the odds of l6Vo to 17Vo domestically. Australian
dollars obtained via a swap
-
at around 147o
-
obviously compare favourably. And most borrowers
want floating rate dollars.
"Ninety-frve per cent of the
swaps are cross currency interest rate swaps," added
Nicholas
Jordan
of Orion Royal Bank. "From floating
dollars to fixed Australian or vice versa."
When investor demand is present, prime non-
Australian names can achieve rates below those at which
the Australian government can borrow. This is due to
the popularity of household names among retail investors
-
the mainstay of the Eurobond investor base, and the
high coupons which Australian dollars carry relative to
the other currency sector in the Eurobond market.
Investors are drawn lrom Germany, Switzerland and
the Benelux countries, according to Orion, with interest
also emanating from
Japan.
Because investor appetite plays such an important
role in the success of a Euro-Austraiian dollar issue,
swap windows only open intermittently. Investor
demand can fluctuate according to anticipation of future
currency and interest rate moves in Australia, as well as
yield differentials at the time of issue between US and
Australian dollar bonds. Although Australian
government bonds offer higher yields, investors are
deterred because they are registered and subject to
witholding tax.
Australian dollar swap rates, which are priced off
Australian Commonwealth bonds, fluctuate wildly,
depending on counterparty availability and investor
demand, along with the quality of the issuers. "The
market swings enormously," said Kerr. "Rates have
gone from 40 basis points over Commonwealths to 25
below in six months."
Orion intermediate only rarely swaps, but more
commonly acts as an arranger, making the timing of a
deal critical. "We've
had a situation where an issue is
arranged at twelve o'clock, the swap offer confirmed to
one, then the issue launched at two," he
joked.
When the conditions are right for an issue, a lot of
pent-up borrowing with attached swaps emerges,
running the risk of swamping the market. Because of this
situation, the market can deteriorate rapidly once
investor demand is saturated. Some lead managers solve
this problem by warehousing paper from a new issue
after the swap, then feeding it out to investors as either
the currency or rates improve.
The Australian dollar market is an arbitrage market,
like any swap currencv sector, but the differentials
between Euro and domestic rates is particularly wide.
"Like
all arbitrages, it will diminish the more it is
exploited and with the maturity of the market," said
Jordan.
"Only when the Australian capital markets
become fully international will raies move closer
together."
Eurosterling swap activity has exploded in 1986,
with as much business in the first three months as in the
whole of 1985. The momentum may slacken, but the
rush of Eurosterling interest rate swaps this year has
established the market sufficiently for it to continue
expanding. Increased trading in sterling instruments
after the Big Bang in October will add a further boost.
Almost half the 33 Eurosterling bond issues this year
involved interest rate swaps and some may also have
involved currency swaps. Michael Baring, a director of
Baring Brothers, says there have been a lot of secondary
market swaps of sterling into dollar funds. Some bankers
see swaps as the driving force in the Eurosterling market
so far this year.
Swap opportunities appeared in February with a
revival of demand for Eurosterling bonds from
Special sponsored supplement 35
SWAPS
continental retail investors. They reckoned that sterling
had stabilized after the oil price plunge and were
attracted by UK interest rates, which were relatively
high bv world standards. So keen were they to buy
sterling paper that some Eurobond issues by top US
corporate names were trading well below gilts in the
secondary market. Gilts are less appealing to investors
because they are registered rather than bearer securities
and carry interest net of tax.
At the same time, UK corporate treasurers felt that it
was worth borrowing fixed-rate funds again, now that
interest rates had fallen
-to
around 107o. Companies
which were either too r*uil to tap the Eurobond market
-
themselves, or which wanted to borrow in tranches to
guard against missing the bottom in interest rates, were
happy to swap their floating rate bank loans for
fixed-rate money.
This paved the way for building societies and foreign
banks, which had a natural need for foating rate funds
to match their assets, to issue relatively cheap Gxed-rate
paper in the Eurosterling market. They then swapped
the proceeds to achieve sub-Libor funds. Three bani<.
swaps arranged by Samuel Montagu achieved rates
"better than I 5 basis points below Libor", said director
Bernard
Jolles.
Building societies are delighted to raise
money at these rates, but the difficulty of finding
counterparties obliges them to issue the bulk of their
Eurosterling debt at floating rates. Cary Lefevre,
assistant general manager of Nationwide Building
Society, says his society raised as much as it thought it
could swap and saved from
t/a?o
to
t/cVo
by doing so.
At least some of the foreign borrowers, such as the
Industrial Bank of
Japan
and Philips Finance, wanted
sterling funds to expand or refinance their UK
operations.
Building societies entered the Eurosterling market in
1985 after the Finance Act allowed them to pay interest
gross, like other Eurobond issuers. Facing 6erce
competition for deposits from banks, they responded by
issuing more than a third of the total Eurosterling bond
issues last year. The building societies' regulatory body
ruled in favour of interest rate swaps in March 1986
and, within days, four of them took advantageof this to
issue fixed-rate debt and swap it for floating. Building
societies face peak mortgage demand in the spring. A
bill expected to become law in
January
l9B7 will permit
them to make currency swaps as well. Nationwide's
Lefevre says he looks forward to issuing Eurodollar
bonds, to be swapped to sterling. He will also consider
other currencies.
The lead managers of the bond issues either 6nd the
counterparties themselves, take the swap onto their own
books, or arrange a swap with another bank, perhaps a
co-lead. The largest deal, a seven-year issue for t75
million by the Nationwide Building Society, was lead
managed and swapped by Credit Suisse First Boston
with a single counterparty, County Bank, but that is
now rare.
Originally, all swaps were matched exactly, but from
I 982 onwards banks have been prepared to match only
part ofa deal. They then hedge the rest to guard against
interest rate changes and warehouse it and hope to
parcel it out among a number of clients. The main
counterparties, receiving the fixed-rate funds, include
38 Special sponsored supplement
companies wanting to fix a specific debt or borrow in
stages, clearing and merchant banks trading swaps,
leasing companies hedging their portfolios, finance
companies and local authorities.
Nearly all the deals swapped this year were for sums
of f,50 million to t75 million and for maturities of five to
seven years
-
very much shorter and sma.ller end of the
Eurosterling market, which has
just
seen fixed-rate
issues for as much as f,l 50 million, floating rate for 1250
million and maturities stretching out to 2l years. The
lower maturity limit is set by Bank of England
regulations which do not permit Eurosterling deals for
less than five years.
Morgan Grenfeli is one of a handful of banks which
run a full-blown unmatched swap book in sterling. This
means it is prepared to make a market in swaps every
day and either way. Noting that the sterling swap
market had stayed still or even contracted while the
dollar swap market had expanded, lvlorgan Grer
spotted a niche. It decided early this year that it coutd
make a reasonable return if it expanded the scope of its
business in this way, taking odd dates and odd amounts.
In the
-
event the step to running an unmatched book
came
just
in time for the bank to beneht from the boom in
Eurosterling issues that began in February. But there
was so much swap trading that "it would have been
worthwhile even if we had not swapped a single new
issue", said Thomas, although it
"unquestionably
strengthened our hand" in winning issue mandates.
Sterling interest rate swaps are not new. UK locaj
authorities set in motion a thriving swap market in 1982
and 1983 by borrowing 6xed rate funds and swapping
them with banks into foating rate funds. This suited the
authorities because they were entitled to borrow
comparitively cheap fixed rate money from the official
Public Works Loan Board and 6xed rate funds were
more expensive than floating in the market at the time.
This arbitrage left them with sub-market floating rate
funds, which they could either use for their ow.
requirements or make a profit on, while the bar
achieved cheaper 6xed rate funds to match part of ther
loan portfolio. But the party ended in early l9B4
because the government saw this as an abuse of
privilege. As a result the swap market is thought to have
shrunk to 12 billion in i984 from f3 billion in 1983.
After this surprising beginning, tle market was
developed by banks who saw it as a means of getting
interest rate exposure, for example borrowing fixed on
tlie expectation of making a turn on rising interest rates.
Thomas of Morgan Grenfell thinks that, although the
market in short-dated Eurosterling bonds is notoriously
sporadic because it depends so much on currency
considerations, an active market in sterling swaps will
continue for three reasons. After the spurt of swaps this
year UK companies have conquered their shyness of the
idea and like the fexibility of swaps. The swap market
has acquired greater depth and solidity because a
number of banks, which were previously prepared to
operate only on a matched basis, now warehouse swaps.
The Big Bang will bring more players into the gilts
market and promote greater trading of all instruments
involving medium term sterling interest rates. This will
spill over into associated markets like glt futures and
options and also swaps, he says.
SWAPS
DEALINGWITHTHE
LATEST TECHNIQUES
The swap has developed a Iot since it emerged. Now when banks and
houses are setting up deals, increasing versatility and virtuosity are
being displayed
When SEK targeted an all-in dollar cost below a
conventional swapped Euro-yen issue, Nikko Securities
and.Coldman Sads krew they would have to come up
with a special skucture. The result was a two-pronged deal
involving, on one hand, a sraight Yl0. 14 billion issue
swapped into dollars and, on the other, a heaver and hell
FRN issue arranged by NiL*o for Flrst Interstate.
Together, the two legs provided SEK with floating dollars
at a cost said to be
just
Ubor minus 60.
In the 6rst stage of the deal, SEK raised Y I 0. I 4 billion
with a straight l0-year Euro-yen issue over l0 years
carrying a 65/aVo coupon. Niklo then covered the coupons
in the forward foreign exchange market and executed a par
forward with SEK on the principal to complete the swap
into dollars. SEK was left with a purely dollar liability.
The tick lay in Nikko not e:<ecuting forward cover for
the 6nal redernption amount
-
only the initial principal and
coupon payments. If the yen strengthaned before
redcnption date, SEK would only deliver $50 million (the
same exchange rate 6xed at the initial elclange of
principal), leaving Nil*o with a shortfall in the forex
market. Nikko then had to devise another scheme to cover
Nihho's Hiro Suzuhi: "The deal utas basically
irutester dioen"
8 Special sponsored supplement
its foreign exchange exposure at the issue's maturity.
It achieved this by launching simultaneously with the first
issue a $60 million FRN for Fust Interstate with a coupon
of Libor plus 25. The higher than normal yield on the bond
compensated the investor for writing an option on the
redernption amount in y*, calculated at the time of
redernption. The investor could both gain and lose on the
exchange rate, giving rise to the name heaven and hell
bond.
In this case, the strike price was set at Y 169/$. If, over
the lifetime of the FRN, the yen srengthened above the
sbike price, the investors would receive a redernption
amount of less than par. If, conversely, the yen weakened,
they would receive an e.xta dollar amount from Frst
Interstate, calculated on the basis of the bond formula $60
million X I * spot
-
169/spot. Nil,ko agreed ro make
good the final amount for First Interstate if positive, and
receive the balance if negative, thus hedsing its shortfall in
the forex market on the first part of the deal. NiL*o also
agreed to pay Fint Interstate erha dollar interest during
the bond's life to cover the higher coupon payments to the
investor.
'The
option elernent in the heaven and hell bond was the
pivot of the whole deal," argued Hiro Suzuki of Nikko's
new products swaps team. "lt meant we hedged the final
principal amount in yen at a better rate than in the forward
foreign exchange market." That, in turn, allowed Nikko to
offer better swap rates to SEK and Frst Interstate.
Moreover, the extra dollar interest paid to Frst Interstate
created an additional dollar liability to match Niklo's
receipts from the interest rate swap.
Suzuki said that the foreign exchange transactions,
hedging the initial principal and coupon flows, took place
mainly in Tokyo, the only place able to achieve the
necessary size and maturity for the deal. "Only
Japanese
Sanls would be able to offer the underlying forex in that size
in yen," he maintained, adding that the timing of the foreign
e{clange operation, as in all currency swaps, was critical.
In the final part of the deal, an interest rate swap with a
US insurance company was arranged, usrnd a
sophisticated discount skucture, swapping SEK's fixed-
rate dollar obfuation into floating rate dollan at a very
competitive rate.
SEK ageed that the heaven and hell FRN issue was
the key factor in achieving their substantially below Ubor
-
cost of firnds. The advantage gained by ihe
-6nal
redernption forward rate was used to hedge the principal
amount due on its initial yen issue: the option provided the
arbitrage to generate cost savings, they say.
According to Suzuki, the deal was one of the most
complicated that Nikl<o has ever accomplished. As
SWAPS
borrowers demand ever tighter terms, banks try to develop
more and more complicatd technical structures to provide
the necessary cost of firn&. For this reason, Suzuki
maintained, swap structures like this are likely to be
repeated.
A triple A rated borro*er like SEK would not have
been able to achieve comparable borrowing costs either
t}"o"eh a straight Euro-yen swapped into floating doliars
according to Suzuki, although he declined to be specific
about exact rates. Only by usrng two issues simultaneously
was it able to drive the costs low enough.
'The deal *ut [asically investor &iven," he summed
up. "As long as we can get hold of investors *ho will be
happy with these bonds, we can continue to produce
struchres which rely on them."
When the Mortgage Bank of Denmark wanted to
borrow Dutch guilders and Swiss francs at a competitive
rate, Citicorp Inveshnent Bank came up with a
multiJegged swap providing an all-in cost of funds at
nearly 50 basis points under market rates for a straight
guilder and Swiss bond issue. The secret lay in a series
of swaps drawing both on Citicorp's capacity to positio-
swaps as well as its network of counterpartie
_
facilitating the five-legged structure.
"Approaching the Euromarket directly for Swiss
francs and guilders would have been too expensive at the
time, but we were tempted by the rates we could obtain
through the swap," said Marian Ziirsen, head of the
banking office at Mortgage Bank of Denmark. She
estimated straight issues would have cost about 5.907o
a;r.d 7.557o respectively, while the swap costs were
5.45?o andT .121o-asaving of 45 and 43 basis poins.
With a favourable spread locked in, the funds were
destined to be on-lent to Mortgage Bank's customers,
consisting mainly of Danish municipal and stdte-run
entities,
I iLe other government agencies, the bank has
an ongoing need for cheap funds to add to its borrowing
portfolio and then lend to domestic bodies, and is
increasingly turning to the swap market to provide
competitive costs of funds. "The swap market has, in
many cases, enabled us to get better rates over the last
year than by going into the Euro or FRN market
ourselves," explained Ziirsen.
The key component of the deal from Citicorp's poi,
of view was lining up a bank counterparty wanting to
pay sterling and receive Dutch guilders
-
an unusual
combination of currencies. Citi was able to dovetail with
Mortgage Bank's guilder needs, therefore forming the
pivot of the exercise. Only when the sterling/guilder
swap was aligned.was the rest of the deal able to proceed
and a $85 million five-year Eurodollar issue for the
Mortgage Bank launched.
What made the initial swap more complar was the
fact that the Mortgage Bank wanted to swap $50
mil[on of its initial $85 million into Swiss francs and $35
million into guilders leaving Citi with a two currency
coupon flow. The Swiss franc stream was positioned in
Citi's warehouse and swapped into floating dollars,
while the guilder flow
-
a more difficult cashflow to deal
with
-
was swapped for floating sterling. The
sterling/dollar currency mismatch was then hedged in the
forward foreign exchange market, then the . dollar
fixed./floating mismatch solved with a straightforward
interest rate swap with the Citi dollar warehouse.
The guilder/sterling swap was the "stick that stirred
the pot", said Mark Blundell, head of swaps at
Citicorp. Without that tailor-made leg
-
done at a
favourable rate
-
the deal would not have worked. But
10 Special sponsored supplement
SWAPS
the structure also relied on Citi's ability to position swaps
on a number of books simultaneously. "'We were able to
position the Swiss franc/dollar and dollar interest rare
swap in our warehouse easily at the same time. Both
capabilities were needed."
Blundell explained that the seven currency swap
books Citicorp maintains are run on a blended basis,
marked to market every evening and valued at the net
present value of the swaps it is carrying. Swaps of the
kind used in the Mortgage Bank deal can therefore be
offset at the current market level'just like that".
"The timing was absolutely critical," added
Frederick Leeuws of Citicorp, who was responsible for
tracing the guilder/sterling
counterparty. "lt was rather
like a
juggler
throwing up balls and catching them all at
the same time." The tlree currency swaps formed a
triangular structure, added Andre Shortell, who
handled the dollar issue, providing a practical solution to
ihe Mortgage Bank's needs.
"We were very impressed by Citicorp's ability to
carry out the swaps," commented Ziirsen. "l've seen
swaps with three or four parties before, but never five.
I'm amazed it can be done." The bank also appointed
Privat Bank as financial adviser on the deal.
The Mortgage Banh has repeated the same structure
to raise cheap Swiss francs and guilders, and also
variations on dollar swaps to obtain other European
currencies at better rates than a direct Euromarket
offering. It will continue to exploit possibilities to swap
what Ziirsen describes as a "significant proportion" of
its primary market borrowing.
"lt's
a fantastic new environment. We've
just
discovered something of great value." These are the
glowing terms used by Bernt Ljunggren in describing the
technique of applying forward swaps to outstanding,
callable debt. Swedish Export Credit Corporation
(SEC), one of the most sophisticated borrowers in the
Euromarket, showed off its discovery when it teamed a
forward swap with an existing swapped
$ I l2 million
143/+7o issue due I 990 and callable in I 988. It was then
able to launch a new frve-year
$200 million 83AVo issue
swapped into an astonishing Libor minus 200 plus.
"lt was a way of cashing in the value of the future call
in today's low interest rate environment," explained Ben
'Weston,
capital markets specialist at Bankers Trust.
Together with colleagues Tim Lindberg and
John
'Watson,
the Bankers' team devised a scheme to
capitalize on current lower inierest rates to effectively
lock in the value of a call on high-coupon debt.
The value of a future call option on a high-coupon,
fixed-rate bond issue is uncertain, Weston argues. If
SEK waits until l9BB to call the issue, inrerest rates may
have risen to erode
-
or even eliminate
-
the value of the
option compared with today's favourable rates.
SEK and Bankers Trust entered into a forward swap
agreement starting on the call date in 1988 and running
to maturity on the outstanding high coupon bond in
1990. Under the agreement, SEK would pay Bankers
an amount equal to the annual coupon payments on the
outstanding issue in return for Libor. Assuming SEK
calls the issue and refinances at Libor fat (a conservative
estimate for SEK), the cashflows remain unchanged.
The forward swap would simply have reversed the swap
on the original issue from years two to four.
Since the payments from SEK were at a much higher
rate than current swap market rates, Bankers Trust was
prepared to compensate SEK with an up-front payment
for receiving l4Vo aganst Ubor. The sum was close to
eight figures
-
the amount Bankers calculated to be the
net present value of the forward swap. The amount
could be calculated precisely with references to readily
available swap market rates, whereas if SEKhad opted
for a debt warrant issue
-
which would have achieved
the same objective of crystallizing the value of the call
feature
-
the pricing would have depended on investor
demand for a low geared instrument (namely,
a warrant
into a high-coupon bond).
Bernt Ljunggren of Sutedbh Export Credit:
happy in"a fantastic neut enoirorunenttt
The reason the swap written by SEK was so valuable
to Bankers was twofold. Firstly, interest rates had
declined considerably since SEK wrote its original
swap, leaving it with an above market income stream it
Special sponsored supplement 11
SWAPS
agreed to pass on to Bankers. Secondly, the yield curve
had flattened, reducing the cost of forward swaps,
making the SEK agreement all the more attractive.
So far, the cashflow picture was the same as that
created by issuing debt warrants, where the borrower
receives a premium in return for offering investors the
right to exercise into debt at a later date. If SEK had
chosen the warrant route, and interest rates fell, the
investors would exercise the warrants and SEK would
call its l+/c%o issue, maintaining the same stream of
payments. Using the warant structure, SEK would
then have invested the proceeds until needed to finance
the call of its original bond. Instead, the up-front savings
created tlrough the forward swap were spread over the
lifetime of the new bond issue which was then swapped
into deep sub-Libor funds. "We ended up with a
sum-certain lump of value which we distributed over the
new issue," said Weston.
SEK had ensured that the funding for the call was
adequately provided for at today's rates. In this
pre-refinancing, as Bankers calls it, SEK had double
financing for the 6rst two years, which at the time suited
its borrowing requirements. With a continuous demand
for funds from its own borrowers, it could easily
incorporate short term (two year) funds into its debt
portfolio.
"The great thing about the asset structure of SEK is
that we can change our balance sheet when we want,"
said Ljunggren. "One of the negative aspects about
options is that they can put pressure on the balance sheet
at the wrong time. But, in our case, the double financing
suited our needs."
The structure had involved three main components
-
a forward swap, a new issue and a second interest rate
swap of the 85/a7o issue, all against the backdrop of
existing debt at higher levels with a call feature.
Following on from two naked debt warrant issues for
DSM and Casunie, which also capitalized on today's
lower rates to reduce interest costs, the SEK Bankers
deal added the extra layer of a five-year
"front" bond to
pre-refinance the call.
"We built on to the existing technology of the
market," noted Lindberg. "lt was the natural follow-on
from debt warrants." W'eston echoes the sentiment.
"When we saw the naked debt warrant structure, we
asked ourselves 'is there another way to skin this cat?' It
was a purely mathematical decision which of the two
-
debt warrants or a forward swap
-
was the most
efficient."
Bankers argues that the forward swap structure and
particularly, the specific structure executed with SEK,
has advantages of flexibility over debt warrants,
enabling the borrower to benefit from a further
mirviment in interest rates. First, if rates continue to fall,
SEK's net new funding is floating-rate, allowing a
further reduction in interest costs over the life of the
structure. They also calculate that when the call is due, if
rates are higher than 14.47o, it would be cheaper for
SEK to leave the high-coupon issue in place and reverse
the forward swap. "'Warrant deals take a view of rates,"
Weston continued. "They suit borrowers who believe
rates have both bottomed out and will not rise to their
previous levels. Forward swaps with swapped pre-
refinancing give the borrower upside potential
14 Special sponsored supplement
whichever direction interest rates move."
Ljunggren's opinion is that the structure shows up the
value of a'call feature on a bond issue, and may
encourage SEK to build in calls into future Euromarket
offerings.
"l think, on the whole, calls tend to be
undervalued by the market. We will be looking at this
type of structure more and more. With the current
volatility of interest rates, options are coming into their
own."
When faced with three separate swap counterparties,
two would-be 6xed dollar payers and one 6xed Swiss.
'
takes quite a balancing act to coordinate all three ir.-
one mega-deal to satisfu everyone. This was the task
facing Nomura International in late March. In a
structure spanning both the London, New York and
Tokyo offrces, Nomura came up with a complex,
multi-party deal involving a labyrinthine stream of
principal and coupon flows, resulting in a better cost of
funds for the three enitities
-
Coca-Cola FHLB
(Federal Home Loans Bank) and NTN (Toy"
Bearing Company)
-
than each could have obtained by
going directly into the market.
Blaine Tomlhson of Nomura: "We stripped the
cashflo@s to get the exposure ute needed. . . "
"Our approach was to see the whole structure as a
series of cashflows rather than separate swapped bond
isspes," said Blaine Tomlinson, Noniura's head of
swaps in London.
"ln addition to the natural geographic
arbitrages between borrowers and investors taking each
borrower to the most receptive investor base there was
the currency option built into the heaven and hell issue,
which had substantial economic value to both issuers."
"We carry a list of borrowers with certain targets in
mind," added Antony Yates of Nomura.
"Coke
and
FHLB wanted fixed dollars, while NTN wanted 6xed
Swiss francs, and it happened they all wanted l0-year
money. It was a matter of matching them all to the best
advantage."
The total transaction size of the structure was
$1.6
billion in notional principal, added Tomlinson, an
indication of the magnitude of the operation. Moreover,
all the market saw was a straight Y30 billion Euro issue
for Coca-Cola, swapped into fixed dollars at an all-in
cost of frve beiow teasuries. The rest o[ the deal, and Tomlinson.
"lt
worked out marginally more economical
the story behind the surprisingly competitive rates than issuing an ordinary Euro-yen issue. The important
achieved for Coca-Cola, were hidden. thing at the time was to get rid of the option."
The pivot of the construction was a Y25 billion Another link was a collar agreement taken out by
l0-year heaven and hell bond issue for the Federal Nomura to cover the eventuality that the yen
Home Loan Bank (FHLB).
The bonds, also known as strengthened to below Y54, at which point the heaven
index currency option notes
(lCONs)
redeem in the yen and hell investor would receive zero. However, Nomura
according to the formula would still be liable to repay the full yen amount to
Coca-Co[a that it would not be able to obtain by
x
:
s672 e08 x . +r i.+3r78 x F- 5-'e8i)x ..
##ffi ::iyil:,::;j,K;,li:" i:.*" ::.d;,H.T, ,*;
Where F = spot maru.tv rare.
shortfall.
P:oceeds from the issue were then swapped for
fixed-rate dollars. The heaven and hell bond structure
offers investors a currency play on the yen/dollar
exchange rate at redemption. The investors, by
accepting a currency risk in return for an average coupon
cn their floater (71/z7o payable in yen) were effectively
rvriting an option for the borrower on the yen/dollar
exchange rate at redemption.
Simultaneous with the heaven and hell issue, Nomura
Iaunched a l0-year Y30 billion issue, which was partly
for Coca-Cola, swapped into dollars.
"At
the time, the
best way to raise dollars was through a yen issue, then
swap," explained Yates. Nomura then exchanged the
swapped portion of the initial principal spot for dollars
as normal in a conventional currency swap, and hedged
forward in the foreign exchange market the ongoing
coupon repayments from yen into dollars.
The real savings were made through the next stage.
Nomura did not cover itself on the forex market on the
final redemption amount, since it had effectively
pre-hedged the Y30 billion it would owe to Coca-Cola
on maturity of the bond through the FHLB. If the yen
strengthened over the lifetime of the bond, the yen
amount it would owe to FHLB (and which FHLB
would owe to the investors) would decrease in such a
way as to offset the foreign exchange loss it would suffer
on receipt of the $ I 00 million from Coca-Cola when the
swap is unwound.
. Given the strength of the forward yen, with interest
rate differentials working in favour of the yen against the
dollar, hedging the flnal redemption amount would have
been expensive. The savings created by omitting this
step
-
using the currency option rather than the forex
market
-
meant Nomura could offer a better swap rate
to Coca-Cola.
What complicated the deal was the principal sums
involved. Coca-Cola only wanted a portion of its issue
swapped into dollars, retaining the balance in yen while
the FHLB heaven and hell issue was for Y25 biltion.
That left a portion of the yen/dollar option left over,
which had to be matched with an equivalent liability on
the other side.
To create the necessary yen/dol[ar exposure,
Nomura created a synthetic Euro-yen issue swapped
into dollars. The structure involved no primary market
issue, but was simply an agreement with a
Japanese
bank to pay yen/receive dollars for both principal and
coupon payments over I 0 years for an amount equal to
the balance of the option left over from the FHLB issue.
"We stripped the cashflows to create the exposure we
needed to match the heaven and hell option," said
SWAPS
Nomura was then left with a residual dollar
fixed/floating mismatch of around $l l0 million, since
both counterparties in the first leg of the deal ,were 6xed
payers. The last layer of the operation brought in
NTN, a
Japanese
corporate,
,which.was
seeking to pay
frxed Swiss. NTN issued a $ll0 million, lO-year
straight issue, which was swapped into fixed Swiss
making use of an agressive Swiss franc dollar swap
Nomura arranged with a bank on the other side. The
company's frxed dollar liability balanced Nomura's
fixed-dollar income and Nbmura found, instead, it had
a Swiss franc dollar mismatch "which was cheaper to do
in the market," said Nick Burge.
"lf we had gone direct to the market for an interest
rate swap we would have had to pay Treasuries plus 85
and received Libor. NTN, when converting its dollar
debt into Swiss francs would have entered into an
interest rate swap, first receiving Treasuries plus 75 and
paying Libor
-
the other side of the quote in the market.
Instead, Nomura paid NTN B0 points, saving the
company three basis points, and itself frve. By avoiding
Special sponsored supplement 15
rix $ I Tr,, ,'n io sI I t', t*
s
Froat$l
Inxswtr
nx$l
lrixven
Fk$l
Iro.*
q
=lrrr-
r
-
Certain swaps relating
to the option and use of the
option have been omitled
sWAPS
going through the bid/offer spread, both sides benefited.
The timing of such a deal is obviously fragile. The
complexity of the operation was compounded by the fact
that payment date for the swaps was originally arranged
for April 2l . When NTN decided it could only make
the payments deadline on April 24, Nomura had to
arrange for an intermediatary bank to assume the
cashfows for the three days. Throughout the operation,
Nomura acted as aranger rather than intermediator;
so, it was not in a position to act as principal for steps not
done back to back. The swaps were closed out over a
period of two and a half weeks, with each swap closed
and heded at the best possible time.
Borrowers with outstanding swapped debt 6nd they
have a swap well above current market levels when
interest rates fall. If the outstanding debt has a call
feature, this can open a window for the borrowers to
cash in the value of the call and lock in today's lower
rates either through a forward swap, from the date of
call through to final redemption, or by issuing debt
warrants now, which refinance the cal[ed portion of debt
at lower levels and give them an upfront premium in
addition thereby reducing the cost of their existing
liability.
dovetailed with the original debt issues in such a way
that they were exercizeable from I 9BB
-
the call date on
the underlying bond issues
-
and exercised into notes
with the same maturity, 199 I
,
as the original bonds.
The Casunie warrants may be exercised from 1988
into $75 million I l7o notes due 199 I , with payment in
cash and a $2.5
per warrant coupon, while the DSM
warrants exercise into $ I 50 million I 03/+Vo notes due
l99l and bear $3.25
per warrant interest for the first
two years.
"The
call element on the underlying bond issues was
the key factor in the structure," says Deirdre Duffu,
swap specialist at Morgan Stanley. "lt
enabled the
borrowers to capitalize on today's lower rates. The
naked warrants structure allowed the borrowers to
realize the value of their option."
If rates continue to fall, investors are more likely to
exercise their warrants into the relatively high yield;-
securities
-
I 17o for Gasunie and 103/c7o for DSM.
-.-
both cases if the warrants are exercised the companies
can calI their original issues and assume the lower coupon
repayments on the warranted issues. The fixed rate
payments received by the borrower on the swap
arranged for the original issue will be at a premium to the
new coupon levels.
Both borrowers pay a call premium for early
redemption of the issues of around I Vo as w ell as interest
to the 6rst exercise date on the issues. In the case of
Casunie the interest is $2.5
per warrant for the first two
years, and the cash proceeds of the warrant issue
warrants Changing debt profile with
Prc-warnnt issue
/ taking into account:
|
-paVlY.call
premium
I two years hence
I
-
pav
$2.5 oer mrant
_
1oo1
interBst on pmceeds
I
tor two yea6
|
-
raceive 75,000 X
|
$zz.azs wamnt
I
pmasds
\
-
reinvest at?
net=Libor-50
not
=
Libor
Otd Mp
f1!.Y.o
?l
net
=
Libor
-
ilTorlglnallssue
proceeds
proceeds
f
taking into account:
|
-
pay
$z.s
per warrant
I interest on procmds
, )
for two y6arc
I
-
receivo 75,000 x
|
$27.875 warrsnt
I
proceeds
(
-
roinvast 8t ?
Old sap
n'!'f
?l
il
origrnal:$re
ll wamnE excrcised
Old sap
ll wa t n nts. u nexarcised
Two Dutch companies
-
Nederlandse Casunie and
DSM
-
found themselves in
just
such a position last
January.
Both had outstanding bond issues dating from
l9B3 and 1984 respectively: Gasunie a $75 million
issue with an I I
t/c%o
coupon and DSM a $ I 50 million
with an llr/a%a coupon. Both issues are due in 199 I
with a call option from l9BB and have been swapped
into a combination of dollar Libor and Dutch guilders.
Morgan Stanley designed a new issue structure to
capitalize on the value of the call option with the first
interest-bearing naked warrants
-
so they are not
attached to any host bond. The warrant issues
20 Special sponsored supplement
(75,000 at a price of $27.875 each) from which willbe
invested a rate probably rather less than the interest
costs for the first two years, creating a negative cost of
carry, although this only has a slight impact on the
economics.
If interest rates rise between now and 1988, on the
other hand, investors will be unlikely to exercise-the
warrants, but Gasunie will have the benefit of the
up-front payment for the warrants minus negative carry
for the first two years. In return for being in a position to
offer warrants on higher coupon debt, Gasunie has
received a cash sum at today's favourable rates.
SWAPS
Peter Hezemans, frnance director at DSM, said:
"'We were very pleased to do the debt warrant issue,
although we won't know until l9B8 whether or not it
would have been better to have waited and recalled our
old debt issue, then reGnanced at present market levels.
If interest rates have fallen in the interim, *e could have
locked in even better rates." Hezemans estimated the
breakeven level for interest rates in I 988 is 9Vo below
which it rvould have been preferable to have simply
recalled the I l)/eVo issue and taken on fresh debt. If
rates are above that, the warrant option will have made
greater savings.
Gasunie linancial officer, Endre Egressy, does not
expect the warrants to be exercised before the I 988
deadline, but explained the initial payment for the
warrants has significantly reduced the cost of servicing
the old debt. The choice, he argued, was really between
betting that rates rvould fall, then recalling and
re-issuing, or issuing debt warrants now to lock in a rate
and receiving a premium.
"The deal was a trade-o[f between the possibility that
doilar rates would go lower and the opportunity to
exploit opportunities in the market," he said.
"lf
dollar
rates go lower, we could say with hindsight it would have
been better to have recalled the old debt, but that's a risk
we were prepa,red to take."
Debt warrant issues should appeal to issuers with
existing callable fixed-rate debt at higher levels who
expect interest rates to start rising, he added.
"We had a
choice between doing nothing and backing our view of
rates
-
we chose the latter."
Both companies have benefited from the flexibility
added to the structure o[ their debt by a call element,
although Hezemans said he would not necessarily be
tempted to issue another callable bond issue
just
to have
the same opportunity again.
"Once
you have issued the
warrants you are not free," he pointed out. "You depend
on the investors either to exercise or not, as they want to
_.
change your debt profile."
Morgan Stanley's Duffy explained that an alternative
strategy for both borrowers to a debt warrant issue
would have been a for*ard swap which would also lock
in lower rates and reduce costs. "lt was an alternative to
achieve the same ends, but we calculated it would have
been less cost effective," she said.
Morgan Stanley estimates the total cost of the
exercise to Gasunie, if the warrants are exercised at the
6rst possible opportunity, is marginally higher than if
they are not, slightly skewing the cost advantage
towards the latter eventuality. Either way, the warrants
work out cheaper than remaining with the status quo
should rates remain constant or rise between now and
I 988.
Japanese
companies have a pre-disposition towards
equity warrants. Nearly all the Eurodollar issues with
attached equity warrants for
Japanese
borrowers last
March were swap driven, resulting either in low-cost
floating dollars or fixed yen. In addition, the warrants
provided for a contingent release of equity at a
favourable level.
"The warrants added value to the bond and acted as
a sweetener," said Hiro Suzuki of Nikko Securities.
That drove the cost of funds lorver and meant the
borrowers could achieve more favourable srvap rates.
Most issues were swapped into floating dollars and then
into fixed non-US currencies; a number were then
swapped into fixed yen. "There's very little market in
fixed dollar/fixed yen swaps, because of the danger to
Japanese
banks of locking into fixed debt in a different
currency."
By swapping with a borrower anxious to achieve
low-cost fixed-rate dolIars, the
Japanese
borrowers
were able to obtain a final cost offunds aslotu as27/a7o.
Nippon Oil, for example, launched a $100 million
deal through Nomura International with a 47o coupon
-
at the time, a record low for a dollar equity warrant
issue. A comparable Euro-yen issue would have cost
Nippon around 67o, while a dollar straight rvould have
cost nearer 874.
The only'awk*ardness' involved in the deals was the
swap pricing, according to Suzuki. The coupon on
equity warrant and convertible issues is set up to I 0 days
after the launch, making it impossible to price a swap
accurately until the final price fixing. The borrower is
left with an uncertain cashflow in the interim, ruling out
the swap. If, between launch and final pricing, the share
price of the company becomes volatile, the coupon must
be adjusted upwards. After the final price is fixed,
however, the swap can be constructed normally.
Investor demand played an important part in the
success of the deals. Mitsubishi's $400 million,
eight-year issue with a3t/z7o coupon traded up as high
as I 07
-
a typical price increase. SinceJanuary I I 986,
naked warrants, together with warrants detached from
the host bond, have been allowed to be sold into
Japan,
where there was reportedly huge demand for the paper.
Other end-takers were found in Switzerland and
Germany.
The recent strength of the Tokyo stock market, along
with yen steadiness, contributed to investor appetite.
Moreover, the warrants allowed dollar-based investors
to buy into the
Japanese
stock market on a hedged basis,
since the doilar/yen exchange rate of the share strike
price was built into the initial terms of the dea[. Buying
Japanese
shares directly from a dollar base would
normally involve forex exposure.
Equity warrant
swaps
Forex market
lntersst rate swap
Y3lleYo $s7
Japaneso
I-l
lmlm{rtty
.6mmnv l-J . benk
s4vo Y5,/e%o $uboa
Equity warrant invostoB
Y51leY"
Euroyen investoE
Special sponsored supplement 21
sWAPS
The spate of issues was launched against the
backdrop of a free a"uil"bility of rwap counterparties,
another critical factor, according to Antony Yates, a
swaps specialist with Nomura International. Given the
recent strength of the Euro-yen market, a ready supply
of Euro-yen issuers surfaced with no natural need for
fixed-rate yen debt but seeking fixed-dollar funding.
Such borrowers formed the logical counterparties for the
yen payers/dollar receivers created through the
Eurodollar issues with equity warrants for
Japanese
issuers.
"Equity warrants compensate the investor for a lower
return on the host bond issue with an equity play," said
Yates.
"Compared with European or US companies,
which demand a 40Vo-50Vo premium on the conversion
price,
Japanese
equity warrants offer a less risky
investment."
The bond with eguity warrants offers relatively less
coupon on the debt, but an equity option nearer the
money, he continued.
"lssues
exercising into European
or US shares are deeper out of the money, but the
investor receives a higher coupon."
Equity warrants are a way of obtaining cheap debt
by taking on the risk of equity conversion at a later date.
But,
Japanese
companies are less deterred than US or
European counterparts by the dangers of equity dilution
and unwanted acquisition bids from unknown
shareholders attendant on warrants, argued Suzuki.
"Japanese companies are like families," he said.
"Merger and acquisition activity tends not to encroach
on that structure. It's a cultural difference spanning
thousands of years."
The net asset ratio of
Japanese
companies is lower
than US or European eguivalents. Equity warrants can
be seen as a way of improving a company's financial
structure, as well as achieving lower cost funding.
"Companies dependent on bank borrowing for a number
of years are now looking to reduce the cost of their debt
and increase capital," Suzuki said.
For
Japanese
companies, there are other advantages
as weil. The amount of money netted via equity
warrants and convertibles is greater than a conventional
share offering or rights issue. Ministry of Finance
guidelines prescribe a straight equity issue should be at a
discount to the current market price, while in the warrant
and convertible market, shares must be released at a
premium to current market levels
-
2l/z%o for warrants
and. 5Vo for convertibles.
"Lots of shares are released at the same time usin
conventional equity offering," added Suzuki, "which-
might have a depressing effect on the share's price. If the
warrants or convertibles are exercised, equity is released
gradually, avoiding the glut."
'Whereas
a European or US company might view the
issue of equity warrants as fundamentally debt with an
added equity play, a
Japanese
company looks upon the
same structure as issuing equity at an attractive price,
while simultaneously reducing the cost of its debt by
means of a lucrative swap. "lt's a way of using your
capital base to get cheap debt," said Yates.
22 Special sponsored supplement