Investment Banking

Chapter 4: Debt Offerings

Thach H. Pham1

February 20, 2024

1
thach.ph@ou.edu.vn
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Outline

1 Bond Offerings

2 Credit Ratings

3 Securitization

4 Hybrids

5 Syndicated Loans

6 Syndication Strategies
Key Concepts & Skills

Bond offering
Creadit ratings
Securitization process
Hybrid instruments
Loan syndication

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Topic

1 Bond Offerings

2 Credit Ratings

3 Securitization

4 Hybrids

5 Syndicated Loans

6 Syndication Strategies
Definitions

On-shore (national market)

Domestic market
Foreign bond
Eurobond
Bearer bonds: poessession is evidence of ownership
Do not have registration requirements
More liquid

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Classification

Fixed rate: straight bond (fixed coupon) & zero-coupon bond

Floating rate: coupon payments are indexed to some reference
rate (reverse floater)
Equity related: convertible bonds & bonds with equity warrants
Asset-backed securities (ABS)

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Process

Origination
Discuss the terms of issuance
Assemble a syndicate
Prepare a credit opinion about the issue
Start a pre-marketing activity (canvasing investors)
Define bond characteristics (provisional)

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Process (contd.)
Book-Building
Announcing the issuance terms
Pricing the bond

Offering Day
Syndicate purchases the bonds from the issuer

Closing Day
The issuer receives the funds

Stabilization Services
Overallotment
Bought deal
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Topic

1 Bond Offerings

2 Credit Ratings

3 Securitization

4 Hybrids

5 Syndicated Loans

6 Syndication Strategies
Definitions

An opinion about the likelihood of default of either an issuer or

an issue made by that issuer.
Based on issuer rating, the seniority of the issue, the presence of
collateral, …
Huge impact on both the credit spread (the interest rate paid by
the issuer) and gross spread (the fee paid by the issuer to the
investment bank)

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Rating Scales

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Split Ratings

Occur when agencies assign different ratings to the same

issue/issuer
To be an indicator of opaqueness

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Solicited & Unsolicited Ratings

Ratings requested by issuers with fee (solicited)

Ratings without being requested by issuers (unsolicited)
Unsolicited ratings has triggered a debate among issuers and
agencies
In principle, unsolicited ratings should be considered less
informative than solicited ratings

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Are Ratings Important to Bond Pricing?

Crucial importance in determining both the fee charged by the

syndicate and the interest rate paid by the issuer
The book-runner reputation, pretigious banks
The seniority of the bond
Subordinated bonds pay higher credit spreads
Subordinated bonds have one notch or 2 notches lower senior
bonds (a notching approach)

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The Accuracy of Rating

Fairly accurately the credit spread of top-rated bonds

Much less informative for worse-rated issues
The credit market cycle: AAA-BBB spread
The reliance decreases when the spread is wider (opaqueness)

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Topic

1 Bond Offerings

2 Credit Ratings

3 Securitization

4 Hybrids

5 Syndicated Loans

6 Syndication Strategies
Definition

Securitization: the process by which loans or receivables are

re-packaged and placed to bond investors. Investors purchase
securities which are backed by the loans or receivables. These
bonds are therefore called Asset Backed Securities (ABS).
The risk of loans or receivables is thus transferred from the bank
(or firm) that originally generated the exposure to the bond
market.

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Process

Transform typically illiquid assets into tradable securities.

The transaction generates cash for the originator , which can be
used to expand their business without an increase in equity
capital.
Special Purpose Vehicle (SPV) (bankcruptcy remote firm):
purchases the assets being securitized from the originator and
financed by issuing bonds

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Credit Enhancement Techniques

Tranching
Overcollateralization
Cash collateral

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Topic

1 Bond Offerings

2 Credit Ratings

3 Securitization

4 Hybrids

5 Syndicated Loans

6 Syndication Strategies
Convertible Bonds

A blend of debt and equity

Option to convert to common shares (the conversion ratio)
Risk estimation is less relevant

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Topic

1 Bond Offerings

2 Credit Ratings

3 Securitization

4 Hybrids

5 Syndicated Loans

6 Syndication Strategies
Definitions

Loans granted by a pool of bank

Hybrid instruments
Book-runner: lead of the syndicate (preparing the information
memorandum, inviting banks to join the syndicate, etc.)

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Purposes

M&As
LBOs

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Lenders

Banks
Insurance companies
Hedge funds

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Topic

1 Bond Offerings

2 Credit Ratings

3 Securitization

4 Hybrids

5 Syndicated Loans

6 Syndication Strategies
Fully Underwritten vs. Best Effort

Fully underwritten loans

The book-runner commits the loan amount
The underwriting risk belongs to the book-runner
Market flex
Best effort loans (arrangements)
The book-runner just commits its final take
The risk is run by the borrower

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Sole Mandate vs. Joint Mandate

The book-building procedure usually mitigates or eliminates the

underwriting risk
If the underwriting risk is deemed to be relevant, a joint
mandate might be a useful solution
The profit per bank will be lower.
If a joint book-runner defaults, the borrower cannot ask to
another book-runner to cover that portion of underwritten loan
(unless it is specified in the term sheet)

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General Syndication vs. Sub-underwriting Plus
General Syndication

Single-step strategy: the book-runner

invites banks to join the syndicate
runs the underwriting risk (in a fully underwritten deal)
Two-step strategy:
the book-runner invites some sub-underwriters to underwrite a
portion of the loan amount
if a sub-underwriter defaults, the mandated arranger will have
to cover that portion of loan

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Roles of the Book-Runner

Specify the invitation amount

Oversubscribed:
Increase the size of the deal
Scale back: pro-rata or on discretional basis

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Fees

The arrangement fee:

compensates for putting together the syndicate and for the
underwriting risk
computed against the underwritten amount
Sub-underwriting fee: to compensate sub-underwriters for the
underwriting risk
Closing fee:
compensates for credit screening
computed against the portion of loan actually granted
Residual pool income: the difference between closing fee
available and closing fee payable

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Fee Distribution
Different Syndicate Structures

Sole Mandate – No Sub-underwriting

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