30 Sept 2013

Types of Facilities

A revolving credit facility is one where the borrower has the ability to repay and redraw (rather like an overdraft).

A term loan, if repaid early, cannot be redrawn.

A bilateral loan is made by one bank to a borrower.

A club deal is where a large borrower arranges for a small group of relationship banks to lend it money. The operation is controlled by the borrower.

Most companies borrow money under a syndicated loan. Here, the arranging bank (appointed by the borrower) manages a syndicate of banks who all lend money on the same terms. The arranging bank controls the process. Upfront fees are paid according to the size of commitment made. The advantages of syndicated lending are that the loan is much more likely to be priced and structured correctly and the borrower saves valuable negotiating time.

It can be argued that large commercial banks grant loans to customers below economic fair value in order to ingratiate themselves with customers in the expectation of winning more lucrative business such as mergers and acquisitions, arranging equity or bond finance, and derivatives. This is more often the case during buoyant economic conditions. 

18 Sept 2013


A covenant is a restriction placed on a borrower designed to afford protection to lenders. If a covenant is breached, the loan may have to be repaid early. There are two basic types of covenants.

Maintenance covenants would set minimum levels on financial indicators such as profitability, cash flow, liquidity and interest cover, and maximum levels on gearing.

Incurrence covenants would restrict a company in:
  •   Taking on more debt
  •   Payment of dividends or other distributions subject to certain criteria
  •   Sale or transfer of assets
  •   Extending guarantees
  •   Granting “negative pledges”
  •   Permitting change of control
The change of control clause has, in recent years, proved very contentious. Most bank loans contain such a clause whereas bonds, until the last few years, did not. In the event that a company would be acquired and the acquiror was financed in a very leveraged way, the bank loans would have to be refinanced immediately, whereas the bonds could become junk and investors would suffer significant losses. Examples of even a putative takeover having such a negative effect on bond prices are Marks & Spencer and J Sainsbury. 

16 Sept 2013

Loan Characteristics

Bank loans have the following attributes:
  • They exhibit flexible payment structures
  • They do not require public disclosure
  • As banks are lending the money directly, they do not require credit ratings. However, more non-bank lenders are becoming part of lending syndicates. There is a secondary market in loans, and loans are being repackaged into structured credit instruments. These factors have led to more loans being rated
  • The interest on loans is usually floating. The most common index is LIBOR, with a margin added. The magnitude of the margin depends on the credit rating and sector of the company, the length and size of the loan, and how aggressive the banks are in lending money at the current point of the business cycle
  • Loans can usually be repaid early at the option of the borrower. This is generally not the case for bonds
  • Loans are more likely to have restrictive covenants than bonds (although more recent bond issues have tended to give borrowers less financial freedom)

12 Sept 2013

Debt & Bank Finance

Debt Finance

The two principal sources of debt finance are bank loans (in various forms) and the bond markets. We shall examine the differences between them. Historically, US corporations have made greater use of the bond markets due to the higher investor acceptance and the quest by banks for higher returns elsewhere. In Europe, the pressure on banks to increase returns for shareholders, the arrival of the euro (creating a pan-European investor base), and the growing use of credit ratings have led to an increasing use of bonds in the last few years. It is now also the case that investment banks make loans to corporates in order to cement their relationships with key clients and to show a commitment to them. Historically, loans were generally made by commercial banks whose balance sheets therefore are much larger than those of investment banks.

Bank Finance

The distinction between uncommitted and committed facilities is important to make.

An uncommitted facility is one which provides short-term (usually up to one year), temporary or seasonal financing. It is relatively cheap, but can be withdrawn by the bank very quickly. Typical uncommitted facilities would include money market lines, foreign exchange lines and overdraft facilities.

A committed facility is longer term (usually between one and five years) and where the borrower pays a fee to the bank for the facility. This fee may depend on the utilisation of the credit line (how much money has been borrowed). Most companies have committed facilities. The amount, maturity and terms of undrawn committed facilities are key indicators as to the financial health of a company. Uses of committed facilities include financing core working capital, financing fixed assets or providing funds for acquisitions (putting together a committed facility when making a takeover bid is often the first step in the M&A process).

In periods of deteriorating credit conditions, banks need to ensure that they have not committed to lend to too many companies at unfavourable rates (from their perspective) and that they have the ability to raise sufficient finance themselves in order to make the loans. 

11 Sept 2013

Equity Valuation Metrics

The P/E ratio (Price-to-Earnings ratio) of a stock (also called its “earnings multiple”, or simply “multiple”) is a measure of the price paid for a share relative to the income or profit earned by the firm per share. A higher P/E ratio means that investors are paying more for each unit of income. It is a valuation ratio included in other financial ratios.

The price per share (numerator) is the market price of a single share of the stock. The earnings per share (denominator) is the net income of the company for the most recent 12-month period, divided by number of shares outstanding.

For example, if Stock A is trading at $30 and the earnings per share for the most recent 12-month period is $3, then Stock A has a P/E ratio of 30/3 or 10. Put another way, the purchaser of Stock A
is paying $10 for every dollar of earnings. Companies with losses or no profit have an undefined P/E ratio. However, a negative P/E ratio may be shown.

By comparing price and earnings per share for a company, one can analyse the market’s stock valuation of a company and its shares relative to the income the company is actually generating. Investors can use the P/E ratio to compare the value of stocks: if one stock has a P/E twice that of another stock, all things being equal, it is a less attractive investment. Companies are rarely equal, however, and comparisons between industries, companies and time periods may be misleading. Hence, more complicated peer group analysis is required.

Care should be taken when analysing P/E ratios. It is also common market practice to use historic P/E ratios, or forward P/E ratios which factor in future consensus corporate growth rates. Either way, how do we interpret in a simple manner what the ratios means? If a company trades on a P/E ratio of 10, we could conclude that it takes about ten years to recoup the price paid for a stock (not including any income from the reinvestment of dividends). In principle, the P/E ratio incorporates the market’s view of future growth prospects and perceived riskiness of a company’s future earnings.

Various interpretations are possible, but the table below gives an indicative guide as to their meaning:

The dividend yield is the dividend paid in the last accounting year divided by the current share price. If a stock paid out $5 per share in cash dividends to its shareholders last year, and its price is currently $50, then it has a dividend yield of 10%.

The earnings yield is the reverse/reciprocal of the P/E ratio. The earnings yield is quoted as a percentage, and is useful in comparing a stock, sector, or the market’s valuation relative to bonds. The earnings yield is also the cost to a publicly traded company of raising capital through the issuance of stock.

10 Sept 2013

Dividend Dates

Once dividends are declared/approved by a company’s Board of Directors, there are four important dates to remember regarding dividends:

Declaration date – is the day the Board of Directors announces its intention to pay a dividend. On this day, a liability is created and the company records that liability on its books; it now owes the money to the stockholders. On the declaration date, the Board will also announce a date of record and a payment date.

Ex-dividend date – is the day after which all shares bought and sold no longer come attached with the right to be paid the most recently declared dividend. Prior to this date, the stock is said to be cum dividend (with dividend): existing holders of the stock and anyone who buys it will receive the dividend, whereas any holders selling the stock lose their right to the dividend. On and after this date, the stock becomes ex-dividend: existing holders of the stock will receive the dividend even if they now sell the stock, whereas anyone who now buys the stock will not receive the dividend. It is expected that a stock’s price will fall on the ex-dividend date by an amount approximately equal to the dividend paid. This reflects the decrease in the company’s assets resulting from the declaration of the dividend. The company does not take any explicit action to adjust its stock price; in an efficient market, this will automatically occur.

Record date – shareholders who have registered their ownership on or before the date of record will receive the dividend. Registration in most countries is essentially automatic for shares purchased before the ex-dividend date.

Payment date – is the day when the dividend will actually be posted to the shareholders of a company or credited to brokerage accounts.