Ngân hàng, tín dụng - Chapter 14: Understanding financial contracts

1Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Chapter 14 Understanding Financial Contracts Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-2 Learning Objectives • Differentiate among the different mechanisms of external financing of firms • Explain why mechanisms of external financing depend upon firm size • Understand how financial contracts may reduce the adverse selection and moral hazard problems of asymmetric information Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-3 Introduction • Chapter focuses on financial contracts between lenders and borrowers • Non-traded financial contracts are tailor-made to fit the characteristics of the borrower • In business financing, the differences in contracting can be great, both in terms of how financial instruments are originated and in the characteristics of the terms of contract 2Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-4 Introduction (Cont.) • Asymmetric information—problems associated with the availability of information about the borrowers who seek funding • Apply this concept to analysis to contrast the differences between consumer and business financing Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-5 How Business Obtains Financing • Businesses need funds for a variety of reasons – Finance permanent assets such as plant and equipment – Finance the acquisition of another business – Finance working capital—inventory or accounts receivable Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-6 How Business Obtains Financing (Cont.) • Financing Small Businesses – Small firms—assets less than $10 million – Vast majority are privately owned with ownership concentrated in a single family – Generally do not need external financing beyond trade credit—delayed payment offered by suppliers – Profitable firms may have sufficient capital to be self- financing – Banks are most likely source of external financing 3Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-7 How Business Obtains Financing (Cont.) • Financing Small Businesses (Cont.) – Provide funds via a short-term loan or line of credit (L/C) for either working capital or purchase of plant and equipment • Short-term loan—negotiated contract with short maturity • Line of Credit – Bank extends a credit for specified period of time – The borrowing firm can draw down funds against L/C – Credit Rationing—insures borrower has access to funds even if bank would prefer to curtail new loans • When financing capital assets the maturity of the loan is typically less than life span of the asset Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-8 How Business Obtains Financing (Cont.) • Financing Small Businesses (Cont.) – Bank Loan Origination (Figure 14.1) • Locate a bank that meets your needs, usually through a referral • The bank’s loan officer conducts a complete credit analysis – Review borrower’s financial statements – Visit the place of business – Assesses the managerial strengths/weaknesses of borrower – Provides an opportunity to develop a one-on-one relationship Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-9 FIGURE 14.1 Bank loan origination. 4Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-10 How Business Obtains Financing (Cont.) • Financing Small Businesses (Cont.) – Bank Loan Origination (Figure 14.1) (Cont.) – Obtain additional information about the firm – Obtain credit report on the firm and borrower – Address any concerns with the borrower • Loan is approved by the bank – Small loan approved by a loan officer – Larger loans are approved by more senior officers – Above a certain amount must get approval from loan committee – Borrower and bank negotiate terms of the loan Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-11 How Business Obtains Financing (Cont.) • Financing Small Businesses (Cont.) – Unique features of a small business loan • During application period and after the loan is granted, develop a relationship between bank and borrower • Banks offer a wide menu of options to borrower • Loans are often collateralized – Pledging of assets against the loan – Secured lender—bank has the right to petition the bankruptcy court to sell the asset pledged as collateral to satisfy the loan Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-12 How Business Obtains Financing (Cont.) • Financing Small Businesses (Cont.) – Unique features of a small business loan (Cont.) • Loans are often collateralized (Cont.) – Unsecured lender—have right to proceeds from sale of assets after secured lenders have been paid – Owner may pledge personal assets as collateral • Loan can be guaranteed by the owner – Borrower is personally liable for any unpaid balance – Lender may require a personal financial statement of the borrower 5Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-13 How Business Obtains Financing (Cont.) • Financing Small Businesses (Cont.) – Unique features of a small business loan (Cont.) • Loan may contain restrictive covenants – Covenant—promises that the company makes to the bank regarding their future actions and strategies – The bank may require an audited financial statement to verify the convents have not been broken – More restrictive covenants are linked to actions indicating the company has become riskier Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-14 How Business Obtains Financing (Cont.) • Financing Small Businesses (Cont.) – Unique features of a small business loan (Cont.) • Loan may contain restrictive covenants (Cont.) – If violated, bank may demand immediate payment of loan – Possible for the borrower to renegotiate the terms of the loan to reflect higher risk • Maturity of small business loans rarely exceeds 5 years • With very small firms, often loan is strictly dependent on creditworthiness of the individual not the small business Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-15 How Business Obtains Financing (Cont.) • Financing Midsize Businesses – Assets between $10 million and $150 million – Large enough to no longer be bank-dependent for external debt financing, but not large enough to issue traded debt in the public bond market – Some are likely to be publicly owned—issue equity traded in the over-the-counter market – Can either be owner managed or managed by someone other than the owner 6Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-16 How Business Obtains Financing (Cont.) • Financing Midsize Businesses (Cont.) – For short-term debt, principally rely on commercial banks – Depending on size of debt and bank, can use either local or non-local banks – Typically have covenants placed on the loan and may pledge collateral – Revolving Line of Credit--access to longer-term debt financing through their commercial bank that combines an L/C with intermediate-term loan Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-17 How Business Obtains Financing (Cont.) • Financing Midsize Businesses (Cont.) – Long-term debt financing is often provided by non- bank institutions • Mezzanine debt funds provide loans to smaller midsize companies • Private Placement Market (Figure 14.2) – Generally a bond issue in excess of $10 million – Bonds do not have to be registered with the SEC – Avoids public disclosure of information – Sold only to financial institutions and high net worth investors Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-18 How Business Obtains Financing (Cont.) • Financing Midsize Businesses (Cont.) • Private Placement Market (Cont.) – Generally not resold by original investor for at least two years – Have covenants that are generally less restrictive than when borrowing from a bank – Terms will be renegotiated one or more times during the life span of the loan if the company wishes to embark on a new strategy 7Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-19 How Business Obtains Financing (Cont.) • Financing Midsize Businesses (Cont.) – Private Placement Origination (Figure 14.2) • Issued through agents, commercial banks or investment banks who structure the contract and market the issue • Due diligence—the agent handling the private placement evaluates the firm’s management, financial condition, and business capabilities • Based on due diligence, the placement issue will receive a formal credit rating which measures the perceived risk Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-20 FIGURE 14.2 Private placement origination. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-21 How Business Obtains Financing (Cont.) • Financing Midsize Businesses (Cont.) – Private Placement Origination (Figure 14.2) (Cont.) • The terms of the contract are negotiated to be attractive to investors— interest rate, maturity, covenants, and any special features • Offering memorandum/term sheet containing information of the firm and the offering are sent to prospective investors • Once the issue is placed, the investors do their own due diligence which verifies the original information 8Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-22 How Business Obtains Financing (Cont.) • Financing Large Businesses – Firms with assets in excess of $150 million – Becomes cost effective to enter the public bond market – These bond issues are liquid assets that are traded in the secondary market – Therefore, can be issued at a lower yield than a nontraded instrument Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-23 How Business Obtains Financing (Cont.) • Financing Large Businesses (Cont.) – Large businesses can afford the high distribution and underwriting costs of a public issue • Additional costs to sell to a wider range of investors • Substantial costs associated with registering the bond with the SEC – Securities Underwriting (Figure 14.3) • Issuer selects an underwriter, generally an investment bank, to assist in issuing and marketing the bond • Underwriters actively market their services to companies large enough to issue in the public market Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-24 FIGURE 14.3 Securities underwriting. 9Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-25 How Business Obtains Financing (Cont.) • Financing Large Businesses (Cont.) – Securities Underwriting (Figure 14.3) (Cont.) • Underwriter does due diligence on the issuer and then issues the following items – Registration Statement—conforms to specific disclosure requirements – Offering (preliminary) prospectus—contains all relevant factual information about the firm and its financing Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-26 How Business Obtains Financing (Cont.) • Financing Large Businesses (Cont.) – Securities Underwriting (Figure 14.3) (Cont.) • Registration statement is blessed by the underwriter, the accountants, and issuing firm’s attorneys • The registration statement is approved by the SEC and can now be distributed • Role of underwriter in the distribution – Underwriting syndicate is formed by the managing underwriter to share responsibility for distribution the issue and the underwriting risk Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-27 How Business Obtains Financing (Cont.) • Financing Large Businesses (Cont.) – Securities Underwriting (Figure 14.3) (Cont.) • Role of underwriter in the distribution (Cont.) – Underwriting risk occurs when the underwriters make a firm commitment to sell the bonds at an agreed price (implied interest rate) – If bonds sell below this price, underwriter takes a loss – Underwriting Spread—hope to sell bonds at a higher offering price, above the commitment price • It is difficult to incorporate highly restrictive covenants in publicly traded bonds 10 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-28 How Business Obtains Financing (Cont.) • Financing Large Businesses (Cont.) – Shelf Registration • Permits the issuer of a public bond to register a dollar capacity with the SEC • Draw down on this capacity at any time • This avoids additional registration requirements • Permits issuers to respond instantaneously to changing market conditions Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-29 How Business Obtains Financing (Cont.) • Financing Large Businesses (Cont.) – Large companies with good credit ratings tend to rely on the commercial paper market for short- term financing – Some very large businesses also issue medium-term notes, which are like commercial paper, except maturities range from one year to five years – Also issue equities, through underwriters, which is another form of external long-term financing Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-30 The Economics of Financial Contracting • Figure 14.4 summarizes method and nature of financial contracting according to firm size. • The concept of transactions costs helps explain why firms of different size rely on different financial contracts to raise funds • However, to fully understand the differences must rely on the concept of asymmetric information—buyers and sellers are not equally informed about the quality of the product 11 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-31 FIGURE 14.4 Credit market comparison. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-32 The Economics of Financial Contracting (Cont.) • Asymmetric Information and Financial Contracting – Adverse Selection • Caused by asymmetric information before a transaction is consummated • Bank loan officer cannot easily tell the difference between high and low quality borrowers • Part of the loan officer’s job is to use credit analysis to uncover relevant information • Asymmetry of information is particularly acute for small firms since there is little publicly available information Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-33 The Economics of Financial Contracting (Cont.) • Asymmetric Information and Financial Contracting (Cont.) – Adverse Selection (Cont.) • As a result, loans are often structured such that borrowers can signal their true quality based on the types of loans they will accept – Is owner willing to pledge personal outside assets as collateral or offer a personal guarantee? – If owner is not willing, this would signal that they are uncertain of the future 12 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-34 The Economics of Financial Contracting (Cont.) • Asymmetric Information and Financial Contracting (Cont.) – Moral Hazard • Occurs after the loan is made • Loan contract may give the firm the incentive to pursue actions that take advantage of the lender – If the firm does very well, the owner does not pay more to the issuer of the bank loan – If the firm does poorly, the owner’s liability is limited to the terms of the loan Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-35 The Economics of Financial Contracting (Cont.) • Asymmetric Information and Financial Contracting (Cont.) – Moral Hazard (Cont.) • Therefore, owners disproportionately share in the upside of increased risk, while lenders disproportionately share in the downside Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-36 The Economics of Financial Contracting (Cont.) • Contracting and Firm Continuum – There are things firms can do to convince potential lenders that they will not engage in risky tactics – Large firms • Relatively easy to observe—any risk shifting is easily detected – Labor contracts are often public knowledge – Supplier relationships are often well known – Marketing success or failure is well documented – Motivated to not switch to high risk activities—the firm’s desire to maintain their reputation 13 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-37 The Economics of Financial Contracting (Cont.) • Contracting and Firm Continuum (Cont.) – Large firms (Cont.) • Therefore, public markets for stocks and bonds will generally reflect true riskiness of investment strategies, with prices and yields determined accordingly Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-38 The Economics of Financial Contracting (Cont.) • Contracting and Firm Continuum (Cont.) – Small firms • External reputations are difficult to establish • Most activities are beyond the public’s scrutiny • Therefore, need proxies to demonstrate they are low risk and committed to not shifting their risk profiles – Outside collateral or personal guarantees place more of the owner’s wealth at risk – Inside collateral, bank files a lien against collateral – Loan covenants prevent risk shifting by explicitly constraining borrower behavior Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-39 The Economics of Financial Contracting (Cont.) • Contracting and Firm Continuum (Cont.) – Small firms (Cont.) • Small firms cannot enter into long-term debt contracts since there is too much flexibility given the incentives to shift risk • Therefore, bank loans to small business are typically made on a short-term basis 14 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-40 The Economics of Financial Contracting (Cont.) • Contracting and Firm Continuum (Cont.) – Midsize Companies • Their information problems lie between small and large size companies • More visible publicly than small, but more informationally impaired than large companies • Still need a financial intermediary at the origination stage to address adverse selection problems and design a tailor-made contract • May have access to long-term debt in the private placement market Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-41 The Economics of Financial Contracting (Cont.) • Firm Continuum (Figure 14.5) – Describes the relationship between information and market access in terms of a firm continuum – The larger the firm, greater and more accurate information becomes available – As a firm matures there is more access to long-term financial contracts, first in the private placement market progressing into publicly traded stocks and bonds Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-42 FIGURE 14.5 Firm continuum. 15 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-43 The Economics of Financial Contracting (Cont.) • Firm Continuum (Figure 14.5) (Cont.) – Growth also enables the firm to obtain different types of short-term credit – A firm may revert back to a form of financial contract typically associated with a smaller firm, but this is consistent with the concept of firm continuum and the firm will do what is in their best interest Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-44 The Economics of Financial Contracting (Cont.) • Consumer Lending, Financial Contracting and Securitization – Asymmetric information also exists in consumer lending – Some consumers are high-risk borrowers, some are low-risk – Adverse selection exists since it might be difficult to determine the riskiness of a potential borrowers – Moral hazard is also present since consumers may borrow for one purpose and switch to a riskier activity Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-45 The Economics of Financial Contracting (Cont.) • Consumer Lending, Financial Contracting and Securitization (Cont.) – Consumer lenders use some of the same techniques as business lenders to solve these problems – Banks may use subtle pricing schemes to sort out low-risk borrowers from high-risk ones and permit loan packages to be tailored for both groups 16 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 14-46 The Economics of Financial Contracting (Cont.) • Consumer Lending, Financial Contracting and Securitization (Cont.) – Asymmetric information is probably less in consumer lending than business lending • Easier to access consumer risk since personal financial information is much less complex • Relatively fewer types of consumer loans so evaluating consumer risk is easier than business loans • Collateral virtually eliminates the asymmetry problem – Easier to securitize consumer loans—pooling a group of loans into a trust and then selling securities issued against the trust