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Property companies have a number of financing
when borrowing in the short term one is to borrow from banks directly and
another is the use of commercial paper which is tapping the money markets.
This can often result in savings in cost over the other borrowing methods.
The sterling commercial paper market started in 1986 and in the beginning it
was only available to larger companies but conditions have since been
relaxed and it is now available to the medium sized companies.
Commercial paper is a very short term IOU piece of paper. The company that
wants to borrow is called the issuer and and the investors are the ones that
lend the money for the short term. The issuing company therefore issuing a
short term security to the investors. Commercial paper is often sold at a
discount rather than paying interest.
To illustrate with an example consider if a company were issuing paper with
a life of three months it might to sell it at say $97
for every $100 of nominal value. Once three months pass the
paper will be repaid at $100 per $100 value.
The interest rates on commercial paper is often expressed in relation to
LIBOR which is the London Interbank Offered Rate. This is the rate in which
banks will lend to each other. There is also LIBID (London Interbank Bid
Rate) which is the lower rate in which banks are prepared to borrow. There
is also a middle rate between the two called the LIMEAN. Interest
rates are often quoted as being so many points above LIBOR or LIBID. A basis
point is one hundredth of a percentage point, so 50 basis points above LIBOR
would be 1/2 percentage point above LIBOR. Consequently if the interest rate
was 7% the interest rate would be 7.5%. Therefore LIBOR is effectively the
cost of funds between banks themselves.
Many different kinds of financing institutions invest in commercial paper
and the average life of commercial paper is about 40 days but can last up to
about 5 years. Although 40 days is a very short time frame. The issuers have
a rolling over function meaning they can repay the money and then issue a
new batch of securities when one batch comes due.
If a company wants to tap the commercial markets it first needs to appoint a
bank to set up a program for it. The bank will then set up a network of
dealers which will act as intermediaries between the issuers and the
potential investors. If a company decides that it wants to raise money it
informs the bank which networks with the various dealers which put offers
out to the potential investors to raise the cash. At present the minimum
denomination for commercial paper are high so the market is not for small
investors. Sometimes the reverse of this situation happens where the
investors send a message to the issuers that they are looking to lend and is
the issuer interested in borrowing.
The issuer needs to appoint a paying agent. The paying agent is the firm
that looks after the technicalities of getting the paper actually into the
hands of the investors and the cash physically into the hands of the issuer.
They are also responsible for making sure the redemptions happen without on
the due date.
Commercial paper is unsecured so the reputation or credit history of the
borrow is important. The paper can also be rated based on its quality.
In some cases if the conditions in the commercial paper market are
unattractive and a company in question already has some commercial paper
outstanding, then the company may have some kind of backup facility in place
such which would give the company access to funds to repay the commercial
paper if the need arises. This kind of guaranteed line of credit often takes
the form of a multiple option facility. Otherwise known as a MOF. This means
that a group of banks has committed to make a certain amount of funds
available at a prearranged rate over LIBOR if the company finds it cannot
raise the money more cheaply. Therefore a MOF provides backing for a
commercial paper financing.
The costs of setting up a commercial paper programme range from about $5000
$20,000 and the interest rate quoted depends on the strength and quality of
the company. For example a quality company might get a rate at around LIBID
while a smaller less well known company with less of a track record might
get a rate of 20 points above LIBOR. In some cases the very large property
companies are not confined to the US market. For example a large US property
company can also tap the commercial markets in the UK or the Euro commercial
paper market. For example the company could borrow sterling and
the swap them into dollars. In this case a fallback MOF would
probably be necessary to account for the currency exchange risk.