Anatomy of the medium-term note market.Over the past decade, medium-term notes Medium-term note (MTN)
A corporate debt instrument that is continuously offered to investors over a period of time by an agent of the issuer. Investors can select from maturity bands of: 9 months to 1 year, more than 1 year to 18 months, more than 18 months to 2 years, etc. (MTNs) have emerged as a major source of funding for U.S. and foreign corporations, federal agencies, supranational Supranational
An international organization, or union, whereby member states transcend national boundaries
or interests to share in the decision-making and vote on issues pertaining to the wider grouping. institutions, and sovereign countries. U.S. corporations have issued MTNs since the early 1970s. At that time, the market was established as an alternative to short-term Short-term
Any investments with a maturity of one year or less.
1. Of or relating to a gain or loss on the value of an asset that has been held less than a specified period of time. financing in the commercial paper market and long-term Long-term
Three or more years. In the context of accounting, more than 1 year.
1. Of or relating to a gain or loss in the value of a security that has been held over a specific length of time. Compare short-term. borrowing in the bond market; thus the name "medium term." Through the 1970s, however, only a few corporations issued MTNs, and by 1981 outstandings amounted to only about $800 million. In the 1980s, the U.S. MTN MTN
A short-form for Medium Term Note.
Medium term notes issued by corporations, much like shorter-term commercial paper.
See medium-term note (MTN). market evolved from a relatively obscure niche market A niche market also known as a target market is a focused, targetable portion (subset) of a market sector.
By definition, then, a business that focuses on a niche market is addressing a need for a product or service that is not being addressed by mainstream providers. dominated by the auto finance companies into a major source of debt financing Debt Financing
When a firm raises money for working capital or capital expenditures by selling bonds, bills, or notes to individual and/or institutional investors. In return for lending the money, the individuals or institutions become creditors and receive a promise to repay for several hundred large corporations. In the 1990s, the U.S. market has continued to attract a diversity of new borrowers, and outside the United States United States, officially United States of America, republic (2005 est. pop. 295,734,000), 3,539,227 sq mi (9,166,598 sq km), North America. The United States is the world's third largest country in population and the fourth largest country in area. , the Euro-MTN See Euro-medium term note. market has grown at a phenomenal rate. By year-end 1992, outstanding MTNs in domestic and international markets stood at an estimated $283 billion (table 1).
1. Size of the worldwide medium-term note market, year-end 1992 Billions of dollars Amount Market sector outstanding, year-end 1992 Total 283 U.S. market 223 Public MTNs f U.S. corporations 176 Federal agency and others 16 Private placements 31 International markets 60 Euro-MTNs 50 Foreign domestic markets 10 Sources. Merrill Lynch & Co., Websters Communications International, Federal Reserve Board.
Most MTNs are noncallable Noncallable
Securities that cannot be called by the issuer prior to maturity.
Noncallable securities include preferred stocks and bonds. These securities usually offer lower yields to investors due to their reduced risk. , unsecured Unsecured
A loan or equity interest that is given without any guarantee of payment, performance, satisfaction or opportunity for return from the recipient. No property, interest or security is used as collateral in either a guarantee or a pledge. , senior debt securities with fixed coupon rates Coupon rate
In bonds, notes, or other fixed income securities, the stated percentage rate of interest, usually paid twice a year. and investment-grade investment-grade
Of, relating to, or being a bond suitable for purchase by institutions under the prudent man rule. Investment-grade is restricted to those bonds graded BBB and above by Standard & Poor's and graded Baa3 and above by Moody's. credit ratings. In these features, MTNs are similar to investment-grade corporate bonds. However, they have generally differed from bonds in their primary distribution process. MTNs have traditionally been sold on a best-efforts basis best-efforts basis
1. An agreement by an investment banker to do its best to oversee but not guarantee the sale of a security issue in the primary market. See also underwriter.
2. by investment banks The following is a list of investment banks Financial conglomerates
Large financial-services conglomerates combine commercial banking and investment banking, and sometimes insurance. and other broker-dealers acting as agents. In contrast to an underwriter underwriter n. a company or person which/who underwrites an insurance policy, issue of corporate securities, business, or project. (See: underwrite)
UNDERWRITER, insurances. One who signs a policy of insurance, by which he becomes an insurer. in the conventional bond market, an agent in the MTN market has no obligation to underwrite To insure; to sell an issue of stocks and bonds or to guarantee the purchase of unsold stocks and bonds after a public issue.
The word underwrite has two meanings. MTNs for the issuer, and the issuer is not guaranteed funds. Also, unlike corporate bonds, which are typically sold in large, discrete offerings, MTNs are usually sold in relatively small amounts either on a continuous or on an intermittent intermittent /in·ter·mit·tent/ (-mit´ent) marked by alternating periods of activity and inactivity.
1. Stopping and starting at intervals.
Borrowers with MTN programs have great flexibility in the types of securities they may issue. As the market for MTNs has evolved, issuers have taken advantage of this flexibility by issuing MTNs with less conventional features. Many MTNs are now issued with floating interest rates or with rates that are computed according to according to
1. As stated or indicated by; on the authority of: according to historians.
2. In keeping with: according to instructions.
3. unusual formulas tied to equity or commodity prices. Also, many include calls, puts, and other options. Furthermore, maturities are not necessarily "medium term" - they have ranged from nine months to thirty years and longer. Moreover, like corporate bonds, MTNs are now often sold on an underwritten basis, and offering amounts are occasionally as large as those of bonds. Indeed, rather than denoting a narrow security with an intermediate maturity, an MTN is more accurately defined as a highly flexible debt instrument that can easily be designed to respond to market opportunities and investor preferences.
The emergence of the MTN market has transformed the way that corporations raise capital and that institutions invest. in recent years, this transformation has accelerated because of the development of derivatives markets The derivatives markets are the financial markets for derivatives. The market can be divided into two, that for exchange traded derivatives and that for over-the-counter derivatives. , such as swaps, options, and futures, that allow investors and borrowers to transfer risk to others in the financial system who have different risk preferences. A growing number of transactions in the MTN market now involve simultaneous transactions simultaneous transaction
See riskless transaction. in a derivatives market.
This article discusses the history and economics of the MTN market, analyzes statistics on MTNs collected by the Federal Reserve, and reviews recent developments in the U.S. and Euro-MTN markets.(1)
BACKGROUND OF THE MTN MARKET(2)
General Motors Acceptance Corporation (GMAC GMAC General Motors Acceptance Corporation
GMAC Graduate Management Admission Council
GMAC Give Me A Call
GMAC Genetic Manipulation Advisory Committee
GMAC Genetic Modification Advisory Committee (Singapore)
GMAC Give Me A Chance ) created the MTN market in the early 1970s as an extension of the commercial paper market. To improve their asset-liability management, GMAC and the other auto finance companies needed to issue debt with a maturity that matched that of their auto loans to dealers and consumers. However, underwriting Underwriting
1. The process by which investment bankers raise investment capital from investors on behalf of corporations and governments that are issuing securities (both equity and debt).
2. The process of issuing insurance policies. costs made bond offerings with short maturities impractical im·prac·ti·cal
1. Unwise to implement or maintain in practice: Refloating the sunken ship proved impractical because of the great expense.
2. , and maturities on commercial paper cannot exceed 270 days. The auto finance companies therefore began to sell MTNs directly to investors. In the 1970s, the growth of the market was hindered by illiquidity in the secondary market and by securities regulations requiring approval by the Securities and Exchange Commission (SEC) of any amendment to a registered public offering. The latter, in particular, increased the costs of issuance significantly because borrowers had to obtain the approval of the SEC each time they changed the posted coupon rates on their MTN offering schedule. To avoid this regulatory hurdle HURDLE, Eng. law. A species of sledge, used to draw traitors to execution. , some corporations sold MTNs in the private placement market.
In the early 1980s, two institutional changes set the stage for rapid growth of the MTN market. First, in 1981 major investment banks, acting as agents, committed resources to assist in primary issuance and to provide secondary market liquidity. By 1984, the captive finance companies Captive Finance Company
A subsidiary whose purpose is to provide financing to customers buying the parent company's product.
The captive finance company is usually wholly owned by the parent company. of the three large automakers had at least two agents for their MTN programs. The ongoing financing requirements of these companies and the competition among agents established a basis for the market to develop. Because investment banks stood ready to buy back MTNs in the secondary market, investors became more receptive receptive /re·cep·tive/ (re-cep´tiv) capable of receiving or of responding to a stimulus. to adding MTNs to their portfolio holdings. In turn, the improved liquidity and consequent con·se·quent
a. Following as a natural effect, result, or conclusion: tried to prevent an oil spill and the consequent damage to wildlife.
b. reduction in the cost of issuance attracted new borrowers to the market.
Second, the adoption by the SEC of Rule 415 in March 1982 served as another important institutional change. Rule 415 permits delayed or continuous issuance of so-called shelf registered corporate securities. Under shelf registrations, issuers register securities that may be sold for two years after the effective date of the registration without the requirement of another registration statement each time new offerings are made. Thus, shelf registration enables issuers to take advantage of brief periods of low interest rates by selling previously registered securities on a moment's notice. In contrast, debt offerings that are not made from shelf registrations are subject to a delay of at least forty-eight hours between the filing with the SEC and the subsequent offering to the public.
The ability of borrowers to sell a variety of debt instruments with a broad range of coupons and maturities under a single prospectus supplement is another advantage of a shelf-registered MTN program. Indeed, a wide array of financing options have been included in MTN filings.(3) For example, MTN programs commonly give the borrower the choice of issuing fixed- or floating-rate debt.(4) Furthermore, several "global" programs allow for placements in the U.S. market or in the Euro-market. Other innovations that reflect the specific funding needs of issuers include MTNs collateralized by mortgages issued by thrift institutions Thrift institution
An organization formed as a depository for primarily consumer savings. Savings and loan associations and savings banks are thrift institutions. , equipment trust certificates issued by railways, amortizing notes issued by leasing companies, and subordinated notes issued by bank holding companies. Another significant innovation has been the development of asset-backed MTNs, a form of asset securitization Securitization
The process of creating a financial instrument by combining other financial assets and then marketing them to investors.
Mortgage backed securities are a perfect example of securitization.
May also be spelled as "securitisation. used predominantly pre·dom·i·nant
1. Having greatest ascendancy, importance, influence, authority, or force. See Synonyms at dominant.
2. to finance trade receivables Receivables
An asset designation applicable to all debts, unsettled transactions or other monetary obligations owed to a company by its debtors or customers. Receivables are recorded by a company's accountants and reported on the balance sheet, and they and include all debts owed and corporate loans. This flexibility in types of instruments that may be sold as MTNs, coupled with the market timing benefits of shelf registration, enables issuers to respond readily to changing market opportunities.
In the early and mid- mid-
Middle: midbrain. 1980s, when finance companies dominated the market, most issues of MTNs were fixed rate, noncallable, and unsecured, with maturities of five years or less. In recent years, as new issuers with more diverse financing needs have established programs, the characteristics of new issues have become less generic. For example, maturities have lengthened length·en
tr. & intr.v. length·ened, length·en·ing, length·ens
To make or become longer.
lengthen·er n. as industrial and utility companies with longer financing needs have entered the market. Indeed, frequent placements of notes with thirty-year maturities have made the designation "medium term" something of a misnomer misnomer n. the wrong name.
MISNOMER. The act of using a wrong name.
2. Misnomers, may be considered with regard to contracts, to devises and bequests, and to suits or actions.
MECHANICS OF THE MARKET
The process of raising funds in the public MTN market usually begins when a corporation files a shelf registration with the SEC.(5) Once the SEC declares the registration statement effective, the borrower files a prospectus supplement that describes the MTN program. The amount of debt under the program generally ranges from $100 million to $1 billion. After establishing an MTN program, a borrower may enter the MTN market continuously or intermittently in·ter·mit·tent
1. Stopping and starting at intervals. See Synonyms at periodic.
2. Alternately containing and empty of water: an intermittent lake. with large or relatively small offerings. Although underwritten corporate bonds may also be issued from shelf registrations, MTNs provide issuers with more flexibility than traditional underwritings in which the entire debt issue is made at one time, typically with a single coupon and a single maturity.
The registration filing usually includes a list of the investment banks with which the corporation has arranged to act as agents to distribute the notes to investors. Most MTN programs have two to four agents. Having multiple agents encourages competition among investment banks and thus lowers financing costs. The large New York-based investment banks dominate the distribution of MTNs.
Through its agents, an issuer of MTNs posts offering rates over a range of maturities: for example, nine months to one year, one year to eighteen months, eighteen months to two years, and annually thereafter (see table 2). Many issuers post rates as a yield spread over a Treasury security of comparable maturity. The relatively attractive yield spreads posted at the maturities of three, four, and five years shown in table 2 indicate that the issuer desires to raise funds at these maturities. The investment banks disseminate dis·sem·i·nate
v. dis·sem·i·nat·ed, dis·sem·i·nat·ing, dis·sem·i·nates
1. To scatter widely, as in sowing seed.
2. this offering rate information to their investor clients. When an investor expresses interest in an MTN offering, the agent contacts the issuer to obtain a confirmation of the terms of the transaction. Within a maturity range, the investor has the option of choosing the final maturity of the note sale, subject to agreement by the issuing company. The issuer will lower its posted rates once it raises the desired amount of funds at a given maturity. In the example in table 2, the issuer might lower its posted rate for MTNs with a five-year maturity to 40 basis points over comparable Treasury securities after it sells the desired amount of debt at this maturity. Of course, issuers also change their offering rate scales in response to changing market conditions. Issuers may withdraw from the market by suspending sales or, alternatively, by posting narrow offering spreads at all maturity ranges. The proceeds from primary trades in the MTN market typically range from $1 million to $25 million, but the size of transactions varies considerably.(6) After the amount of registered debt is sold, the issuer may "reload (1) To load a program from disk into memory once again in order to run it. Reload is entirely different than reinstall. Reinstall means that you have to run the install program from a CD-ROM or floppy disk and perform the installation procedure over again. " its MTN program by filing a new registration with the SEC.
1. Having a plane surface; flat.
2. Organized as a table or list.
3. Calculated by means of a table.
resembling a table. DATA OMITTED]
Although MTNs are generally offered on an agency basis, most programs permit other means of distribution. For example, MTN programs usually allow the agents to acquire notes for their own account and for resale resale n. selling again, particularly at retail. In many states a "resale license" or "resale number" is required so that the state can monitor the collection of sales tax on retail sales.
RESALE. at par or at prevailing market prices. MTNs may also be sold on an underwritten basis. In addition, many MTN programs permit the borrower to bypass financial intermediaries Financial intermediaries
institution that provide the market function of matching borrowers and lenders or traders. by selling debt directly to investors.
THE ECONOMICS OF MTNS AND
In deciding whether to finance with MTNs or with bonds, a corporate borrower weighs the interest cost, flexibility, and other advantages of each security.(7) The growth of the MTN market indicates that MTNs offer advantages that bonds do not. However, most companies that raise funds in the MTN market have also continued to issue corporate bonds, suggesting that each form of debt has advantages under particular circumstances CIRCUMSTANCES, evidence. The particulars which accompany a fact.
2. The facts proved are either possible or impossible, ordinary and probable, or extraordinary and improbable, recent or ancient; they may have happened near us, or afar off; they are public or .
Offering Size, Liquidity, and Price
The amount of the offering is the most important determinant determinant, a polynomial expression that is inherent in the entries of a square matrix. The size n of the square matrix, as determined from the number of entries in any row or column, is called the order of the determinant. of the cost differential between the MTN and corporate bond markets. For large, standard financings (such as $300 million of straight debt with a ten-year maturity) the all-in interest cost to an issuer of underwritten corporate bonds may be lower than the all-in cost All-In Cost
Shorthand for "all-included" costs, which are expressed as the interest paid or received for total costs of a financial transaction.
All-in costs include the spread, commission, interest payments, and any other fees resulting from the transaction. of issuing MTNs. This cost advantage arises from economies of scale in underwriting and, most important, from the greater liquidity of large issues. As a result, corporations that have large financing needs for a specific term usually choose to borrow with bonds. From an empirical point of view, the liquidity premium, if any, on small offerings has yet to be quantified. Nevertheless, the sheer volume of financing in the MTN market suggests that any liquidity premium that may exist for small offerings is not a significant deterrent de·ter·rent
Tending to deter: deterrent weapons.
1. Something that deters: a deterrent to theft.
2. to financing. According to market participants The term market participant is used in United States constitutional law to describe a U.S. State which is acting as a producer or supplier of a marketable good or service. When a state is acting in such a role, it may permissibly discriminate against non-residents. , the interest cost differential between the markets has narrowed in recent years as liquidity in the MTN market has improved. Many borrowers estimate that the premium is now only about 5 to 10 basis points.(8)
Furthermore, many borrowers believe that financing costs are slightly lower in the MTN market because its distribution process allows borrowers to price discriminate dis·crim·i·nate
v. dis·crim·i·nat·ed, dis·crim·i·nat·ing, dis·crim·i·nates
a. . Consider a stylized styl·ize
tr.v. styl·ized, styl·iz·ing, styl·iz·es
1. To restrict or make conform to a particular style.
2. To represent conventionally; conventionalize. example of a company that needs to raise $100 million. With a bond offering, the company may have to raise the offering yield significantly, for example, from 6 percent to 6.25 percent, to place the final $10 million with the marginal buyer. In contrast, with MTNs the company could raise $90 million by posting a yield of 6 percent; to raise the additional $10 million, the company could increase its MTN offering rates or issue at a different maturity. Consequently, because all of the debt does not have to be priced to the marginal buyer, financing costs can be lower with MTNs.
The Flexibility of MTNs
Even if conventional bonds enjoy an interest cost advantage, this advantage may be offset by the flexibility that MTNs afford. Offerings of investment-grade straight bonds are clustered at standard maturities of two, three, five, seven, ten, and thirty years. Also, because the fixed costs fixed costs,
n.pl the costs that do not change to meet fluctuations in enrollment or in use of services (e.g., salaries, rent, business license fees, and depreciation). of underwritings make small offerings impractical, corporate bond offerings rarely amount to less than $100 million. These institutional conventions impede im·pede
tr.v. im·ped·ed, im·ped·ing, im·pedes
To retard or obstruct the progress of. See Synonyms at hinder1.
[Latin imped corporations from implementing a financing policy of matching the maturities of assets with those of liabilities. By contrast, drawdowns from MTN programs over the course of a month typically amount to $30 million, and these drawdowns frequently have different maturities and special features that are tailored to meet the needs of the borrower. This flexibility of the MTN market allows companies to match more closely the maturities of assets and liabilities.
The flexibility of continuous offerings also plays a role in a corporation's decision to finance with MTNs. With MTNs, a corporation can "average out" its cost of funds Cost of Funds
The interest rate paid on an outstanding loan.
Money isn't free! Cost of funds is the cost of borrowing money.
See also: Interest Rate
Cost of funds
Interest rate associated with borrowing money. by issuing continuously rather than coming to market on a single day. Therefore, even if bond offerings have lower average yields, a risk-averse Risk-averse
Describes an investor who, when faced with two investments with the same expected return but different risks, prefers the one with the lower risk. borrower might still elect to raise funds in the MTN market with several offerings in a range of $5 million to $10 million over several weeks, rather than with a single $100 million bond offering.
The flexibility of the MTN market also allows borrowers to take advantage of funding opportunities. By having an MTN program, an issuer can raise a sizable siz·a·ble also size·a·ble
Of considerable size; fairly large.
siza·ble·ness n. amount of debt in a short time; often, the process takes less than half an hour. Bonds may also be sold from a shelf registration, but the completion of the transaction may be delayed by the arrangement of a syndicate Syndicate
organized crime unit throughout major cities of the United States. [Am. Hist.: NCE, 2018]
See : Gangsterism , the negotiation of an underwriting agreement Underwriting agreement
The contract between a corporation issuing new publicly offered securities and the managing underwriter as agent for the underwriting group. Compare to agreement among underwriters. , and the
"pre-selling" of the issue to investors. Furthermore, some corporations require that underwritten offerings Underwritten offering
A purchase and sale. receive prior approval by the president of the company or the board of directors. In contrast, a corporate treasurer may finance with MTNs without delay and at his or her discretion.(9)
1. Marked by, exercising, or showing prudence and wise self-restraint in speech and behavior; circumspect.
2. Free from ostentation or pretension; modest. Funding with MTNs
The MTN market also provides corporations with the ability to raise funds discreetly dis·creet
1. Marked by, exercising, or showing prudence and wise self-restraint in speech and behavior; circumspect.
2. Free from ostentation or pretension; modest. because the issuer, the investor, and the agent are the only market participants that have to know about a primary transaction. In contrast, the investment community obtains information about underwritten bond offerings from a variety of sources.
Corporations often avoid the bond market in periods of heightened uncertainty about interest rates and the course of the economy, such as the period after the 1987 stock market crash. Underwritings at such times could send a signal of financial distress Financial distress
Events preceding and including bankruptcy, such as violation of loan contracts. to the market. Similarly, corporations in distressed industries, such as commercial banking in the second half of 1990, can use the MTN market to raise funds quietly rather than risk negative publicity in the high profile bond market. Thus, during periods of financial turmoil, the discreet nature of the MTN market makes it an attractive alternative to the bond market.
"Reverse Inquiry" in the MTN market
Another advantage of MTNs is that investors often play an active role in the issuance process through the phenomenon known as "reverse inquiry." For example, suppose an investor desires to purchase $15 million of A-rated finance company debt with a maturity of six years and nine months. While such a security may not be available in the corporate bond market, the investor may be able to obtain it in the MTN market through reverse inquiry. In this process, the investor relays the inquiry to an issuer of MTNs through the issuer's agent. If the issuer finds the terms of the reverse inquiry sufficiently attractive, it may agree to the transaction even if it was not posting rates at the maturity that the investor desires.
According to market participants, trades that stem from reverse inquiries account for a significant share of MTN transactions. Reverse inquiry not only benefits the issuer by reducing borrowing costs but also allows investors to use the flexibility of MTNs to their advantage. In response to investor preferences, MTNs issued under reverse inquiry often include embedded options Embedded Option
An option that is an inseparable part of another instrument. Compare this to a normal (or bare) option, which trades separately from the underlying security.
A common embedded option is the call provision in most corporate bonds. and frequently pay interest according to unusual formulas. This responsiveness of the MTN market to the needs of investors is one of the most important factors driving the growth and acceptance of the market.
THE FEDERAL RESERVE BOARD'S SURVEY
OF U.S. CORPORATE MTNS
The Federal Reserve surveys U.S. corporations with MTN programs. These companies provide data on a confidential basis on the amount of MTNs they issue; respondents In the context of marketing research, a representative sample drawn from a larger population of people from whom information is collected and used to develop or confirm marketing strategy. report monthly, quarterly, or annually depending on how active they are in the market. At year-end, all MTN issuers are asked to provide data on the amount of their outstandings. The data on gross issuance begin in January 1983, and the data on outstandings have been collected since year-end 1989. The Federal Reserve obtains information on new programs from announcements of SEC Rule 415 registrations and contacts with MTN agents.
Because the participation rate in the Federal Reserve survey is 100 percent, it provides an accurate measure of the volume of MTN financing by U.S. corporations in the U.S. public market. However, while the U.S. corporate sector is the largest segment of the MTN market, MTNs have been issued in other markets and by non-U.S. corporations. For example, several U.S. corporations have issued MTNs in the Euro-market. Also, the survey does not include MTNs issued in the U.S. public market by government-sponsored agencies, such as the Federal National Mortgage Association, by supranational institutions, and by non-U.S. corporations. Furthermore, although the database includes MTNs issued by bank holding companies, it does not include deposit notes and bank notes offered by banks because these securities are exempt from SEC registration. Perhaps most important, the database does not include privately placed MTNs. The private placement market is particularly attractive to issuers who wish to gain access to U.S. investors without having to obtain SEC approval for a public offering. According to MTN agents, non-U.S. corporations are the largest borrowers in the market for privately placed MTNs. Because the financing costs are usually lower in the public market than in the less liquid private market, most U.S. corporations choose to issue public, SEC-registered MTNs.
Issuance Volume and Industry of the Issuers
From 1983 through 1992, the volume of MTN issuance in the public market increased in each year, rising from $5.5 billion in 1983 to $74.2 billion in 1992, and totaled $330 billion over the ten-year period (table 3). Similarly, the number of borrowers increased from 12 in 1983 to 208 in 1992, and totalled 402 corporations for the period (table 3).
[TABULAR DATA OMITTED]
Borrowers in the MTN market span a wide array of industry groups. In the financial sector, major borrowers include auto finance companies, bank holding companies, business and consumer credit institutions, and securities brokers. In the nonfinancial sector, participants in the MTN market include utilities, telephone companies, manufacturers, service firms, and wholesalers and retailers. Within industry groups, the auto finance companies have been the heaviest borrowers, raising $88 billion over the period. In relative terms, however, issuance by auto finance companies declined from an 87 percent share of the MTN market in 1983 to 18 percent in 1992.
In the early to mid-1980s, financial companies dominated the MTN market. Indeed, in 1983, only two nonfinancial companies issued MTNs, and they accounted for less than 1 percent of the issuance volume. In recent years, however, nonfinancial companies have increased their share of the market, and from 1990 through 1992, they accounted for about one-third of MTN issuance.
The increase in the volume of MTN issuance reflects a dramatic increase in the number of new borrowers in the market. In each year from 1984 through 1992, at least twenty companies issued MTNs for the first time, and most of the new entrants have been nonfinancial companies. In 1991, for example, sixty-six new borrowers entered the market, of which fifty-five were nonfinancial companies. As a result of this trend, in each year beginning in 1990, the total number of nonfinancial firms issuing MTNs has exceeded the total number of financial issuers.
The Volume of Corporate MTNs Outstanding
and the Components of Net Borrowing
Outstanding MTNs and issuer use of MTN programs have increased sharply since 1989. In the aggregate, outstanding MTNs increased from $76 billion in 1989 to $176 billion in 1992 (table 4). Over this period, outstandings of nonfinancial firms increased from $18.5 billion to $67.6 billion, while outstandings of financial corporations increased from $57.5 billion to $108.2 billion. For individual firms, outstandings of MTNs averaged $504 million in 1992, compared with $350 million in 1989.
4. Medium-term notes outstanding, 1989-92 Millions of dollars Year-end Market sector 1989 1990 1991 1992 Total outstanding 76,016 100,040 142,316 175,782 Financial 57,505 69,146 89,823 108,180 Nonfinancial 18,511 30,894 52,493 67,602 Average outstanding 350 383 453 504 Financial 504 591 788 925 Nonfinancial 180 215 262 291
The data on net borrowing, that is, the year-over-year change in outstandings, can be dissected dis·sect·ed
1. Botany Divided into many deep, narrow segments: dissected leaves.
2. Geology Cut by irregular valleys and hills.
Adj. 1. to determine the sources of growth in the market. For the market as a whole, new entrants accounted for about one-third of net borrowing in 1990, one-fourth of net borrowing in 1991, and less than one-fifth in 1992 (table 5). Thus, firms that had already issued MTNs accounted for most of the recent growth in the market. In the financial sector, in particular, new entrants accounted for only a small proportion of the growth, simply because a large share of the financial firms that could enter the MTN market did so in the 1980s. Among nonfinancial firms, in contrast, new entrants have continued to fuel a significant share of the growth in the market.
5. Analysis of net borrowing in the corporate medium-term note market, 1990-92 Millions of dollars Year over year Net borrowing, by type of borrower 1990 1991 1992 Total net borrowing All U.S. corporations 24,024 42,275 33,466 Financial 11,641 20,677 18,357 Nonfinancial 12,382 21,599 15,109 Net borrowing by new entrants All U.S. corporations 8,070 9,711 5,983 Financial 2,341 1,926 526 Nonfinancial 5,729 7,785 5,457 Net borrowing by existing issuers All U.S. corporations 15,953 32,565 27,482 Financial 9,300 18,751 17,831 Nonfinancial 6,653 13,814 9,652 Memo: Ratio of net borrowing by new entrants to total net borrowing All U.S. corporations .336 .230 .179 Financial .201 .093 .029 Nonfinancial .463 .360 .361
The corporations issuing MTNs have had high credit ratings. Since 1983, more dun 99 percent of MTNs have been rated investment grade (Baa or higher) at the time of issuance (table 6). In 1992, $51 billion of the $74 billion in MTN offerings were rated single A, and six firms, issuing a total of $540 million, had Ba ratings. Outstanding MTNs also tend to have high credit ratings, but not as high as the ratings on new offerings because of the preponderance pre·pon·der·ance also pre·pon·der·an·cy
Superiority in weight, force, importance, or influence.
Noun 1. preponderance of rating downgrades in recent years. Nevertheless, 98 percent of outstanding MTNs were rated investment grade at year-end 1992 (table 7).
[TABULAR DATA OMITTED]
Maturities and Yield Spreads
Maturities on MTNs reflect the financing needs of the borrowers. Financial firms tend to issue MTNs with maturities matched to the maturity of loans made to their customers. Consequently, in the financial sector, maturities are concentrated in a range of one to five years, and only a small proportion are longer than ten years (chart 1). Nonfinancial firms, in contrast, often use MTNs to finance long-lived assets, such as plant and equipment. As a result, maturities on MTNs issued by nonfinancial corporations cover a wider range, and in 1992, 25 percent to 30 percent were longer than ten years.
Yields on fixed-rate MTNs, commonly quoted as a yield spread over a Treasury security of comparable maturity, reflect the credit risk of the borrower. Other factors held constant, Baa-rated MTNs have higher yield spreads than A-rated MTNs, which in turn have higher yield spreads than Aa-rated MTNs (chart 2). Yield spreads also vary over time, particularly over the course of the business cycle. Spreads on A-rated MTNs increased from 60 basis points over Treasury securities in July 1990, a cyclical cyclical
Of or relating to a variable, such as housing starts, car sales, or the price of a certain stock, that is subject to regular or irregular up-and-down movements. trough Trough
The stage of the economy's business cycle that marks the end of a period of declining business activity and the transition to expansion. , to 140 basis points in January 1991.(10)
The Relative Size of the MTN market
The MTN market accounts for a significant share of borrowing by U.S. corporations. One measure of the size of the market is the ratio of outstanding MTNs to the amount of outstanding public debt (MTNs plus public corporate bonds). According to this definition of market share, MTNs accounted for 16 percent of public corporate debt in 1992, compared with 9 percent in 1989 (table 8). This ratio understates the size of the MTN market, however, because the market is still relatively new, and outstandings are growing rapidly.
[TABULAR DATA OMITTED]
An alternative measure of the size of the market is the volume of investment-grade MTN issuance as a percentage of total investment-grade debt issuance (MTNs plus underwritten straight bonds). By this definition, the share of investment-grade debt issued as MTNs rose from 18 percent in 1983 to a peak of 42 percent in 1990 (table 9). In 1992, the ratio fell to 37 percent, a decline that mainly reflects the heavy volume of refinancing Refinancing
An extension and/or increase in amount of existing debt. in the corporate bond market, especially in the nonfinancial sector. This ratio of debt issuance may overestimate o·ver·es·ti·mate
tr.v. o·ver·es·ti·mat·ed, o·ver·es·ti·mat·ing, o·ver·es·ti·mates
1. To estimate too highly.
2. To esteem too greatly. the size of the MTN market because MTNs typically have shorter maturities than corporate bonds.
[TABULAR DATA OMITTED]
MTNs represent an increasingly important source of credit to nonfinancial corporations, as companies have shifted funding from alternative credit markets. In general, nonfinancial corporations that borrow in the MTN market have access to other major credit markets: corporate bonds, commercial paper, bank loans, and privately placed bonds. From 1989 through 1992, net borrowing by nonfinancial corporations in the MTN market increased $49 billion, while borrowing in the other four markets increased an estimated $102 billion (table 10). Notably, corporate borrowing in the public bond market rose $100 billion, while borrowing at banks fell $35 billion. The shift to long-term financing Long-term financing
Liabilities repayable in more than one year plus equity. (MTNs and bonds) over this period is a typical, cyclical phenomenon that occurs in periods of slow economic growth and falling long-term interest rates. However, some of the growth of the MTN market reflects a secular decline in the role of banks as financial intermediaries.
10. Funding by nonfinancial corporations in major domestic credit markets, 1989-92 Billions of dollars Outstandings at year-end Net change from Market 1989 1992 1989 to 1992 Medium-term notes 18.5 67.6 49.1 Public bonds 607.5 707.9 100.3 Commercial paper 107.1 108.3 1.2 Bank loans 553.5 518.8 -34.7 Privately placed bonds 265.0 300.0 35.0 Source. For all series except public bonds, Federal Reserve Board; for public bonds, Moody's Investors Service.
IN THE MTN MARKET
In recent years several changes have occurred in the MTN market as a result of innovations in other capital markets. Among the most important changes in the MTN market are the increasing use of "structured" MTNs, the increasing participation by banking organizations in the market, and the development of a system for book-entry clearing and settlement of MTN transactions. Also, foreign corporations have begun to use the MTN market more frequently since the adoption of SEC Rule 144A Rule 144A
A Securities & Exchange Commission rule modifying a two-year holding period requirement on privately placed securities to permit qualified institutional buyers to trade these positions among themselves. in April 1990.
In recent years, an increasing share of MTNs have been issued as part of structured transactions. In a structured MTN, a corporation issues an MTN and simultaneously enters into one or several swap agreements to transform the cash flows that it is obligated ob·li·gate
tr.v. ob·li·gat·ed, ob·li·gat·ing, ob·li·gates
1. To bind, compel, or constrain by a social, legal, or moral tie. See Synonyms at force.
2. To cause to be grateful or indebted; oblige. to make. The simplest type of structured MTN involves a "plain vanilla Refers to the bare minimum of functions that are known to be available in an application or system. Contrast with bells and whistles. " interest rate swap Interest Rate Swap
A deal between banks or companies where borrowers switch floating-rate loans for fixed rate loans in another country. These can be either the same or different currencies. . In such a financing, a corporation might issue a three-year, floating-rate MTN that pays LIBOR LIBOR
See: London Interbank Offered Rate
See London interbank offered rate (LIBOR). plus a premium semiannually sem·i·an·nu·al
Occurring or issued twice a year.
semi·an . At the same time, the corporation negotiates a swap transaction in which it agrees to pay a fixed rate of interest semiannually for three years in exchange for receiving LIBOR from a swap counterparty Counterparty
The other participant, including intermediaries, in a swap or contract. . As a result of the swap, the borrower has synthetically created a fixed-rate note because the floating-rate payments are offsetting. (See the box for an outline of this transaction.)
At first glance, structured transactions seem needlessly need·less
Not needed or wished for; unnecessary.
need complicated. A corporation could simply issue a fixed-rate MTN. However, as a result of the swap transaction, the corporation may be able to borrow at a lower rate than it would pay on a fixed-rate note. Indeed, most MTN issuers decline to participate in structured financings unless they reduce borrowing costs at least 10 or 15 basis points. Issuers demand this compensation because, compared with conventional financings, structured financings involve additional expenses, such as legal and accounting costs and the cost of evaluating and monitoring the credit risk of the swap counterparty. For complicated structured transactions, most issuers require greater compensation.
Many structured transactions originate o·rig·i·nate
1. To bring into being; create.
2. To come into being; start. with investors through a reverse inquiry. This process begins when an investor has a demand for a security with specific risk characteristics. The desired security may not be available in the secondary market, and regulatory restrictions or bylaws The rules and regulations enacted by an association or a corporation to provide a framework for its operation and management.
Bylaws may specify the qualifications, rights, and liabilities of membership, and the powers, duties, and grounds for the dissolution of an prohibit pro·hib·it
tr.v. pro·hib·it·ed, pro·hib·it·ing, pro·hib·its
1. To forbid by authority: Smoking is prohibited in most theaters. See Synonyms at forbid.
2. some investors from using swaps, options, or futures to create synthetic securities. Through a reverse inquiry, an investor will use MTN agents to communicate its desires to MTN issuers. If an issuer agrees to the inquiry, the investor will obtain a security that is custom-tailored to its needs. The specific features of these transactions vary in response to changes in market conditions and investor preferences. For example, in 1991 many investors desired securities with interest rates that varied inversely in·verse
1. Reversed in order, nature, or effect.
2. Mathematics Of or relating to an inverse or an inverse function.
3. Archaic Turned upside down; inverted.
1. with short-term market interest rates. In response to investor inquiries, several corporations issued "inverse (mathematics) inverse - Given a function, f : D -> C, a function g : C -> D is called a left inverse for f if for all d in D, g (f d) = d and a right inverse if, for all c in C, f (g c) = c and an inverse if both conditions hold. floating-rate" MTNs that paid an interest rate of, for example, 12 percent minus LIBOR. At the time of the transaction, the issuers of inverse floating-rate MTNs usually entered into swap transactions to eliminate their exposure to falling interest rates.
While structured transactions in the MTN market often originate with investors, investment banks also put together such transactions. Most investment banks have specialists in derivative derivative: see calculus.
In mathematics, a fundamental concept of differential calculus representing the instantaneous rate of change of a function. products who design securities to take advantage of temporary market opportunities. When an investment bank identifies an opportunity, it will inform investors and propose that they purchase a specialized spe·cial·ize
v. spe·cial·ized, spe·cial·iz·ing, spe·cial·iz·es
1. To pursue a special activity, occupation, or field of study.
2. security. If an investor tentatively ten·ta·tive
1. Not fully worked out, concluded, or agreed on; provisional: tentative plans.
2. Uncertain; hesitant. agrees to the transaction, the MTN agents in the investment bank will contact an MTN issuer with the proposed structured transaction.
Most investors require that issuers of structured MTNs have triple-A or double-A credit ratings. By dealing with highly rated issuers, the investor reduces the possibility that the value of the structured MTN will vary with the credit quality of the issuer. In limiting credit risk, the riskiness of the structured MTN mainly reflects the specific risk characteristics that the investor prefers.(11) Consequently, federal agencies and supranational institutions, which have triple-A ratings, issue a large share of structured MTNs. The credit quality profile of issuers of structured MTNs has changed slightly in recent years, however, as some investors have become more willing to purchase structured MTNs from single-A corporations. In structured transactions with lower-rated borrowers, the investor receives a higher promised yield as compensation for taking on greater credit risk.
Market participants estimate that structured MTNs accounted for 20 percent to 30 percent of MTN volume in the first half of 1993, compared with less than 5 percent in the late 1980s. The growth of structured MTNs highlights the important role of derivative products in linking various domestic and international capital markets. Frequently, the issuers of structured MTNs are located in a different country from that of the investors.
The increasing volume of structured transactions is testimony to the flexibility of MTNs. When establishing MTN programs, issuers build flexibility into the documentation that will allow for a broad range of structured transactions. Once the documentation is in place, an issuer is able to reduce borrowing costs by responding quickly to temporary opportunities in the derivatives market. The flexibility of MTNs is also evident in the wide variety of structured MTNs that pay interest or repay principal according to unusual formulas. Some of the common structures include the following: (1) floating-rate MTNs tied to the federal funds rate Federal Funds Rate
The interest rate at which a depository institution lends immediately available funds (balances at the Federal Reserve) to another depository institution overnight. , LIBOR, commercial paper rates, or the prime rate, many of which have included caps or floors on rate movements; (2) step-up MTNs, the interest rate on which increases after a set period; (3) LIBOR differential notes, which pay interest tied to the spread between, say, deutsche mark LIBOR and French franc LIBOR; (4) dual currency MTNs, which pay interest in one currency and principal in another; (5) equity-linked MTNs, which pay interest according to a formula based on an equity index, such as the Standard & Poor's 500 or the Nikkei; and (6) commodity-linked MTNs, which have interest tied to a price index or to the price of specific commodities such as oil or gold. The terms and features of structured MTNs continue to evolve in response to changes in the preferences of investors and developments in financial markets.
Banking organizations are major participants in the MTN market. Like other corporations, bank holding companies must file registration documents with the SEC when issuing public securities. Consequently, the Federal Reserve survey captures MTNs issued by bank holding companies. Over the ten-year survey period, thirty-five bank holding companies raised funds in the MTN market, and from 1989 to 1992, outstanding MTNs of bank holding companies increased from $8.3 billion to $17.9 billion. Although most of these MTNs have senior status in relation to other debt outstanding, a few bank holding companies have issued subordinated MTNs. Subordinated MTNs of bank holding companies typically have long maturities of about ten years. Under regulatory capital requirements Capital requirements
Financing required for the operation of a business, composed of long-term and working capital plus fixed assets. , subordinated debt Subordinated Debt
A loan (or security) that ranks below other loans (or securities) with regard to claims on assets or earnings. Also known as "junior security" or "subordinated loan". with a maturity of five years or longer qualifies as tier 2 capital Tier 2 Capital
A term used to describe the capital adequacy of a bank. Tier II capital is secondary bank capital that includes items such as undisclosed reserves, general loss reserves, subordinated term debt, and more.
This is related to Tier 1 Capital. .
In contrast to public offerings by bank holding companies, securities issued by banks are exempt from registration under section 3(a)2 of the Securities Act of 1933. In recent years, a growing number of banks have issued exempt securities Exempt securities
Instruments exempt from the registration requirements of the Securities Act of 1933 or the margin requirements of the SEC Act of 1934. Such securities include government bonds, agencies, munis, commercial paper, and private placements. , called bank notes, that have characteristics in common with certificates of deposit (CDs), MTNs, and short-term bonds.
Like CDs, most bank notes are senior, unsecured debt Unsecured debt
Debt that does not identify specific assets that the debtholder is entitled to in case of default. obligations issued by the bank. In the event of the insolvency insolvency
Condition in which liabilities exceed assets so that creditors cannot be paid. It is a financial condition that often precedes bankruptcy. In the context of equity, insolvency is the inability to pay debts as they become due; insolvency under the balance-sheet of the issuing institution, bank notes are likely to rank equal with deposits, except in states where deposits have priority over other debt obligations. As with institutional CDs, nearly all bank notes are sold to institutional investors Institutional Investor
A non-bank person or organization that trades securities in large enough share quantities or dollar amounts that they qualify for preferential treatment and lower commissions. in minimum denominations of $250,000 to $1 million. Bank notes are not covered not covered Health care adjective Referring to a procedure, test or other health service to which a policy holder or insurance beneficiary is not entitled under the terms of the policy or payment system–eg, Medicare. Cf Covered. by FDIC FDIC
See: Federal Deposit Insurance Corporation
See Federal Deposit Insurance Corporation (FDIC). insurance, nor are they subject to FDIC insurance assessments. CDs, in contrast, are insured for $100,000 per depositor. Furthermore, in the event of a bank failure, the FDIC could choose to protect the financial interests of some or all depositors or other creditors without treating bank notes in the same manner.
Like MTNs, bank notes may be offered continuously or intermittently in relatively small amounts that typically range from $5 million to $25 million. In addition, as with MTNs, most medium-term bank notes have maturities that range from one to five years.(12) However, ratings on senior bank notes are typically one notch notch (noch) incisure; an indentation on the edge of a bone or other organ.
aortic notch dicrotic n.
1. higher than the ratings on senior MTNs, which are issued at the holding company level. Reflecting these differences in ratings and priority in the firms' capital structures, the yields on banks notes usually are significantly lower than the yields on MTNs of comparable maturity.
Some bank notes, which are similar to corporate bonds, are sold in large, underwritten, discrete offerings that range from $50 million to $1 billion. However, they differ from corporate bonds in that they are not registered with the SEC. From 1988 through 1992, banks issued $14.3 billion of underwritten, senior bank notes, including $7.8 billion in 1992. In the first half of 1993, they issued $6.3 billion.
Book-Entry Clearing and Settlement of MTNs
In the early and mid-1980s, high administrative costs administrative costs,
n.pl the overhead expenses incurred in the operation of a dental benefits program, excluding costs of dental services provided. deterred some issuers from establishing MTN programs. Among the most significant of the administrative costs were those arising from transferring physical securities to investors. These costs included printing, delivery, safekeeping Safekeeping
The storage of assets or other items of value in a protected area.
Individuals may use self-directed methods of safekeeping or the services of a bank or brokerage firm. , messengers, insurance, and recordkeeping. Moreover, issuers incurred significant costs in the disbursement DISBURSEMENT. Literally, to take money out of a purse. Figuratively, to pay out money; to expend money; and sometimes it signifies to advance money.
2. of interest and principal payments to each individual noteholder. According to market estimates, the direct costs of transferring physical securities range from $5 to $30 per transaction. For small offerings, the costs of physical delivery can add significantly to the all-in cost of borrowing. As a result, many issuers refused to sell MTNs in denominations of less than $1 million.
Since 1988, the costs of clearing and settlement of MTNs have decreased substantially as a computer-based system of book-entry recordkeeping has supplanted physical certificates. When an MTN is issued under the book-entry system, an agent bank for the issuer uses a computer link with The Depository Trust Company Depository Trust Company (DTC)
DTC is the world's largest central securities depository. It accepts deposits of over 2 million equity and debt securities issues (valued at $23 trillion) from over 65 countries for custody, executes book-entry deliveries (valued at over $116 trillion (DTC DTC
See: Depository Transfer Check
See: Depository Trust Company
See Depository Trust Company (DTC). ) to enter the descriptive information and settlement details of the transaction. The sales agent receives a copy of the computer record from DTC, and the investor receives a trade confirmation from the sales agent and periodic ownership statements from the custodian bank Custodian bank
Applies mainly to international equities. Bank or other financial institution that keeps custody of stock certificates and other assets of a mutual fund, individual, or corporate client. See: Depository Trust Company (DTC) , in lieu of Instead of; in place of; in substitution of. It does not mean in addition to. physical certificates. Secondary market trades are likewise recorded with computer entries. Under the book-entry system, an issuer makes one wire transfer to DTC that covers all interest payments on each interest payment date. This payment process contrasts with the process for physical certificates in which issuers make separate payments to each investor. Similarly, under the book-entry system, when the MTN matures, the issuer makes only one funds transfer to DTC. The DTC book-entry process costs $4 for each issuance, and each participant in a transaction pays between $1.29 and $1.54 for subsequent deliveries in the primary and secondary markets. Besides reducing the direct cost of issuance, the book-entry system also lowers the likelihood of delayed delivery delayed delivery
Delivery of a certificate after the day on which delivery would occur with a regular-way contract. Delayed delivery is sometimes specified by the seller when the order to sell is entered. See also seller's option contract. because of logistical lo·gis·tic also lo·gis·ti·cal
1. Of or relating to symbolic logic.
2. Of or relating to logistics.
[Medieval Latin logisticus, of calculation problems and reduces the chances of failed trades arising from paperwork errors.
Book entry has become the preferred method of clearing and settlement in the MTN market. According to DTC, issuance of book-entry MTNs rose from $600 million in 1988 to $80 billion in 1992 (table 11). Moreover, outstanding MTNs under the book-entry system amounted to $160 billion at year-end 1992, a total that includes 16,495 individual securities.(13)
11. Issuance and outstandings of book entry medium-term notes, 1988-1993:Ql End of period Issuance volume Principal Period (billions of amount Number of Number of dollars) outstanding issuers issues (billions of dollars) 1988 0.6 0.6 5 136 1989 15.6 16.2 138 2,001 1990 37.3 51.4 225 6,670 1991 66.5 106.2 368 12,660 1992 80.2 159.8 451 16,495 1993: Q1 25.4 177.8 484 17,254 Source. The Depository Trust Company.
Borrowing by Foreign Entities in the MTN
Market and SEC Rule 144A(14)
In the 1980s, SEC disclosure requirements associated with public offerings discouraged dis·cour·age
tr.v. dis·cour·aged, dis·cour·ag·ing, dis·cour·ag·es
1. To deprive of confidence, hope, or spirit.
2. To hamper by discouraging; deter.
3. foreign corporations from issuing MTNs in the U.S. public market. For foreign corporations, the most burdensome requirement is that financial statements conform to Verb 1. conform to - satisfy a condition or restriction; "Does this paper meet the requirements for the degree?"
coordinate - be co-ordinated; "These activities coordinate well" U.S. generally accepted accounting principles The standard accounting rules, regulations, and procedures used by companies in maintaining their financial records.
Generally accepted accounting principles (GAAP) provide companies and accountants with a consistent set of guidelines that cover both broad accounting . Most foreign issuers would have to incur To become subject to and liable for; to have liabilities imposed by act or operation of law.
Expenses are incurred, for example, when the legal obligation to pay them arises. An individual incurs a liability when a money judgment is rendered against him or her by a court. considerable legal and accounting expenses to meet this requirement, and many would have to disclose more information about their operations than is required in their home markets. The expense of registering securities and satisfying ongoing reporting requirements has also deterred foreign entities from borrowing in the U.S. market. Foreign issuers could avoid the costs of a public offering by selling MTNs in the U.S. private placement market. However, yields on most private placements included an illiquidity premium resulting from regulatory restrictions on trading.
The adoption of SEC Rule 144A in April 1990 effectively created an alternative market in which foreign corporations could gain access to U.S. investors without having to satisfy the disclosure requirements for public offerings. Rule 144A allows institutional investors to trade private placements among themselves with few restrictions. To protect less sophisticated investors, the SEC requires that 144A securities be sold only to "qualified institutional buyers In law, a Qualified Institutional Buyer is a purchaser of securities that is financially sophisticated and is legally recognized by security market regulators to need less protection from sellers than most members of the public. ," which own and invest in a minimum of $100 million in securities. This definition is broad enough to include most of the institutions that buy MTNs, such as banks and bank trust departments, insurance companies, pension funds, mutual funds, investment advisers, and state and local governments.(15) A foreign issuer of a 144A security must provide, upon demand by a security holder or potential purchaser, a brief description of the business and financial statements for the three most recent fiscal years, which can be in the accounting format used in the issuer's home country. Privately placed MTNs are an example of a security that may be eligible for resale under Rule 144A.
Since the adoption of Rule 144A, issuance of MTNs by foreign corporations in the U.S. private market has increased markedly. According to the Securities Data Corporation, issuance increased from $2.2 billion in 1990 to $10 billion in 1992. In general, MTNs issued by foreign corporations under Rule 144A have similar characteristics to those sold by U.S. corporations in the public market. Both typically are dollar denominated and investment grade, with standard covenants.
DEVELOPMENTS IN THE DISTRIBUTION
In the early and mid-1980s, the major difference between MTNs and corporate bonds was in their primary method of distribution: Typically, agents placed MTNs in relatively small amounts continuously or intermittently, while underwriters placed large, discrete amounts of corporate bonds. This strict classification no longer applies, however. A growing number of MTN offerings have the characteristics of traditional corporate bonds, and regional dealers now sell a significant percentage of MTNs. Thus, as the MTN market has matured, it has become harder to define the securities and to describe their mode of distribution.
One important change in the distribution process is that a larger share of MTNs are now sold on a principal basis, rather than on an agented basis. In a principal transaction, the MTN dealer purchases an MTN for its own account and later resells it to investors. In a "riskless principal Riskless Principal
Two principal transactions occurring at the same price that are reported only once as an agency transaction.
This is a principal transaction that synthesizes an agency transaction by removing the risks involved with holding a position. " transaction, when the dealer buys the MTN, it has already lined up an investor that has agreed to the terms of the resale. Riskless principal transactions often involve structured MTNs. In other principal transactions, dealers underwrite MTNs when they have not lined up investors but expect to do so easily and quickly.
Large, Discrete Offerings
Corporations now more often sell MTNs that are nearly indistinguishable from corporate bond offerings. These MTN offerings typically have large face amounts of $100 million or more, the typical size of corporate bond offerings. They are sold on an underwritten basis, and they often have relatively long maturities of ten or thirty years. Furthermore, announcements of such offerings appear along with announcements of corporate bond offerings in financial publications. In 1992, thirty-one corporations issued $7.14 billion of MTNs in large, discrete, underwritten offerings, compared with less than $1 billion between 1983 and 1989 (chart 3).
Despite the similarities to corporate bonds, these large, discrete, underwritten securities technically are MTNs because they are issued from MTN shelf registrations. To most investors, this technical difference is largely irrelevant because the securities have the essential features of corporate bonds. As a result, the securities reportedly do not command a yield premium relative to the yield on corporate bonds.
As large, discrete offerings of MTNs have become more common, the distinction between MTNs and corporate bonds has blurred blur
v. blurred, blur·ring, blurs
1. To make indistinct and hazy in outline or appearance; obscure.
2. To smear or stain; smudge.
3. . As a result, the arguments for financing with MTNs have become more compelling. By setting up an MTN program, a corporation does not give up the advantages of issuing large, underwritten securities that typically would be accomplished with a corporate bond offering. However, unlike a shelf registration for corporate bonds, an MTN program gives the corporation the flexibility to issue in small amounts continuously and to participate more actively in structured transactions.
Distribution through Regional Dealers
Through the mid-1980s, the major New York New York, state, United States
New York, Middle Atlantic state of the United States. It is bordered by Vermont, Massachusetts, Connecticut, and the Atlantic Ocean (E), New Jersey and Pennsylvania (S), Lakes Erie and Ontario and the Canadian province of investment banks distributed nearly all MTNs to investors. As the market has matured, regional dealers have placed an increasing volume of MTNs. According to market estimates, placements through regional dealers now account for 5 to 15 percent of MTN issuance volume. In these placements, regional dealers receive information about issuers' offering rate schedules from MTN agents. In turn, the regional dealers communicate this information to their investor clients. When an investor buys an MTN through a regional dealer, the regional dealer receives a selling concession Selling concession
The discount underwriters offer the selling group on securities in a new issue.
See concession. from the MTN agent. Placements through regional dealers improve efficiency in the market by broadening the investor base for MTNs. Many regional dealers have contacts with smaller institutional investors, such as small banks, municipalities, and individuals with high net worth, that represent a relatively stable source of funding.
Distribution of MTNs with Small
Denominations to "Retail" Investors
When the market first developed, most MTNs were sold primarily to institutional investors. Indeed, most MTN programs had minimum denominations of $100,000, which precludes small investors Small investor
An individual person investing in small quantities of stock or bonds. This group of investors makes up a minimal fraction of total stock ownership.
small investor , sometimes called retail investors Retail Investor
Individual investors who buy and sell securities for their personal account, and not for another company or organization.
Retail investors buy in much smaller quantities than larger institutional investors. , from purchasing MTNs. In addition, some issuers declined to issue MTNs in denominations below $1 million because bookkeeping bookkeeping, maintenance of systematic and convenient records of money transactions in order to show the condition of a business enterprise. The essential purpose of bookkeeping is to reveal the amounts and sources of the losses and profits for any given period. and administrative costs become more burdensome with smaller offerings. In recent years, however, book-entry clearing through DTC and advances in computer bookkeeping have decreased the cost of issuing in small denominations. As a result, many issuers have registered MTN programs with minimum denominations of $1,000, the standard in the corporate bond market. Although most MTNs are still sold to institutional investors, the lowering of minimum denominations has broadened the investor base to include smaller investors. Regional dealers place a significant proportion of the smaller offerings with small institutional investors.
Several MTN programs have recently been designed specifically to tap the retail market without significantly increasing the administrative costs to issuers. The process of issuing retail MTNs may differ slightly from that of MTNs sold to institutions. In one type of retail MTN program, an issuer will post rates weekly with retail brokers. For example, an issuer might post a rate of 4 percent for two-year MTNs and 5 percent for five-year MTNs. During the week that these rates are posted, regional brokerage firms market the securities to retail investors, who place orders in minimum denominations of $1,000. At the end of the week, the regional brokerage firms will contact the corporate issuer and indicate the aggregate volume of orders for notes at each maturity, and the corporation will issue one security at each maturity. In the example, several hundred retail investors could place orders for MTNs with maturities of two and five years, but the administrative costs for the corporate issuer would reflect only two issues from the shelf registration. While this system has the potential to broaden the investor base for MTNs, the size of the retail MTN market is still small relative to the institutional market.
Although the size of MTN offerings has always varied considerably, the variation has become wider as a result of developments in the distribution of MTNs. In 1992, the size of MTN offerings ranged from less than $5,000 to more than $500 million (chart 4). In terms of dollar volume, about 65 percent of MTNs had an issue size between $5 million and $100 million. However, several firms have issued a large volume of MTNs with denominations of less than $5 million. While these offerings account for less than 5 percent of the dollar volume of total proceeds, they represent 45 percent of the number of issues.
MTNs have become a major source of financing in international financial markets, particularly in the Euro-market. Like Euro-bonds, Euro-MTNs are not subject to national regulations, such as registration requirements.(16) Although Euro-MTNs and Euro-bonds can be sold throughout the world, the major underwriters and dealers are located in London, where most offerings are distributed.
Although the first Euro-MTN program was established in 1986, the market represented a minor source of financing throughout the 1980s. In the 1990s, the Euro-MTN market has grown at a phenomenal rate, with outstandings increasing from less than $10 billion in early 1990 to $68 billion in May 1993 (chart 5). New borrowers account for most of this growth, as a majority of the 190 entities that have established Euro-MTN programs did so in the 1990s. As in the U.S. market, flexibility is the driving force behind the rapid growth of the Euro-MTN market. Under a single documentation framework, an issuer with a Euro-MTN program has great flexibility in the size, currency denomination Denomination
The stated value found on financial instruments.
This term applies to most financial instruments with monetary values. The denomination for bonds and securities would be face value or par value. , and structure of offerings. Furthermore, reverse inquiry gives issuers of Euro-MTNs the opportunity to reduce funding costs by responding to investor preferences.
The characteristics of Euro-MTNs are similar, but not identical, to MTNs issued in the U.S. market. In both markets, most MTNs are issued with investment-grade credit ratings, but the ratings on Euro-MTNs tend to be higher. In 1992, for example, 68 percent of Euro-MTNs had Aaa or Aa ratings, compared with 13 percent of U.S. corporate MTNs. In both markets, most offerings have maturities of one to five years. However, offerings with maturities longer than ten years account for a smaller percentage of the Euro-market than of the U.S. market. In both markets, dealers have committed to provide liquidity in the secondary market, but by most accounts the Euro-market is less liquid.
In many ways, the Euro-MTN market is more diverse than the U.S. market. For example, the range of currency denominations of Euro-MTNs is broader, as would be expected. The Euro-market also accommodates a broader cross-section of borrowers, both in terms of the country of origin and the type of borrower, which includes sovereign countries, supranational institutions, financial institutions, and industrial companies. Similarly, Euro-MTNs have a more diverse investor base, but the market is not as deep as the U.S. market.
In several respects, the evolution of the Euro-MTN market has paralleled that of the U.S. market. Two of the more important developments have been the growth of structured Euro-MTNs and the emergence of large, discrete offerings. Structured transactions represent 50 percent to 60 percent of EURO-MTN issues, compared with 20 percent to 30 percent in the U.S. market. In the Euro-MTN market, many of the structured transactions involve a currency swap Currency Swap
A swap that involves the exchange of principal and interest in one currency for the same in another currency.
Currency swaps were originally done to get around the problem of exchange controls. in which the borrower issues an MTN that pays interest and principal in one currency and simultaneously agrees to a swap contract that transforms required cash flows to another currency. Most structured Euro-MTNs arise from investor demand for debt instruments that are otherwise unavailable in the public markets. To be able to respond to investor driven structured transactions, issuers typically build flexibility into their Euro-MTN programs. Most programs allow for issuance of MTNs with unusual interest payments in a broad spectrum of currencies and with a variety of options.
Large, discrete offerings of Euro-MTNs first appeared in 1991, and about forty of these offerings occurred in 1992. They are similar to Euro-bonds in that they are underwritten and are often syndicated using the fixed-price reoffering method. As a result of this development, the distinction between Euro-bonds and Euro-MTNs has blurred, just as the distinctions between corporate bonds and MTNs has blurred in the U.S. market.
The easing of regulatory restrictions by foreign central banks This is a list of central banks.
Contents A B C D E F G H I J K L M N O P Q R S T U V W Y Z has played an important role in the growth of the Euro-MTN market. For example, over the past year MTNs denominated in deutsche marks have emerged as a major sector in the Euro-market as a result of regulatory changes made by the Bundesbank in August 1992. Under the previous rules, foreign borrowers could only issue debt denominated in deutsche marks through German subsidiaries or other German financial firms, and maturities could not be shorter than two years. Debt denominated in deutsche marks also had to be listed on a German exchange, and these offerings were subject to German law, clearing, and payment procedures. These rules effectively precluded issuers from establishing multicurrency Euro-MTN programs with a deutsche mark option.
In the August 1992 deregulation Deregulation
The reduction or elimination of government power in a particular industry, usually enacted to create more competition within the industry.
Traditional areas that have been deregulated are the telephone and airline industries. , the Bundesbank removed the minimum maturity requirement on debt denominated in deutsche marks issued by foreign nonbanks, and it eliminated or simplified issuance procedures for all issuers. Although the new rules require that a "German bank" act as an arranger or dealer, the definition is broad enough to include German branches and subsidiaries of foreign banks. The arranger is required to notify the Bundesbank monthly of the volume and frequency of issues denominated in deutsche marks. As a result of the Bundesbank's deregulation, from 1991 to 1992, the share of Euro-MTN offerings denominated in deutsche marks increased from 1.4 percent to 4.8 percent, while the volume of issuance in deutsche marks rose from $268 million to $1.69 billion. Other central banks have instituted similar liberalizations that may result in rapid growth of MTNs denominated in other currencies, such as the Swiss franc Noun 1. Swiss franc - the basic unit of money in Switzerland
franc - the basic monetary unit in many countries; equal to 100 centimes
centime - a fractional monetary unit of several countries: France and Algeria and Belgium and Burkina Faso and Burundi and and the French franc.
OUTLOOK FOR THE MTN MARKET
Few innovations in finance have been as successful as the medium-term note. Its success derives from its remarkable adaptability a·dapt·a·ble
Capable of adapting or of being adapted.
a·dapta·bil to the needs of both borrowers and investors. The success can be measured by the number of borrowers, the diversity of note structures, and the amount of outstanding MTNs, all of which have increased dramatically over the past decade.
The adoption of SEC Rule 415 in 1982 was the key event that removed the regulatory impediments IMPEDIMENTS, contracts. Legal objections to the making of a contract. Impediments which relate to the person are those of minority, want of reason, coverture, and the like; they are sometimes called disabilities. Vide Incapacity.
2. to continuous offerings of corporate notes. Other regulatory changes, such as SEC Rule 144A and liberalizations by European central banks European Central Bank (ECB)
Bank created to monitor the monetary policy of the countries that have converted to the Euro from their local currencies. The original 11 countries are: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, , have been instrumental in the development of new sectors in the MTN market. As a result of these regulatory changes, financial markets have become more efficient. In 1992, the SEC eased restrictions on the types of securities eligible for shelf registration. As a result of this ruling, asset-backed MTNs may emerge as the next major growth sector in the public MTN market.
(1.) The Federal Reserve Board conducts a survey of borrowing by U.S. corporations in the public MTN market, the largest sector of the worldwide market. The Federal Reserve collects these data to improve its estimates of new securities issues of U.S. corporations, as published in the Federal Reserve Bulletin, and to improve estimates of corporate securities outstanding, as shown in the flow of funds Flow of funds
In the context of municipal bonds, refers to the statement displaying the priorities by which municipal revenue will be applied to the debt.
In the context of mutual funds, refers to the movement of money into or out of a mutual funds or between or among accounts. (2.) Material in this and the next two sections was originally presented in "Corporate Medium-Term Notes," Leland Crabbe, The Continental Bank Journal of Applied Corporate Finance, vol. 4 (Winter 1992), pp. 90-102. (3.) For example, MTNs have been callable Callable
Applies mainly to convertible securities. Redeemable by the issuer before the scheduled maturity under specific conditions and at a stated price, which usually begins at a premium to par and declines annually. , putable, and extendible; they have had zero coupons, step-down or step-up coupons, or inverse floating rates; and they have been foreign currency denominated or indexed, and commodity indexed. (4) The most common indexes for floating-rate MTNs are the following: the London interbank offered rate London Interbank Offered Rate
A short-term interest rate often quoted as a 1,3,6-month rate for U.S.dollars. (LIBOR), commercial paper, Treasury bills, federal funds Federal Funds
Funds deposited to regional Federal Reserve Banks by commercial banks, including funds in excess of reserve requirements.
These non-interest bearing deposits are lent out at the Fed funds rate to other banks unable to meet overnight reserve , and the prime rate. MTN programs typically give the issuer the option of making floating-rate interest payments monthly, quarterly, or semiannually. (5) SEC-registered MTNs have the broadest market because they have no resale or transfer restrictions and generally fit within an investor's investment guidelines guidelines,
n.pl a set of standards, criteria, or specifications to be used or followed in the performance of certain tasks. . (6) Financing strategies vary among the borrowers. Some corporate treasurers prefer to "go in for size" on one day with financings in the $50 million to $100 million range, reasoning that smaller offerings are more time consuming. Furthermore, a firm may be able to maintain a "scarcity value scarcity value n → valor m de escasez
scarcity value n → valeur f de rareté
scarcity value n → " for its debt by financing intermittently with large offerings, rather than continuously with small offerings. Other treasurers prefer to raise $50 million to $100 million over the course of several days with $2 million to $10 million drawdowns. These corporate treasurers argue that a daily drawdown Drawdown
The peak to trough decline during a specific record period of an investment or fund. It is usually quoted as the percentage between the peak to the trough.
Notes: of $50 million is an indication that they should have posted a lower offering rate. In regard to the posting of offering rates, some treasurers post an absolute yield, while others post a spread over Treasuries, usually with a cap on the absolute yield. A few active borrowers typically post rates daily in several maturity sectors; less active borrowers post only in the maturity sector in which they seek financing and suspend postings when they do not require funds. (7) Apart from the distribution process, MTNs have several less significant features that distinguish them from underwritten corporate bonds. First, MTNs are typically sold at par, while traditional underwritings are frequently sold at slight discounts or premiums to par. Second, the settlement for MTNs is in same-day funds, whereas corporate bonds generally settle in next-day funds. Although MTNs with long maturities typically settle five business days after the trade date (as is the convention in the corporate bond market), MTNs with short maturities sometimes have a shorter settlement period.
Finally, semiannual Semiannual
An event that occurs twice in a calendar year.
A bond with semiannual coupons would issue payment once every six months.
See also: Annual, Bond, Coupon Bond interest payments to noteholders are typically made on a fixed cycle without regard to the offering date of the maturity date of the MTN; in contrast, corporate bonds typically pay interest on the first or fifteenth In music, a fifteenth (sometimes abbreviated 15ma) is the interval between one musical note and another with one-quarter or quadruple the frequency. It corresponds to two octaves. It is the fourth harmonic. day of the month at six-month and annual intervals from the date of the offering. The interest payment convention in the MTN market usually results in a short or a long first coupon and in a short final coupon. Consider, for example, an MTN program that pays interest on March 1 and September 1 and at maturity of the notes. A $100,000 MTN sold on May 1 with a 9 percent coupon and a fifteen-month maturity from such a program would distribute a "short" first coupon of $3,000 on September 1, a full coupon full coupon
See current coupon. f $4,500 on March 1, and a "short" final coupon of $3,750 plus the original principal on August 1 of the following year. Like corporate bonds, interest on fixed-rate MTNs is calculated on the basis of a 360-day year of twelve 30-day months. (8.) Commissions to MTN agents typically range from 0.125 percent to 0.75 percent of the principal amount of the note sale, depending on the stated maturity Stated maturity
For the CMO tranche, the date the last payment would occur at zero CPR. and the credit rating assigned as·sign
tr.v. as·signed, as·sign·ing, as·signs
1. To set apart for a particular purpose; designate: assigned a day for the inspection.
2. at the time of issuance. Fees to underwriters of bond offerings are somewhat higher. (9.) The administrative costs may be lower with MTNs than with bonds. After the borrower and the investor have agreed to the terms of a transaction in the MTN market the borrower files a one-page pricing supplement with the SEC, stating the sale date, the rate of interest, and the maturity date of the MTN. In contrast, issuers of corporate bonds sold from shelf registrations are required to file a prospectus supplement. (10.) These yield spreads are estimated using the model presented in Leland E. Crabbe and Christopher M. Turner, "A Dynamic Linear Model of the Determinants of Yield Spreads on Fixed-Income Securities Fixed-income securities
Investments that have specific interest rates, such as bonds. ," (Board of Governors of the Federal Reserve System Board of Governors of the Federal Reserve System
The managing body of the Federal Reserve System, which sets policies on bank practices and the money supply. , working paper, June 1993). (11.) An additional reason for the high credit quality of structured MTNs is that some investors, such as money market funds, face regulatory restrictions on the credit ratings of their investments. See Leland Crabbe and Mitchel A. Post, "The Effect of SEC Amendments to Rule 2a-7 on the Commercial Paper Market," Finance and Economics Discussion Series 199 (Board of Governors of the Federal Reserve System, May 1992). (12.) Banks also issue bank notes with shorter maturities that range from seven days to one year. These short-term bank notes are sold to money market investors with interest calculated on a CD basis or discount basis. As with medium-term bank notes, short-term bank notes are issued at the bank level, and they are not insured. Short-term bank notes differ from commercial paper in that commercial paper is an obligation of the bank holding company. (13.) These figures on issuance and outstandings are not directly comparable with those reported in the Federal Reserve's survey because the DTC totals include bank notes and deposit notes issued by banks, as well as MTNs issued by foreign corporations. (14.) See Mark S. Carey, Stephen D. Prowse, John D. Rea, and Gregory F. Udell, "Recent Developments in the Market for Privately Placed Debt," Federal Reserve Bulletin, vol. 79 (February 1993), pp. 77-92. (15.) Besides meeting the securities test, banks and savings and loans savings and loan n. a banking and lending institution, chartered either by a state or the Federal government. Savings and loans only make loans secured by real property from deposits, upon which they pay interest slightly higher than that paid by most banks. must also have a net worth of at least $25 million. In contrast to other investors, broker-dealers must own only $10 million of securities. (16.) Bonds and MTNs may be classified as either domestic or international. By definition, a domestic offering is issued in the home market of the issuer. For example, MTNs sold in the United States by U.S. companies are domestic MTNs in the U.S. market. Similarly, MTNs sold in France by French companies are domestic MTNs in the French market. Bonds and MTNs sold in the international market can be further classified as foreign or Euro. Foreign offerings are sold by foreign entities in a domestic market of another country. For example, bonds sold by foreign companies and sovereigns in the U.S. market are foreign bonds, known as "Yankee bonds Yankee bonds
Foreign bonds denominated in U.S. dollars and issued in the United States by foreign banks and corporations. These bonds are usually registered with the SEC. Such as, bonds issued by originators with roots in Japan are called Samurai bonds. ." Euro-bonds and Euro-MTNs are international securities offerings that are not sold in a domestic market. As a practical matter, statisticians Statisticians or people who made notable contributions to the theories of statistics, or related aspects of probability, or machine learning: A to E