Paperless securities - not just for finance companies.
Ford Motor Credit Co. and IBM Credit Corp. are among a handful of corporate issuers to respond to former SEC Chairman John S. R. Shad's encouragement to issue new debt in global book-entry form, saving the expense and hassles of physical certificates, transfer agents, paying agents, and registrars. (Other names for this paperless process are book-entry-only and full book-entry.)
Finance companies have been the first corporate issuers to embrace paperless debt because they are the most prolific issuers and the fastest to pick up on new ideas. When those with a lower issuance volume understand the ongoing benefits, like the yearly savings in paying agent fees, they surely will want to follow.
"Book-entry delivery and settlement is useful to anybody in the securities market," says Daniel F. Benton, director of trading at Salomon Brothers Inc. "The costs have got to be lower."
Consolidated Rail Corp. recently became the first nonfinance company to use global book-entry for plain vanilla notes. Global book-entry has already been used by a variety of issuers for their auction-rate preferred stock and notes. Included are AMR, CSX, GTE, Hartford Fire Insurance, Kroger, Texas Instruments, USX, Virginia Electric & Power, and Weyerhauser. Global book-entry is now being used in the burgeoning market for medium-term notes and is expected to be available to the huge commercial paper market shortly.
A trend could be developing toward paperless corporate debt, according to Craig N. Green, manager of the international treasury division at Ford Credit. "The U.S. government switched to full book-entry, as have most federal agencies and many municipal issuers. We believe book-entry corporate debt is a logical extension of this trend."
In fact, global book-entry corporate debt offering have lagged global municipal offerings by a considerable margin--there have been hundreds of the latter since the first deal in late 1982. The pioneering efforts of a leading underwriter, working with a team of consultants, was a major stimulus there. Municipal issuers have generally been pleased. Greg D. Leddy, director of finance for the Metropolitan Water District of Southern California, believes that "global book-entry issues will become even more common in municipal offerings because of substantial savings in bond printing and debt administration costs. The same kinds of savings would apply for the private sector in the case of corporate issues."
The first global book-entry corporate debt was Ford Credit's $200 million, three-year note distributed in October of 1986. Former SEC chairman Shad indicated that "Ford Credit's new issue will save [the firm] thousands of dollars of transfer and certificate printing costs over the lifer of the issue and will provide greater processing efficiencies to Ford, its investors, and securities brokers and custodians." Others will follow Ford's lead, Shad predicted.
By midyear 1988, Ford Credit had issued 22 global notes for an aggregate amount of $4.9 billion. The $200 million of three-year notes that IBM Credit issued in August of 1987 were the first global security to be listed on the NYSE. Traditional (and costly) requirements for engraved certificates were waived by the Exchange in recognition of the fundamental workings of the book-entry system.
IBM Credit issued an additional $300 million of global notes in November of 1987. "Information from our underwriters indicate that both issues were well received by investors overall," says Thomas F. Cardigan, treasurer of IBM Credit. "We had only one or two inquiries from brokers on behalf of their individual clients regarding whether certificates would be available if desired and how the interest would be paid to the investor, but this did not seem to dissuade any investors. Overall, we feel that our investors are satisfied with our use of global book-entry."
Pleasing the players
The paperless program is available through the securities depositories so long as the initial purchasers or managing underwriters are members of, or clear accounts through institutions that are members of, one of the depositories. The Depository Trust Co. (DTC), the largest depository, had approximately $3.2 trillion of securities on behalf of its participant members at midyear 1988. The others, the Midwest Securities Trust Co. and the Philadelphia Depository Trust Co., had holdings of $107 billion and $50 billion, respectively, at midyear 1988. Roughly $134 billion of the aggregate holdings of these depositories were in global book-entry form.
Underwriters like the system. Says Salomon Brothers' Benton: "It's just cheaper for the issuer, the investor, and the dealer to do it through the depository--you don't have physical delivery; you don't have insurance; clearing and registration are a lot easier. There is also a certain credit safety because you now know who all the players are. There is a list of people who belong in the system--it's just more formal, more controlled."
Investors benefit, too. "One of our goals is to keep our investor base satisfied with holding our notes," says James F. McWilliams, manager of long-term financing for IBM Credit. "One of the keys to doing so is ensuring that the note-holders receive their payments and notices in a timely manner. "We feel that the global book-entry notes will provide an efficient means of paying our investors and keeping them informed about such things as early redemptions. We believe that the use of global book-entry may, in fact, reduce the potential for such errors as lost checks." William H. Erickson, executive director of the Utah Housing Finance Agency, adds that "bond-holders are used to dealing with electronic entries and prefer not to be bothered by a piece of paper."
At SEC securities immobilization workshops held in 1985, participants concluded that the immobilization of corporate debt, rather than equity, was a next logical step in the introduction of global book-entry following the success in the municipal debt market.
The success of the immobilization within depositories of corporate debt, with approximately 75 percent of all outstanding corporate debt (and much higher percentages of recent issues) held in depositories, makes global book-entry the logical choice.
"The investor base has become increasingly institutional," explains Ford Credit's Green. "For recent Ford Credit issues, approximately 90 percent of the notes already were held in the name of DTC. As a result, changing to 100 percent book-entry on new deals was a non-event for most investors." Since certificates are infrequently used, why incur the costs and administrative burdens associated with them?
Exactly how do issuers benefit?
The economic benefits of paperless corporate debt are analogous to those in the government and foreign equity sectors. * Certificate printing, signature, and authentication costs are eliminated. * Handling, shipping, storage, and insurance costs for certificates and closing travel expenses are substantially cut. * Ongoing transfer costs are eliminated. * Partial redemption costs, as well as those associated with tender, rate resettings, and remarketing, and their associated headaches are largely eliminated. Issuers don't need to appoint a bank as transfer agent, registrar, or paying agent. The depository system, with its network of bank and broker participants, effectively provides for all of these functions to be performed at no cost whatsoever to the issuer. For example, with interest payments, the issuer simply makes a single payment for the entire amount due to the depository. The depository credits its bank and broker participants who in turn credit the beneficial owners.
Transfers of beneficial ownership are handled through electronic debits and credits from one depository participant to another. The corporate issuer is in a position to track changes of ownership in its securities through an ongoing examination of depository reports received either electronically or on paper output.
In addition to direct cost savings, a major benefit of global issuance is the reduction in the administrative burden of handling the debt. According to Ford's Green, "the primary advantage of BEO corporate debt for both issuer and investor is ease of administration--no certificates to be concerned with and the trustee deals with only one bondholder (DTC)." These efficiencies become more and more valuable as increasingly complex structures and rapid market timing become commonplace and strategies to reduce overall debt costs begin to embrace administrative as well as financial approaches.
Issuers can access the market much more rapidly and benefit from quicker closings on deals. "An important advantage is the reduced time between final purchase contract negotiations and the closing date," says director of finance Leddy of the Metropolitan Water District of Southern California. "The underwriters include market risk for this span of time in their pricings. Hence an argument can be made for lower costs of debt by using global book-entry."
It is difficult to quantify precisely the cost savings from a global issue, and these savings can vary widely among issuers. The SEC has received estimates that indicate that issuers can save approximately $200,000 on a present value basis over the life of a typical $100 million, 20-year debt issue. Savings probably are going to be greater for issuers who sell securities that have a large number of retail investors and those that involve complex structures such as resettable rates, puts, and tenders.
Accommodating same-day funds
Equity and long-term debt issues settle today in next-day--or clearinghouse--funds, whereas a potpourri of money market and pseudo money market instruments (like resettable or medium-term notes) as well as mortgage-backed and government securities settle in same-day, or "federal," funds.
Depositories, with a heritage in equities, corporate bonds, and municipal bonds, until recently provided services for only those securities that settle in next-day funds. The expanding market for instruments that settle in federal funds has brought demands for the creation of depository services to support these instruments.
A same-day funds settlement (SDFS) service introduced by DTC in July of 1987 will extend the depository's book-entry services to include medium-term notes, jumbo CDs, commercial paper, and mortgage-backed securities. A similar same-day funds development process is being undertaken at the Midwest depository. In late March of 1988, Chrysler Financial Corp. began global book-entry offerings of medium-term notes through DTC's SDFS system.
The SDFS program is scheduled to be extended to the $400 billion commercial paper market on a pilot basis in mid 1989. It will permit the elimination of commercial paper notes and the archaic practice followed by hundreds of messengers carrying the paper between issuers' and purchasers' banks in lower Manhattan.
"We believe that global book-entry for commercial paper will yield the same advantages as global book-entry for other securities: simplicity of use, cost savings, and a reduction in the potential for errors by eliminating the risk of lost notes or late deliveries," says Karen W. Reynolds, a financial analyst for IBM Credit.
Another advantage: fosters new products
An important advantage of global book-entry is that it offers the ability to innovate new securities products that might not have been practical with certificated instruments. Investment bankers have brought to market new products at a prolific rate.
Complex securities often involve a high level of ongoing communication and interaction among the issuer, investment bankers, and investors. This interaction is stymied by the presence of physical certificates.
Dutch auction-rate preferred is a good example of a new product whose development was aided by the global book-entry approach. Shearson Lehman introduced the first such issue in 1984 under the name "money market preferred." Dividend rates are reset every 49 days and investors can tender their stock for payment. Since 1984, various underwriters have distributed through DTC hundreds of global book-entry issues of auction-rate and tender-rate preferred stock and notes. Although targeted as a "money market" instrument, the instruments have in the past employed the depository's next-day funds systems rather than resorting to paper certificates. Global book-entry offerings of auction-rate and tender-rate preferred stock and notes now are being distributed solely through the SDFS system, and all outstanding issues have been reclassified to SDFS.
Other global book-entry securites include: * Convertible money market preferred--Texas Instruments issued, in March of 1987, the first convertible security to come to market in global book-entry form. * Warrants linked to currency exchange rates--General Electric Capital was the first to offer warrants in global book-entry form. It sold two million currency exchange warrants in June of 1987. * Remarketed reset notes--GE Capital issued $500 million of remarketed reset notes in late 1987. The notes pay fixed-rate, semi-annual interest for three years. Then the rate is reset every two to five years. Before an interest reset period ends, the owner may tender the notes for their face value. "The book-entry approach facilitates investor transactions such as warrant exercise or tendering of notes to a remarketing agent," says Roger Heine, assistant treasurer at GE Capital. "We'll continue to consider book-entry for our debt issues, particularly for complex structures."
The credit companies, because of their intensive activity in the market, are more sophisticated and more innovative than the average borrower. Thus, they have been the first to use global book-entry for corporate debt. But, it's clearly as significant a strategy for today's financial leaders in many other kinds of businesses, even though their volume is more modest. Says executive director Erickson of Utah Housing Finance Agency: "It has been of great benefit in that we save money, and it seems to be something that was inevitable."
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|Author:||Fredman, Albert J.|
|Date:||Jan 1, 1989|
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