| Extendible Note 101 |
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| 16/07/2006 | |
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Philippe Henry, Head of Debt Finance & Advisory, and Jean-Philippe Brioudes, member of the Debt Origination department at HSBC France, answer this week's 101 on extendible notes. 1- What is an extendible note? Extendible notes are floating rate securities that include options exercisable at each coupon date by noteholders to extend / "re-initialize" the maturity of the notes to retain a constant maturity (or not to extend – depending on the terms and conditions of the notes) - up to a pre-defined final maturity date. Initial maturity is typically 13 months, 18 months or 2 years. Typical final maturities are 5 or 6 years. On each quarter's coupon payment date, the maturity of the notes can be extended (or not extended) – by a further quarter according to the wish of the holder. Coupons go up over the life of the notes in order to incentivize investors to extend the maturity (eg: the recent HSBC France extendible carried the following coupon structure: Years 1-2: 3m€+4bps, Years 3-4: 3m€+6bps, Years 5-6: 3m€+8bps). This ensures that investors will tend to exercise their option and roll the maturity to the final maturity. Unless there is a severe deterioration in the credit profile of the company, investors will keep the notes until the final maturity. To exercise the option to extend (or not) the notes, investors need to notify the clearing systems within a certain timeframe prior to the coupon date (say between 30 and 10 days before the coupon payment date). The rationale for issuers is severalfold. Firstly, it enables them to lock-in mid-term funding at low spreads. Assuming investors keep the notes until the final maturity, the average spread paid by the issuer is significantly lower than the spread the issuer would have had to pay for a straight 5-6 year funding. Secondly, this instrument class allows issuers to diversify their source of financing by raising mid term financing with money market funds that are usually restricted to investing in short dated paper (up to 18 months, potentially 2 years). Finally, it allows borrowers to reduce frequent new issuances to refinance amortisation. The size of such transactions ranges from small private placements to benchmark issues (eg: HSBC USD3bn). Demand for extendible notes is strong across Dollar, Euro and Sterling. Extendible notes can be issued off an issuer's EMTN Program. This product can be used by financial and corporate issuers. In the US the product has been used by many issuers such as GECC, HSBC Finance and several European banks. In Europe, issuers such as Telecom Italia, Iberdrola, CFCM and HSBC France have tapped into this market. 2- Why should an investor buy this type of instruments? Money market funds which typically cannot invest beyond two years can earn higher spreads as they continue to extend the Notes. It also allows diversification from traditional short dated paper. 3- Since when have these instruments been available on the European markets? Why has this structure only recently appeared in Europe? Extendible notes are a new structure to the European markets. They follow a well established model from the US where they target 2a7 Money market Funds, which have restrictions of 397 days. The European market can operate with an automatic extension, in contrast to the active extension required in the US. In euros, the bulk of the demand comes from French money-market funds. |
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