The Many Different Types of Debt – Corporate Finance II: Financing Investments and Managing Risk

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So here is the dead structure for monsanto and this is what i mean by that structure instead of just looking at the total amount of debt that a company has right in the case of monsanto it’s 10.5 billion dollars what we’re going to look at is what type of debt does the company have in this case right i listed here all the different types of that securities that

Monsanto had of issued at that time this is essentially september 2016 is the same time period we’re looking at in the previous example right so you can see that there is commercial paper revolving credit term loans so the purpose of this lecture is for us to learn what’s the difference between all these different types of debt and how companies choose between

These different types of debt security the idea is that that has many faces so that is not going to come only with on one mask there is going to be many different types of debt let’s talk about these these five types commercial paper revolving credit term loans bonds and capital leases starting with commercial paper if you look at the the the that table i showed

You for monsanto commercial paper represents 18.3 percent of the total debt the company has so what’s the characteristic of commercial paper commercial paper is a short-term debt that the maturity is less than 270 days so even less than a year it’s sold directly to the market so if a company uh has commercial paper you’re not really borrowing from a bank you’re

Borrowing money directly to uh from investors in the market there is no intermediary okay and because of this characteristic this is a type of debt that is relevant only for firms that have very high credit ratings to be able to access this market where you know you can freely borrow from investors on a short-term basis without an intermediary what happens is

That this market is really only available for companies that have high credit ratings like monsanto for example has a dbb credit rating it can have some commercial paper but companies that have lower ratings or companies that don’t have credit ratings are not going to be able to access this this market if we look at the data what i did is i pulled out from the uh

Uh financial statistics of the united states how much commercial paper was outstanding for the non-financial corporate sector at the end of 2015 and the figure was 176.5 billion that might seem like a lot but you’ll see that it’s a small market compared to bonds and bank loans okay let me also say that if you had to obtain this data for financial companies you

Would see larger numbers financial companies like banks and insurance companies they rely more on commercial paper but non-financial companies do not rely so much on um on this specific market then in that example in the monsanto data we have revolving credit and we talked about this in corporate finance one already revolving credit is it comes from a credit

Line it’s a bank loan that originates from a credit line drawdown okay that data shows us that monsanto has an undrawn credit line of 1 billion 1.074 billion but the revolving credit is actually zero and here’s the question i want you to think about we talked about it in corporate finance one i wanted to refresh your memory why would monsanto have a credit line

If it does not use it the credit line is going to cost money and monsanto is not using it what’s going on the answer is that the credit line is used mostly for insurance in this case okay the idea is that monsanto is going to is going to draw on the credit line if it has trouble refinancing its other liabilities for example in corporate finance one we gave

An example of accounts payable if a company has trouble refinancing accounts payable it may be useful to have a credit line that you can use to manage your liquidity or monsanto may have trouble refinancing commercial paper right we showed that monsanto does use commercial paper market if you have trouble refinancing your commercial paper it might be useful to

Have a credit line that you can use as a backup so it makes sense actually that you have a credit line but you don’t use it if you’re using it for insurance right if you had drawn the whole thing then you know it can no longer be used for insurance what you see in the data is that companies like monsanto that have a high credit rating are going to have credit

Like you know are going to have undrawn credit lines that they use for insurance purposes moving down that table we have the term loans so a term loan is a bank loan that does not originate from a credit uh line drawdown so it’s a loan uh that it’s it’s it’s money you borrow from from the bank with a fixed maturity that’s why it’s called term and it does not

Originate from a credit line drawdown otherwise it would be called revolving credit okay it can be short or long term and for for monsanto it wasn’t a very important form of financing monsanto used or uses only three percent only three percent of the total debt was coming from term loans essentially what monsanto is doing is using bonds for for its financing so

79 of the of the debt that monsanto has comes from bonds that monsanto issues in the financial markets like the bond we were talking about remember that i gave an example of a specific monsanto bond that is how the company is financing itself long term rather than bank loans they are using bonds okay finally we have capital leases what is a capital is you can

Think of this essentially as renting right instead of buying a equipment buying a machine and borrowing money to buy the machine what a company can do is to rent the machine this rental is going to generate a liability right so if you if you have a lease you’re going to have to make the rental payment to the other party in this transaction right so this capital

Lease that you see in monsanto’s balance sheet is a lease that that cannot be cancelled right the let’s see is the is the company who who rents the equipment right so we call the lease a capital lease if the lease cannot be cancelled before the end of the contract so it has this uh liability component right so if you have this lease you have to make the rental

Payment however for monsanto what if you look at the data monsanto actually didn’t have any leases right capital leases are only going to be important in certain industries like airlines here you have jet blue let’s look at jet blue that structure is another example and it’s it’s very similar to monsantos in many ways so for example it’s uh most of the of the

Debt that jetblue that jetblue has comes from from bonds it doesn’t really rely on uh bank loans that much uh it has zero revolving credit right but it has a credit line here undrawn credit line of 600 million so similar right the main difference here is that jetblue does use leases so eight percent of the total debt that that jetblue has corresponds to leasing

Right so essentially airlines are going to lease they use the leasing market to rent airplanes instead of borrowing money and buying airplanes airlines are also renting airplanes and you can see that in the balance sheet of jetblue

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The Many Different Types of Debt – Corporate Finance II: Financing Investments and Managing Risk By Phan Thi Xuan