How large should the discount (X) be to make this an attractive deal for Rabobank? 2.
How large must the annual fee (F) be to make this an attractive deal for Morgan Guaranty? 3.
How small must the combination of F and X be to make this an attractive deal for B.F. Goodrich? 4.
Is this an attractive deal for the savings banks?
Is this a deal where everyone wins? If not, who loses?
Players: Morgan Bank, Rabobank, and B.F. Goodrich, Salomon Brothers, Thrift Institutions and Saving Banks
In early 1983, Goodrich needed $50 million to fund its ongoing financial needs. However, Goodrich was reluctant to borrow (short term debt) from its committed bank lines because of the following reasons: 1.
It would lose substantial about of its remaining short term capital availability under its bank lines. 2.
It would compromise its future flexibility by borrowing in the short term.
Instead, it wanted to borrow for an 8 year range (or longer) at a fixed rate.
However, since the general level of interest rates were pretty high, and Goodrich’s credit ratings had dropped from BBB to BBB-. Goodrich believed that it would have to pay 13% interest for a 30 year corporate debenture.
Salomon Brothers had advised Goodrich that they could borrow in the US public debt market with a floating rate debt issue tied to the LIBOR, and then swap payments with Euro market bank that had raised funds in the fixed-rate Eurobond market.
Note: The reason that Salomon were confident that this could be done is described as follows: 1.
There was a recent deregulation of deposit markets had allowed deposit institutions to offer new variable rate money market deposit accounts. 2.
As result of these new offerings large thrift institutions
Rabobank had AAA debt ratings, and assets exceeding $42.0 billion. Also, Rabobank had never borrowed in the Eurobond market prior to the deal with Goodrich, and Morgan. Since Rabobank conducted only small amount of dollar based business, and most of the dollar denominated assets were loans whose rates floated with LIBOR. Historically, Rabobank was able to fund these loans through the following: •
Interbank deposits at LIBOR.
Prime Eurodollar CD’s.
This was the first time that Rabobank would venture into the Eurobond market. Note: Because of Rabobank’s AAA rating it would be able to borrow in the Eurodollar market at very competitive rates.
Morgan Guaranty Bank:
Morgan acted as an intermediary guarantor between the Goodrich, and Rabobank to implement the swap. Morgan was merely agreeing to act as a conduit assuming no default payments. In fact, if Goodrich defaulted it could not collect the floating rate stream from Morgan. The swap was a two way or no way transaction. This was true for the bilateral agreement between Rabobank, and Morgan also.
Morgan had an AAA credit rating, and an international reputation, this guarantee effectively lowered whatever credit risk might have otherwise been present in the swap agreement to acceptable levels for Rabobank.
In commissions, Morgan received an initial one time fee of $125,000.00, and an undisclosed annual fee for each of the next 8 years. The going rate for such swap transactions has been between 8 - 37.5 basis points.
Salomon advised Goodrich to look into the possibility of issuing a LIBOR associated floating rate debt, and eventually underwrote the first part of the Swap transaction by selling the BF Goodrich floating rate note in the US bond market.
Thrift Institutions and Saving Banks:
Due to recent deregulation of the deposit markets, and resulting competition, large Thrift Institutions had aggressively priced their new deposit accounts, and as a result had recaptured large flows of funds. These institutions were looking to invest these funds and had the following alternatives: •
30 year fixed rate residential mortgages. This investment option was risky because if...
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