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Commercial Paper

Property companies have a number of financing when borrowing in the short term one is to borrow from banks directly and another is the use of commercial paper which is tapping the money markets. This can often result in savings in cost over the other borrowing methods.
The sterling commercial paper market started in 1986 and in the beginning it was only available to larger companies but conditions have since been relaxed and it is now available to the medium sized companies.
Commercial paper is a very short term IOU piece of paper. The company that wants to borrow is called the issuer and and the investors are the ones that lend the money for the short term. The issuing company therefore issuing a short term security to the investors. Commercial paper is often sold at a discount rather than paying interest.
To illustrate with an example consider if a company were issuing paper with a life of three months it might to sell it at say $97 for every $100 of nominal value. Once three months pass the paper will be repaid at $100 per $100 value.
The interest rates on commercial paper is often expressed in relation to LIBOR which is the London Interbank Offered Rate. This is the rate in which banks will lend to each other. There is also LIBID (London Interbank Bid Rate) which is the lower rate in which banks are prepared to borrow. There is also a middle rate between the two called the LIMEAN.  Interest rates are often quoted as being so many points above LIBOR or LIBID. A basis point is one hundredth of a percentage point, so 50 basis points above LIBOR would be 1/2 percentage point above LIBOR. Consequently if the interest rate was 7% the interest rate would be 7.5%. Therefore LIBOR is effectively the cost of funds between banks themselves.

Many different kinds of financing institutions invest in commercial paper and the average life of commercial paper is about 40 days but can last up to about 5 years. Although 40 days is a very short time frame. The issuers have a rolling over function meaning they can repay the money and then issue a new batch of securities when one batch comes due.
If a company wants to tap the commercial markets it first needs to appoint a bank to set up a program for it. The bank will then set up a network of dealers which will act as intermediaries between the issuers and the potential investors. If a company decides that it wants to raise money it informs the bank which networks with the various dealers which put offers out to the potential investors to raise the cash. At present the minimum denomination for commercial paper are high so the market is not for small investors.  Sometimes the reverse of this situation happens where the investors send a message to the issuers that they are looking to lend and is the issuer interested in borrowing.
The issuer needs to appoint a paying agent. The paying agent is the firm that looks after the technicalities of getting the paper actually into the hands of the investors and the cash physically into the hands of the issuer. They are also responsible for making sure the redemptions happen without on the due date.

Commercial paper is unsecured so the reputation or credit history of the borrow is important. The paper can also be rated based on its quality.
In some cases if the conditions in the commercial paper market are unattractive and a company in question already has some commercial paper outstanding, then the company may have some kind of backup facility in place such which would give the company access to funds to repay the commercial paper if the need arises. This kind of guaranteed line of credit often takes the form of a multiple option facility. Otherwise known as a MOF. This means that a group of banks has committed to make a certain amount of funds available at a prearranged rate over LIBOR if the company finds it cannot raise the money more cheaply. Therefore a MOF provides backing for a commercial paper financing.
The costs of setting up a commercial paper programme range from about $5000 to
$20,000 and the interest rate quoted depends on the strength and quality of the company. For example a quality company might get a rate at around LIBID while a smaller less well known company with less of a track record might get a rate of 20 points above LIBOR. In some cases the very large property companies are not confined to the US market. For example a large US property company can also tap the commercial markets in the UK or the Euro commercial paper market. For example the company could borrow sterling and the  swap them into dollars. In this case a fallback MOF would probably be necessary to account for the currency exchange risk.


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