Bank Instruments

There are many types of instruments or assets that can be used in investment strategies. This includes; stocks, commodities, precious metals and fixed income or debt instruments. International Capital Management however, focuses on bank instruments for use in arbitrage and managed buy-sell structuring. The three predominate instruments are Medium Term Notes (MTN), Stand-By Letters of Credit (SBLC's), and Bank Guarantees (BG's). Each of these instruments have various stages to them, fresh cut or first title / beneficiary; slightly seasoned or second title / beneficiary, or seasoned.

This is not intended to be an exhaustive recitation or even an abridged version, only a succinct review of what they are, and how they can be utilized for profit generation.

Medium Term Notes (MTN's)

A medium term note is a debt instrument that is issued by an institution. That institution may be a bank or any other corporate entity. There are a myriad of rules, regulations, laws, and methods that the issuer must abide by, all of which are beyond the scope of this web page. Should you, the reader, wish to learn more, please contact us and we will be more than happy to oblige. As mentioned above, this type of instrument has multiple phases or stages to it: first title, second title, and seasoned. There exists opportunity for profit at these stages. The following question and answer format will provide a bit of information, which we are happy to expand on.

What is and What Are “Medium-Term Note Programs”?

Medium-term note (“MTN”) programs enable companies to offer debt securities on a regular and/or continuous basis.  Traditionally, the securities issued under these programs have filled the financing gap between short-term commercial paper, which has a maturity of nine months or less, and long-term debt, which has maturities of 30 years or more. As compared to other forms of debt securities, MTNs tend to have their own type of settlement procedures and marketing methods, which are similar in some respects to those of commercial paper.

Although medium-term notes typically have maturities of between two to five years, they are not required to have medium terms. In fact, it is common for companies to issue both short-term and long-term securities under an MTN program.

Why Have A Medium-Term Note Program?

Like a shelf registration statement, an MTN program enables a company to sell a wide range of debt securities without having to complete the SEC’s registration or review process for each issuance. In addition, an MTN program uses a master set of disclosure documents, agreements with selling agents or dealers, and issuing and paying agency agreements to help minimize the new documentation that is needed for each offering.

Who Develops MTN Programs?

Historically, many MTN programs were developed by the commercial paper departments of investment banks. Securities from these programs were offered and sold on a principal or agency basis from a broker-dealer’s trading desk. The programs often were administered by a bank’s specialty group rather than through the typical relationship bankers.

What Types Of Issuers Establish MTN Programs?

Are The Debt Securities In An MTN Program Ever Guaranteed By An Entity Other Than The Issuer?

Yes. Particularly among financial institution issuers, it is common for an operating subsidiary (such as a bank subsidiary of a bank holding company) to have a higher credit rating on its indebtedness than the parent corporation (such as a bank holding company). Accordingly, many MTN programs are structured so that:

• The operating subsidiary is the actual issuer of the securities, and the parent holding company is the guarantor; or
• The parent holding company is the issuer of the securities, and one or more operating subsidiaries are guarantors.
• Some MTN programs use a special purpose financing subsidiary as the issuer or the guarantor.

What Types Of Offerings Are Completed Using MTN Programs?

In light of the convenience offered by shelf registration and MTN programs, issuers use MTN programs:

• To effect small and medium-sized offerings of debt securities to investors that seek specific terms (known as “reverse inquiry” trades);
• To effect large, syndicated offerings of debt securities that might, in the absence of an MTN program, be offered through a shelf takedown;
• To offer structured notes, such as equity-linked, currency-linked, and commodity-linked securities; and
• To operate a “retail note program,” in which an issuer offers debt securities with small minimum denominations to “retail” investors.

What Types Of Securities Normally Are Sold Through Medium-Term Note Programs?

Historically, the most common type of security issued under an MTN program is a fixed-rate, non-redeemable senior debt security. However, MTN programs typically include other types of debt securities, including floating rate, zero coupon, non-U.S. denominated, amortizing, multi-currency, subordinated, or indexed securities.

Common reference rates for floating rate securities issued under MTN programs include LIBOR, EURIBOR, the prime rate, the Treasury rate, the federal funds rate and the CMS rate. Most MTN programs are rated “investment-grade” by one or more nationally recognized rating agencies.

Who Sets The Terms Of Medium-Term Notes?

Profiting From MTN’s

The typical “end buyer” of MTN’s are pension funds, insurance companies, mutual funds. Before the MTN gets to this stage though, it goes through many “levels”. For instance:

• Fresh Cut or First Title
• Slightly Seasoned or Second Title
• Exchange Listed – wholesale
• Retail

It is the stage between Exchange Listed – Wholesale and Retail that the opportunity to profit is most easily accessed. Once these instruments are listed on an exchange, they theoretically become "liquid". It is quite often that holders, or owners if you will, at the listing stage, or shortly thereafter express interest in liquidating their position in whole of in part. Through purchase methods such as Bloomberg simultaneous Buy / Sell tickets, and others, negotiated acquisitions may occur below the quoted "market-price".

Once complete, depending on the buyer's strategy and analysis, they are held for either the long-term, or short-term. Typically though, the end buyer or long-term holder consists of insurance company's, pension funds, mutual funds, and other extremely large institutions.

Stand-by Letters of Credit (SBLC) and Bank Guarantees (BG's)

There are many different types or forms of SBLC's, as well as uses for them. These include but are not limited to international trade finance, credit enhancement, financial, insurance, and many, many others. One thing in common with all of them, is that they adhere to specific rules, which have been agreed to internationally. These rules are: UCP600 (Uniform Customs and Practices), URDG758 (Uniform Rules for Demand Guarantees), ISP98 (International Standby Practices).

For our purposes, profiting, we focus on financial SBLC's that are typically referred to as "fresh cut".

Let’s examine the SBLC a bit to understand what this instrument is, and why it is a focus as an investment object.

A Standby Letter of Credit (SBLC) as an investment vehicle or object is one that is:

• Cash-Backed - Issued by a prime bank such as HSBC PLC, or Barclay’s, PLC, (or similar).
• Is callable.
• May be extended
• Transferable to a second beneficiary

A common misconception is that it is the bank that issues these instruments. The reality is that a banks high net-worth account holder instructs the bank to issue a SBLC, with the bank being the delivery entity. The account holder is also referred to as the provider, or the cutter of new SBLC issues. 

The provider receives from a “buyer” of freshly cut SBLC’s a fee to use his or her funds to instruct the bank to issue the instrument. The fee is typically in the 40’s. This means that the provider is charging the buyer a price somewhere in the 40% range of face value of the instrument. Of course, the provider will need to pay something to the bank to actually issue the instrument. Often, the fee that bank charges its client is minuscule – less than 10% of face value.

The provider does not typically undertake to issue a single SBLC but requires the buyer to enter into a DOA (Deed of Agreement) or contract to purchase with multiple issues of these instruments, commonly referred to as a tranche. These DOA's, which are stated in face value amounts, can last for a week to many months.  The provider is paid for each and tranche that occurs, as is the provider’s bank.

While there are numerous reasons that a buyer will enter into this contract with the provider, for the profiting purposes, only a single reason is detailed herein. Specifically, the near-term resale of the newly purchased SBLC.

Just as there are buyers for “fresh cut” SBLC’s, so too are there buyers for “slightly seasoned” SBLC’s. A slightly seasoned SBLC is a SBLC that has already been purchased and issued. The slightly seasoned SBLC buyer will typically purchase the slightly seasoned instrument in the 60’s, or 60% of face value. This buyer then becomes the beneficiary or the instrument.

As with the fresh cut provider, the slightly seasoned buyer will enter into a contract, with a specified total face value, with the owner of the SBLC.

It is by this method, that within structured buy-sell programs, profit is obtained in risk-less arbitrage. By identifying and negotiating with the fresh cut provider, while doing the same with the slightly seasoned buyer, the SBLC's are ultimately purchased from the provider on a pre-sold basis. One other important aspect to consider: A stand-by letter of credit may also be pledged as collateral for a loan. This is often referred to as monetizing.