Question
What is Toque Brothers all-in cost (that is, the effective overall borrowing rate, or IRR of the loan, recognizing all fees) of the direct Euro-denominated
What is Toque Brothers all-in cost (that is, the effective overall borrowing rate, or IRR of the loan, recognizing all fees) of the direct Euro-denominated ten-year bullet loan from Banco de Barcelona? What is Toque Brothers all-in cost for direct CAD-denominated borrowing from The Bank of the Maritimes? Does swapping seem viable? Evaluate the potential gains to swapping by comparing the relative borrowing costs of both Toque Brothers and Delicioso in both Canadian dollars and Euro. From Toque Brothers viewpoint, are these attractive swap opportunities; does a Canadian dollar loan combined with an appropriate swap arrangement seem more attractive than directly borrowing Euro? From Deliciosos viewpoint, will either of the proposed swap arrangements have a significant impact on their capital structure? Do the proposed swap arrangements seem attractive?
Toque Brothers Construction (TBC) is a Canadian-based firm specializing in planning and building large-scale construction projects that typically take multiple years to complete. Until recently, its focus has been on projects in Canada (and, to a lesser extent, in the northern part of the United States). More recently, TBC has begun to pursue its long-held ambition to expand outside of the northern North America geographic region. In particular, Toque Brothers has recently entered into a contract to build an international toll highway in Europe, on the Iberian peninsula. The planned highway will be located primarily in Spain, and partially in Portugal. In nearly all of its previous construction contracts, TBC was contracted by another party to provide turnkey construction, and possibly later upkeep, for a large-scale project. Past examples include roads, tunnels, airstrips, and buildings. At completion, the project was then fully owned by the contracting party. In contrast, for the Iberian toll highway, TBC would retain a significant partial equity ownership. TBC therefore faces both large construction payments and costs over the next few years, and expected toll revenues over the next few decades, the vast majority of which will be denominated in Euro. As a result of this, TBC has decided that it should engage in meaningful Euro-denominated borrowing in conjunction with this project. Historically, because of its geographic focus, Toque Brothers has worked, banked, and borrowed almost exclusively in Canadian dollars (CAD); the primary exception to this has been its usage of US dollars (USD). TBC's main banking in recent years has been conducted with (Canadian-based) The Bank of the Maritimes. TBC currently has outstanding debt at The Bank of the Maritimes, as well as a relatively small unused credit line there. One possible borrowing plan is for Toque Brothers is to directly borrow, and repay, Euro. Banco de Barcelona is willing to lend Toque Brothers 50 million. This would be structured as a so-called bullet loan (wherein the principal is repaid only at the maturity date of the loan). This loan would be 10 years to maturity, at an interest rate of 7.50% (interest paid and compounded) semiannually, with front-end fees of 0.70%, which would reduce the principal TBC actually received. Partly due to recent macroeconomic problems in its home country (Spain), Banco de Barcelonas bonds have a relatively low credit rating (B+ from Standard & Poors, considered speculative, or less-than-investment grade). Toque Brothers has engaged the investment banking firm of Morgenthau and Company, to investigate and suggest other approaches to achieve Euro borrowing; their fee is conditional on a successfully executed plan. One obvious suggestion is for TBC is to issue Euro-denominated bonds. However, due to the size of the firm, and its relative unfamiliarity in European bond market circles, this idea has been rejected as infeasible at this date. Another suggestion is for Toque Brothers is to take a Canadian dollar-denominated loan and enter into an appropriate swap arrangement to convert this effectively into a Euro- denominated loan. With respect to a Canadian dollar loan, The Bank of the Maritimes has expressed its willingness to lend (around 50 million worth of) Canadian dollars for either a ten-year or eleven-year period at an interest rate of 5.80% (interest paid and compounded) semiannually. All principal on this loan would be repaid at the maturity date. The Bank of the Maritimes does not charge any upfront fees for loans; its policy is to reflect its costs in the interest rate charged. Morgenthau and Company is aware that Delicioso (a major multinational food company, headquartered in the United States, that typically has a wide variety of bonds outstanding, of various maturities, currency denominations, and outstanding amounts) is potentially interested in being involved. Delicioso management (specifically, the CFO's office, which is in charge of overall corporate capital structure and hedging decisions) has already indicated its willingness to swap out some part of its current borrowing arrangements, if offered an attractive opportunity. Delicioso bonds all carry an investment grade rating of BBB+ from Standard and Poor's. Delicioso typically has bonds outstanding in a variety of currencies. In particular, Delicioso has two Euro-denominated bonds which may be of interest. The first bond was issued five years ago, it has 10 years remaining until maturity. It has annual coupon payments of 7.50%, and recent trading price of 107.60. The second bond was issued nine years ago, it has 11 years remaining until maturity. It has annual coupon payments of 6.25%, and recent trading price of 98.40. The outstanding face (or par) value of each of these bond issues is 300 million. Delicioso recently issued CAD 500 million of 5.25% annual coupon, 10-year bonds. They currently trade at 100.30. (See Exhibit 1 for details of Delicioso bonds.) Two ideas for a swap have been suggested. Both of these are based on Toque Brothers borrowing the Canadian dollar equivalent of around 50 million from The Bank of the Maritimes. In the first case, Toque Brothers and Delicioso would swap repayments on a 5.80% (semiannual) 10-year CAD 64 million loan, and repayments associated a 7.30% (annual) interest rate 10-year 50 million loan. In the second case, Toque Brothers and Delicioso would swap repayments on a 5.80% (semiannual) 11-year CAD 64 million loan, and repayments associated with a 7.10% (annual) interest rate 11-year 50 million loan. In both cases, Toque Brothers would pay a fee of CAD 200,000 to Morgenthau and Company for their services. In neither case does Delicioso plan to borrow additional funds at this time, but simply to enter into an attractive swap arrangement. (See Exhibit 2 for proposed loans to Toque Brothers, and Exhibit 3 for a summary of the proposed swaps.) Spot exchange rates are currently EUR 1 = CAD 1.2800 and CAD 1 = USD 1.0200. These spot exchange rates have been relatively stable in recent weeks, and it is expected that these rates will hold, at least for the time required to set up any swap. Exhibit 1. Summary of outstanding bonds of Delicioso (a selection) Currency Face value Age (since issue) Maturity Coupon Price EUR EUR CAD 300 million 300 million 500 million 5 years 9 years 0 years 10 years 11 years 10 years 7.50% 6.25% 5.25% 107.60 98.40 100.30 Exhibit 2. Proposed loans to Toque Brothers Lender Maturity Payments Principal Interest rate Fees Banco de Barcelona 10 years semiannual EUR 50 million 7.50% 0.70% The Bank of the Maritimes various semiannual CAD 64 million 5.80% none Exhibit 3. Summary of proposed swaps Swap 1. Toque Brothers pays to Delicioso: all future payments associated with a EUR 50 million, 10 years until maturity, 7.30% annual payment bullet loan. Delicioso pays to Toque Brothers: all future payments associated with a CAD 64 million, 10 years until maturity, 5.80% semiannual payment bullet loan. Swap 2. Toque Brothers pays to Delicioso: all future payments associated with a EUR 50 million, 11 years until maturity, 7.10% annual payment bullet loan. Delicioso pays to Toque Brothers: all future payments associated with a CAD 64 million, 11 years until maturity, 5.80% semiannual payment bullet loan. Toque Brothers Construction (TBC) is a Canadian-based firm specializing in planning and building large-scale construction projects that typically take multiple years to complete. Until recently, its focus has been on projects in Canada (and, to a lesser extent, in the northern part of the United States). More recently, TBC has begun to pursue its long-held ambition to expand outside of the northern North America geographic region. In particular, Toque Brothers has recently entered into a contract to build an international toll highway in Europe, on the Iberian peninsula. The planned highway will be located primarily in Spain, and partially in Portugal. In nearly all of its previous construction contracts, TBC was contracted by another party to provide turnkey construction, and possibly later upkeep, for a large-scale project. Past examples include roads, tunnels, airstrips, and buildings. At completion, the project was then fully owned by the contracting party. In contrast, for the Iberian toll highway, TBC would retain a significant partial equity ownership. TBC therefore faces both large construction payments and costs over the next few years, and expected toll revenues over the next few decades, the vast majority of which will be denominated in Euro. As a result of this, TBC has decided that it should engage in meaningful Euro-denominated borrowing in conjunction with this project. Historically, because of its geographic focus, Toque Brothers has worked, banked, and borrowed almost exclusively in Canadian dollars (CAD); the primary exception to this has been its usage of US dollars (USD). TBC's main banking in recent years has been conducted with (Canadian-based) The Bank of the Maritimes. TBC currently has outstanding debt at The Bank of the Maritimes, as well as a relatively small unused credit line there. One possible borrowing plan is for Toque Brothers is to directly borrow, and repay, Euro. Banco de Barcelona is willing to lend Toque Brothers 50 million. This would be structured as a so-called bullet loan (wherein the principal is repaid only at the maturity date of the loan). This loan would be 10 years to maturity, at an interest rate of 7.50% (interest paid and compounded) semiannually, with front-end fees of 0.70%, which would reduce the principal TBC actually received. Partly due to recent macroeconomic problems in its home country (Spain), Banco de Barcelonas bonds have a relatively low credit rating (B+ from Standard & Poors, considered speculative, or less-than-investment grade). Toque Brothers has engaged the investment banking firm of Morgenthau and Company, to investigate and suggest other approaches to achieve Euro borrowing; their fee is conditional on a successfully executed plan. One obvious suggestion is for TBC is to issue Euro-denominated bonds. However, due to the size of the firm, and its relative unfamiliarity in European bond market circles, this idea has been rejected as infeasible at this date. Another suggestion is for Toque Brothers is to take a Canadian dollar-denominated loan and enter into an appropriate swap arrangement to convert this effectively into a Euro- denominated loan. With respect to a Canadian dollar loan, The Bank of the Maritimes has expressed its willingness to lend (around 50 million worth of) Canadian dollars for either a ten-year or eleven-year period at an interest rate of 5.80% (interest paid and compounded) semiannually. All principal on this loan would be repaid at the maturity date. The Bank of the Maritimes does not charge any upfront fees for loans; its policy is to reflect its costs in the interest rate charged. Morgenthau and Company is aware that Delicioso (a major multinational food company, headquartered in the United States, that typically has a wide variety of bonds outstanding, of various maturities, currency denominations, and outstanding amounts) is potentially interested in being involved. Delicioso management (specifically, the CFO's office, which is in charge of overall corporate capital structure and hedging decisions) has already indicated its willingness to swap out some part of its current borrowing arrangements, if offered an attractive opportunity. Delicioso bonds all carry an investment grade rating of BBB+ from Standard and Poor's. Delicioso typically has bonds outstanding in a variety of currencies. In particular, Delicioso has two Euro-denominated bonds which may be of interest. The first bond was issued five years ago, it has 10 years remaining until maturity. It has annual coupon payments of 7.50%, and recent trading price of 107.60. The second bond was issued nine years ago, it has 11 years remaining until maturity. It has annual coupon payments of 6.25%, and recent trading price of 98.40. The outstanding face (or par) value of each of these bond issues is 300 million. Delicioso recently issued CAD 500 million of 5.25% annual coupon, 10-year bonds. They currently trade at 100.30. (See Exhibit 1 for details of Delicioso bonds.) Two ideas for a swap have been suggested. Both of these are based on Toque Brothers borrowing the Canadian dollar equivalent of around 50 million from The Bank of the Maritimes. In the first case, Toque Brothers and Delicioso would swap repayments on a 5.80% (semiannual) 10-year CAD 64 million loan, and repayments associated a 7.30% (annual) interest rate 10-year 50 million loan. In the second case, Toque Brothers and Delicioso would swap repayments on a 5.80% (semiannual) 11-year CAD 64 million loan, and repayments associated with a 7.10% (annual) interest rate 11-year 50 million loan. In both cases, Toque Brothers would pay a fee of CAD 200,000 to Morgenthau and Company for their services. In neither case does Delicioso plan to borrow additional funds at this time, but simply to enter into an attractive swap arrangement. (See Exhibit 2 for proposed loans to Toque Brothers, and Exhibit 3 for a summary of the proposed swaps.) Spot exchange rates are currently EUR 1 = CAD 1.2800 and CAD 1 = USD 1.0200. These spot exchange rates have been relatively stable in recent weeks, and it is expected that these rates will hold, at least for the time required to set up any swap. Exhibit 1. Summary of outstanding bonds of Delicioso (a selection) Currency Face value Age (since issue) Maturity Coupon Price EUR EUR CAD 300 million 300 million 500 million 5 years 9 years 0 years 10 years 11 years 10 years 7.50% 6.25% 5.25% 107.60 98.40 100.30 Exhibit 2. Proposed loans to Toque Brothers Lender Maturity Payments Principal Interest rate Fees Banco de Barcelona 10 years semiannual EUR 50 million 7.50% 0.70% The Bank of the Maritimes various semiannual CAD 64 million 5.80% none Exhibit 3. Summary of proposed swaps Swap 1. Toque Brothers pays to Delicioso: all future payments associated with a EUR 50 million, 10 years until maturity, 7.30% annual payment bullet loan. Delicioso pays to Toque Brothers: all future payments associated with a CAD 64 million, 10 years until maturity, 5.80% semiannual payment bullet loan. Swap 2. Toque Brothers pays to Delicioso: all future payments associated with a EUR 50 million, 11 years until maturity, 7.10% annual payment bullet loan. Delicioso pays to Toque Brothers: all future payments associated with a CAD 64 million, 11 years until maturity, 5.80% semiannual payment bullet loanStep by Step Solution
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