DEBT-EQUITY SWAP A transaction in which the obligations (debts) of a company or individual are exchanged for something of value (equity).

In the case of a publicly-traded company, this would generally entail an exchange of bonds for stock. The value of the stocks and bonds being exchanged are typically determined by the market at the time of the swap. A debt/equity swap is a refinancing deal in which a debtholder gets an equity position in exchange for cancellation of the debt. The swap is generally done to help a struggling company continue to operate (after all, an insolvent company can't pay its debts or improve its equity standing). However, sometimes a company may simply wish to take advantage of favorable market conditions. Covenants in the bond indenture may prevent a swap from happening without consent. Definition: In the financial world, debt-to-equity swaps are common transactions. The resulting hybrid transaction enables the borrower to transform loans into shares of stock, or equity. Most commonly, a financial institution (such as an insurer or bank) holds the new shares after the original debt is transformed to equity shares. Equity represents money invested into a corporation or enterprise by owners called shareholders. The equity owner usually receives voting rights, and may vote in the yearly meeting of shareholders concerning the corporation or enterprises management or next steps. If the entity pays dividends, the shareholder receives cash flow as he owns equity. If the shareholder sells the equity held in the corporation or enterprise, he may achieve a profit, loss, or no change in the original capital invested. Equity of the entity or corporation is calculated by subtracting combined assets from total liabilities. The net worth of the corporate or enterprise represents equity, or what the entity owns less what the entity owes. Debt-to-Equity Swap Converting debt to equity occurs when the lender converts a loan amount (or a loan amount represented by outstanding bonds) into equity shares. No cash exchange occurs in the debt-toequity swap. Illustration: If a corporation with an outstanding loan has interim financial difficulties, the lender may request a debt-to-equity swap. The corporation would give up a percentage of ownership in the business in order to exchange debt to equity shares. If the corporation owed $100 million, the

company might agree to give the lender a 10 percent or greater ownership in the enterprise in exchange for the debt to equity conversion. Accounting of the Debt-to-Equity Swap The corporations financial department makes journal entries on the date of the debt -to-equity swap transaction date. Converting the entire $100 million loan to equity on the date of the transaction allows the corporation to debit the books by the full $100 million. The common equity account is then credited by the new equity issue (at $10 million, or 10 percent). The financial department also deducts the interest expense to report any losses incurred in the debt-to-equity swap conversion. HOW DOES THE COMPANY CONVERT DEBT INTO EQUITY? Occasionally, a company will need to undergo some financial restructuring to better position itself for long term success. One possible way to achieve this goal is to issue a debt/equity or an equity/debt swap. In the case of an equity/debt swap, all specified shareholders are given the right to exchange their stock for a predetermined amount of debt (i.e. bonds) in the same company. A debt/equity swap works the opposite way: debt is exchanged for a predetermined amount of equity (or stock). The value of the swap is determined usually at current market rates, but management may offer higher exchange values to entice share and debt holders to participate in the swap. After the swap takes place, the preceding asset class is canceled for the newly acquired asset class. There are many possible reasons why management would wish to restructure a company's finances. One possible reason may be that the company must meet certain contractual obligations, such as a maintaining a debt/equity ratio below a certain number, or a company may issue equity to avoid making coupon and face value payments because they feel they will be unable to do so in the future. The contractual obligations mentioned can be a result of financing requirements imposed by a lending institution, such as a bank, or may be selfimposed by the company, as detailed in the company's prospectus. A company may self-impose certain valuation requirements to entice investors to purchase its stock. Illustration: Assume there is an investor who owns a total of $1,500 in ZXC Corp stock. ZXC has offered all shareholders the option to swap their stock for debt at a rate of 1:1, or dollar for dollar. In this example, the investor would get $1,500 worth of debt if he or she elected to take the swap. If, on the other hand, the company really wanted investors to trade shares for bonds, it can sweeten the deal by offering a swap ratio of 1:1.5. Since investors would receive $2,250 (1.5 *

$1,500) worth of debt, they essentially gained $750 for just switching asset classes. However, it is worth mentioning that the investor would lose all respective rights as a shareholder, such as voting rights, if he swapped his equity for debt. WHAT ARE THE TAX IMPLICATIONS AND ITS REQUIREMENTS? Under Philippine Accounting standards, no accounting gain on debt restructuring is recognized. The carrying amount of the liabiliity is the basis of recording the issuance of shares of stock is credited to an additional paid in capital account. Any difference between the carrying amount of the liability and the par value of the shares of stock is credited to an additional paid in capital account. An equity swap has no effect on total assets because no asset is used to settle debt. Liquidity and solvency position remain unaffected by this arrangement. On the other hand, total liabilities will decline as a result of payment of a debt while stockholders equity will increase as a result of the issuance of the shares of stocks. An equity swap has no effect on the cash flow statement because the cash account is not affected by the transaction. However, equity interest of the stockholders may be affected by additional issued shares. The ownership of existing stockholder will be diluted when creditors are converted into stockholders. Existing stockholders should be aware of this pursuing an equity swap because the voting power and policy making power that they used to enjoy may be curtailed by the new stockholder. Possible tax benefits A debt for equity swap can result in favourable tax treatment for both the company and the creditor. Where both parties are subject to corporation tax, the release of a debt is generally deemed to be income in the hands of the company (other than as part of insolvency proceedings). However, where the release is in consideration of the issue of ordinary shares, the company will not be deemed to receive income. The creditor will get a deduction equal to the difference between the carrying value and the market value of the loan and, going forward, the creditors base cost in the shares in the company will be equal to the market value of the released debt. THE PROCEDURES IN THE SEC. IF IT IS A LISTED COMPANY, WHAT HAPPENS?

WHAT IS SYNDICATED LOAN? A loan offered by a group of lenders (called a syndicate) who work together to provide funds for a single borrower. The borrower could be a corporation, a large project, or a sovereignty (such as a government). The loan may involve fixed amounts, a credit line, or a combination of the two. Interest rates can be fixed for the term of the loan or floating based on a benchmark rate such as the London Interbank Offered Rate (LIBOR). Typically there is a lead bank or underwriter of the loan, known as the "arranger", "agent", or "lead lender". This lender may be putting up a proportionally bigger share of the loan, or perform duties like dispersing cash flows amongst the other syndicate members and administrative tasks. Also known as a "syndicated bank facility". The main goal of syndicated lending is to spread the risk of a borrower default across multiple lenders (such as banks) or institutional investors like pensions funds and hedge funds. Because syndicated loans tend to be much larger than standard bank loans, the risk of even one borrower defaulting could cripple a single lender. Syndicated loans are also used in the leveraged buyout community to fund large corporate takeovers with primarily debt funding. Syndicated loans can be made on a "best efforts" basis, which means that if enough investors can't be found, the amount the borrower receives will be lower than originally anticipated. These loans can also be split into dual tranches for banks (who fund standard revolvers or lines of credit) and institutional investors (who fund fixed-rate term loans). WHAT IS SPREAD AND MARGIN IN CORPORATE FINANCE? Net Interest margin A performance metric that examines how successful a firm's investment decisions are compared to its debt situations. A negative value denotes that the firm did not make an optimal decision, because interest expenses were greater than the amount of returns generated by investments. Calculated as:

Illustration: ABC Corp has a return on investment of $1,000,000, an interest expense of $2,000,000 and average earning assets of $10,000,000. ABC Corp's net interest margin would be -10%. This would mean that ABC Corp has lost more money due to interest expenses than was earned from investments. In this case, ABC Corp would have been better off if it had used the investment funds to pay off debts instead to making an investment. Net Interest Rate Spread The difference between the average yield a financial institution receives from loans and other interest-accruing activities and the average rate it pays on deposits and borrowings. The net interest rate spread is a key determinant of a financial institution's profitability (or lack thereof). In simple terms, the net interest spread is like a profit margin. The greater the spread, the more profitable the financial institution is likely to be; the lower the spread, the less profitable the institution is likely to be. While the federal funds rate plays a large role in determining the rate at which an institution lends immediate funds, open market activities ultimately shape the rate spread. The NIM is a difference between interest earned and interest paid , both are on actual dollars actually on deposit or lent out. This is like a profit margin for the bank on the total business done . The Interest spread is a rate difference between average rate paid to depositors and average rate obtained from borrowers. It is an average measure across all deposits and loans . Illustration: Tthe bank may have different maturities for loan and deposit , so the YTM , coupon etc could be different between loan and deposit . The spread is only an indicative figure to know how profitable the bank may be in the coming years WHAT IS COMMITMENT FEE? A fee charged by a lender to a borrower for an unused credit line or undisbursed loan. A commitment fee is generally specified as a fixed percentage of the undisbursed loan amount. The lender charges a commitment fee as compensation for keeping a line of credit open or to guarantee a loan at a specific date in future. The borrower pays the fee in return for the assurance that the lender will supply the loan funds at the specified future date and at the contracted interest rate, regardless of conditions in the financial and credit markets.

A commitment fee is different from interest; although, the two are often confused. A commitment fee is separate from the interest rate that is charged by the lender on the loan. A key distinction is that the commitment fee is charged on the undisbursed loan amount, while interest is charged on the disbursed amount of the loan. WHAT IS REVOLVING CREDIT? A line of credit where the customer pays a commitment fee and is then allowed to use the funds when they are needed. It is usually used for operating purposes, fluctuating each month depending on the customer's current cash flow needs. Often referred to as "revolver." Revolving lines of credit can be taken out by both corporations and individuals. The bank that is in agreement with the customer guarantees a maximum amount that can be loaned to the customer. Along with the commitment fee there are also interest expenses for corporate borrowers and carry forward charges for consumer accounts. ON FLOATING-RATE INTEREST, WHAT ARE THE OTHER SPECIFIC STANDARD IN THE MARKET BESIDE FROM LIBOR? LIBOR An interest rate at which banks can borrow funds, in marketable size, from other banks in the London interbank market. The LIBOR is fixed on a daily basis by the British Bankers' Association. The LIBOR is derived from a filtered average of the world's most creditworthy banks' interbank deposit rates for larger loans with maturities between overnight and one full year.` The LIBOR is the world's most widely used benchmark for short-term interest rates. LIBOR rates were first used in financial markets in 1986 after test runs were conducted in the previous two years. Today, LIBOR has reached such stature that the rate is published daily by the BBA at about 11:45 a.m. GMT. LIBOR is set by 16 international member banks and, by some estimates, places rates on a staggering $360 trillion of financial products across the globe LIBOR is important because it is the rate at which the world's most preferred borrowers are able to borrow money. It is also the rate upon which rates for less preferred borrowers are based. For example, a multinational corporation with a very good credit rating may be able to borrow money for one year at LIBOR plus four or five points. Another prominent trait of LIBOR is that it can dilute the effects of Fed rate cuts. Most investors think it's great when the Fed cuts rates, or at least they welcome the news. If LIBOR rates are high, the Fed cuts look a lot like taking a vacation to Hawaii and getting rain every day. High

LIBOR rates restrict people from getting loans, making a lower Fed discount rate a nonevent for the average person. Countries that rely on the LIBOR for a reference rate include the United States, Canada, Switzerland and the United Kingdom. LIBID The average interest rate which major London banks borrow Eurocurrency deposits from other banks. LIBID is calculated through a survey of London banks to determine the interest rate which they are willing to borrow large eurocurrency deposits. Unlike LIBOR, which is determined by the average interest rate which banks are willing to lend eurocurrency deposits, LIBID refers to the rate which banks bid to borrow. LIMEAN The mid-market rate in the London Interbank market, which is calculated by averaging the offer rate (LIBOR) and the bid rate (LIBID). The LIBOR is the rate at which funds are sold in the market, while the LIBID is the rate at which the funds are purchased in the market. The LIMEAN rate can be used by institutions borrowing and lending money in the interbank market, instead of using the LIBID or LIBOR rates, in any lending agreements. It can also be used to gain insight into the average rate at which money is being borrowed and lent in the interbank market. WHAT IS THE DIFFERENCE BETWEEN LIBID AND LIBOR? Both LIBID and LIBOR are rates primarily used by banks in the London interbank market. The London interbank market is a wholesale money market in London where banks exchange currencies either directly or through electronic trading platforms. The acronym LIBID stands for London Interbank Bid Rate. It is the bid rate that banks are willing to pay for eurocurrency deposits in the London interbank market. Eurocurrency deposits refer to money in the form of bank deposits of a currency outside the country that issued the currency. However, eurocurrency deposits may be of any currency in any country. The most common currency deposited as eurocurrency is the US dollar. For example, if US dollars are deposited in a European bank or any bank outside the U.S, then the deposit is referred to as a eurocurrency. LIBOR stands for London InterBank Offered Rate. LIBOR is the interest rate at which banks borrow money from other banks in the London interbank market. The LIBOR is set on a daily

basis by the British Bankers' Association. The LIBOR is derived from a filtered average of the world's most creditworthy banks' interbank deposit rates for larger loans with maturities between overnight and one full year. LIBOR is the most widely used point of reference for short-term investment interest rates. WHAT IS THE DIFFERENCE BETWEEN LIBOR, LIBID AND LIMEAN? LIBOR, LIBID and LIMEAN are all reference rates used to benchmark short-term interest rates. The London Interbank Offered Rate (LIBOR) is the rate at which banks can borrow unsecured funds from other banks in the London interbank market. The London Interbank Bid Rate (LIBID), on the other hand, is the rate that banks are willing to pay for unsecured funds from other banks in the London interbank market. Both these rates (especially LIBOR) are considered the foremost global reference rates for short-term interest rates. They are derived from a filtered average of the world's most credit-worthy banks' interbank bid/ask rates for institutional loans with maturities that range between overnight and one year. The London Interbank Mean Rate (LIMEAN) is considered the mid-market rate in the London Interbank market. LIMEAN is the calculated average between LIBOR and LIBID and can be used to identify the spread between the two rates. LIMEAN is also used by institutions borrowing and lending money in the interbank market (rather than using LIBOR or LIBID), and is a reliable reference to the rate most indicative of the interbank market. LIBOR and LIBID are both calculated and published daily. However, unlike LIBID, which has no formal correspondent responsible for fixing it, LIBOR is set and published daily at 6am EST (11am in London) by the British Bankers' Association. LIBOR is also used extensively as a key reference rate for a variety of global financial instruments such as short-term interest futures contracts, forward rate agreements, interest rate swaps and currency options. LIBOR is also a key driver in the Eurodollar market, because it is used as the reference rate for valuing eurodollar futures contracts.