Over a decade ago as well as a strong current presence, medium-term notes (MTNs) have emerged as a major source of funding for U.S. and foreign corporations, federal agencies, supranational institutions, and sovereign countries.
MTN's have been around since the early 1970's. At that time, the market was established as an alternative to short-term financing in the commercial paper market and long-term borrowing in the bond market; thus the name "medium term." Through the 1970s, however, only a few corporations issued MTNs, and by 1981, outstandings amounted to only about 0 million. In the 1980s, the U.S. MTN market evolved from a relatively obscure niche market dominated by the auto finance companies into a major source of debt financing for several hundred large corporations. In the 1990s, the U.S. market continued to attract a diversity of new borrowers. Outside the United States, the EuroMTN market has grown at a phenomenal rate. Currently, outstanding MTNs in domestic and international markets stand over trillion dollars (Sources. Merrill Lynch & Co., Websters Communications International, Federal Reserve Board).
Most MTNs are noncallable, unsecured, senior debt securities with fixed coupon rates and investment-grade credit ratings. In these features, MTNs are similar to investment-grade corporate bonds. However, they generally differ from bonds in their primary distribution process. MTNs have traditionally been sold on a best-efforts basis by investment banks and other broker-dealers acting as agents. In contrast to an underwriter in the conventional bond market, an agent in the MTN market has no obligation to underwrite MTNs for the issuer, and the issuer is not guaranteed funds. Also, unlike corporate bonds, which are typically sold in large, discrete offerings, MTNs are usually sold in relatively small amounts either on a continuous or on an intermittent basis.
Borrowers with MTN programs have great flexibility in the types of securities they may issue. As the market for MTNs has evolved, issuers have taken advantage of this flexibility by issuing MTNs with less conventional features. Many MTNs are now issued with floating interest rates or with rates that are computed according to unusual formulas tied to equity or commodity prices. Also, many include calls, puts, and other options. Furthermore, maturities are not necessarily "medium term" - they have ranged from nine months to thirty years and longer. Moreover, like corporate bonds, MTNs are now often sold on an underwritten basis, and offering amounts are occasionally as large as those of bonds. Indeed, rather than denoting a narrow security with an intermediate maturity, an MTN is more accurately defined as a highly flexible debt instrument that can easily be designed to respond to market opportunities and
The emergence of the MTN market has transformed the way that corporations raise capital and in which institutions invest. In recent years, this transformation has accelerated because of the development of derivatives markets, such as swaps, options, and futures, that allow investors and borrowers to transfer risk to others in the financial system who have different risk preferences. A growing number of transactions in the MTN market now involve simultaneous transactions in a derivatives market.
BACKGROUND OF THE MTN MARKET
General Motors Acceptance Corporation (GMAC) created the MTN market in the early 1970s as an extension of the commercial paper market. To improve their asset-liability management, GMAC and the other auto finance companies needed to issue debt with a maturity that matched that of their auto loans to dealers and consumers. However, underwriting costs made bond offerings with short maturities impractical, and maturities on commercial paper cannot exceed 270 days. The auto finance companies therefore began to sell MTNs directly to investors. In the 1970s, the growth of the market was hindered by illiquidity in the secondary market and by securities regulations requiring approval by the Securities and Exchange Commission (SEC) of any amendment to a registered public offering. The latter, in particular, increased the costs of issuance significantly because borrowers had to obtain the approval of the SEC each time they changed the posted coupon rates on their MTN offering schedule. To avoid this regulatory hurdle, some corporations sold MTNs in the private placement market.
In the early 1980s, two institutional changes set the stage for rapid growth of the MTN market. First, in 1981 major investment banks, acting as agents, committed resources to assist in primary issuance and to provide secondary market liquidity. By 1984, the captive finance companies of the three large automakers had at least two agents for their MTN programs. The ongoing financing requirements of these companies and the competition among agents established a basis for the market to develop. Because investment banks stood ready to buy back MTNs in the secondary market, investors became more receptive to adding MTNs to their portfolio holdings. In turn, the improved liquidity and consequent reduction in the cost of issuance attracted new borrowers to the market.
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