Chase s Strategy for Syndicating the Hong Kong Disneyland LoanWe are investment bankers, not commercial bankers, which means that we underwrite to distribute, not to put a loan on our balance sheet. Matt Harris, MD, Chase Securities

Project Appraisal and Finance Group 14 | Section A Ankit | Inderpreet | Indu | Khalid | Mohit

Introduction: Case (1/2) August 2000 Hong Kong International Theme Parks Ltd (HKTP): an entity jointly owned by The Walt Disney Company and the Hong Kong government HKTP awarded Chase Manhattan Bank the mandate to lead a HK$3.3 bn bank financing for the construction of the HK$14 bn HKTP and resort complex 17 major banks invited to bid on deal Disney chose Chase because of its global leadership in syndicated finance and its firm commitment to underwrite the full loan amount Chase responsible for raising the funds regardless of how the bank market reacted to the deal

Introduction: Case (2/2) Chase HQs in NY, but HK office responsible for executing the deal Deliver a syndication that met both the bank market s expectations for participation levels and credit quality , and the sponsor s desire for a rapid closing with a supportive bank group Direct consequences on Chase s reputation as a leader in syndicated finance, its returns as an underwriter, and its credit exposure as a lender Alternatives: General Syndication 2-stage Syndication, with a sub-underwriting prior to prior to general syndication

Decide: Banks to invite Allocation of fees and titles Loan to retain on B/S

Introduction: Hong Kong (1/2) 150 years as a British Colony In 1997, HK became the Hong Kong Special Administrative Region (HKSAR) within the People s Republic of China Transfer of Sovereignty Agreement, China assured SAR a high degree of autonomy under a one country, two systems concept Some concerns: political freedoms and civil rights, but preserved British legal system and free market economy New govt. maintained low taxes, unrestricted capital movement, a stable HK$, and a duty free port

Introduction: Hong Kong (2/2) One among the Asian Tigers Its prosperity ranked with large countries in Western Europe Economy: Based on services, tourism and international trade Few natural resources; relatively high labour costs

Recession: Thai currency crisis 1997 Unemployment rate more than doubled GDP fell for the first time in 20 years Stock market crashed Tentative recovery by mid-1999 Decline in o/p remained a subject of public concern

People on HK banking on a Disney theme park to create more jobs and end a slump in tourism

Introduction: The Walt Disney Company (1/2) Inception in 1923 Multinational, multimedia entertainment giant Revenues > $20bn Debt rating: A Annual Operating cash flow: $5bn

Business Segments: 1. Theme Parks and Resorts 2. Media Networks 3. Studio Entertainment 4. Consumer Products 5. Internet/Direct Marketing 7 Theme parks (+4 in the works), 27 hotels with 36,888 rooms, 2 cruise ships, 728 Disney stores, 1 broadcast n/w, 10 TV stations, 9 international Disney channels, 42 radio stations, 1 internet portal, 5 major internet websites, interests in 9 US cable networks, and a library containing thousands of animated and live films and TV episodes.

Introduction: The Walt Disney Company (2/2) Theme Parks and Resorts segment Company owned and operated the original Disneyland in Anaheim, California and the Walt Disney World resort complex in Orlando, Florida US and Tokyo parks successful Earned fees & royalties on Tokyo Disneyland(1983) and Disneyland Paris(1992)

Disneyland Paris experienced financial problems due to: European recession Large initial capital expenditures Overly aggressive capital structure, dependent upon real estate sales for debt service (project debt = 75% of project value) To avoid bankruptcy, had to forgo some of its management and other fees; banks active in HK market restructured loans

Importance of international growth: US gives 80% of its revenues, has only 5% of world population

Introduction: Hong Kong Disneyland (1/5) In December 1999, Disney and the HK Govt. signed a comprehensive agreement for a new theme park and resort complex to be located on the northeastern end of Lantau Island. According to the agreement, the project would have 3 phases: Phase I would include a Disneyland-style park with several themed lands featuring Disney rides and attractions, as well as one or two hotels and a retail, dining, and entertainment complex. Phases II and III were less well defined, but included options to develop adjoining sites at some point in the future.

Development strategy: Learning from our experience with Disneyland Paris [a deal that experienced financial problems shortly after opening], the strategy for Hong Kong was to start small and then to add capacity over time as demand grew. In fact, Phase I included plans to double capacity within the first ten years of operations. The real keys to success are having the land available for growth and the ability to finance this growth out of operating cash flow.

Introduction: Hong Kong Disneyland (2/5) Because most of the construction site was currently ocean, the sponsors had to reclaim land. The HK Govt. agreed to pay for land reclamation and infrastructure development at a cost of HK $14 billion. According to the target dates, land reclamation would begin at the end of 2000, resort construction would begin in 2002, and the park would open for business in 2005. The Government supported the project because it expected the park to generate sizable public benefits. One local economist estimated that land reclamation and construction would generate 16,000 new jobs, while the resort would generate 18,000 jobs at opening and up to 36,000 jobs within ten years.

Introduction: Hong Kong Disneyland (3/5) A new corporation, Hongkong International Theme Parks Limited (HKTP), was created to construct, own, operate, and finance the project. It planned to raise the HK $14 billion construction cost from 4 sources:

This sum does not include an additional $14 billion of land value and associated infrastructure development contributed by the HK Govt.

Introduction: Hong Kong Disneyland (4/5) The HK Govt. and Disney agreed to provide equity shares of HK $3.25 billion (57% share) and HK $2.45 billion (43% share), respectively. In addition, the HK Govt. agreed to provide HK $6.1 billion of subordinated debt with a 25-year maturity and repayments starting 11 years after opening day. This left a shortfall of HK $2.3 billion (16% of total capital), which the HK Govt. hoped to fill with some kind of external finance. Inclusion of private sector financing would not only show that the project was viable in the eyes of the international banking community, but would also provide independent oversight of construction as well as monitoring of ongoing operations. Eventually, HKTP decided to raise HK $2.3 billion through a 15-year, nonrecourse term loan for construction and HK $1.0 billion in a 15-year, nonrecourse revolving credit facility for post-construction working capital needs.

Introduction: Hong Kong Disneyland (5/5) Because HKTP did not need significant construction funds until after the land reclamation was complete, it had the option of waiting until 2002 before raising the bank debt. By waiting, it could delay paying the commitment fees charged by the banks. Although it had two years in which to place the commercial loan, the Asian loan market was showing signs of recovery by early 2000. Knowing the structuring and syndication process could take six to nine months, it decided to start the process sooner rather than later. Its fear, given the recent volatility in the Asian banking market, was that if it waited until 2002, it might not be able to get a loan, never mind a loan with attractive pricing.

Winning the Mandate Disney Deal Team for HK$3.3 bn financing: VP, Corporate Finance and assistant treasurer Director, Corporate Finance Manager, Corporate Finance Senior Analyst, Corporate Finance VP and Counsel

Developed a Term Sheet for bank financing and contacted company s relationship banks and other banks expert in HK syndicated loan market Discussions: Get preliminary expression of interest and assessment of current conditions in HK bank market Disney explained: wanted to raise HK$3.3 bn non-recourse loan package on a fully underwritten basis and expected to scale up to 3 lead arrangers for the transaction

Introduction: Chase Manhattan Bank (1/2) It was highly predictable that Disney would contact Chase Manhattan Bank. One of Disney s top 10 relationship banks Chase was the third largest bank in the U.S. (> $400 bn assets and $175 bn loans in 1999) A leader in the field of syndicated finance. In 1999, lead arranger for 34% of total syndicated loans by dollar volume in the US (nearest competitor: 21%) Dominant in US market for loans greater than $1bn; led 47.5% of deals, 3 times more than the nearest competitor The financial press had recognized Chase s leadership with numerous awards: Best Loan House of the Last 25 Years 1974-1999 (International Finance Review) Best at U.S. Syndicated Loans 1999 (Euromoney) Best Project Finance Arranger in the U.S. 1999 (Project Finance)

Introduction: Chase Manhattan Bank (2/2) Not the market leader in all loan types or all locations but a formidable competitor in most markets, including Asia Over 400 professionals in its Global Syndicated Finance Group with offices in London, NY, HK, Tokyo and Sydney Each office had structuring and distribution teams The largest syndicated lending platform in the Asia Pacific region More people and greater coverage, so able to do the largest and most difficult deals

Making the Short List (1/2) 3 ways to approach a deal: bid aggressively to win bid less aggressively without fear of losing no bid

Although Disney was an important global client, the deal did not seem that attractive to Chase initially. It had a long tenor (15 years) which banks don t like, it had to contend with the problems at Disneyland Paris, the sponsors wanted to mandate as many as 3 lead arrangers which hurts its economics, and its competitors, especially the local banks like Bank of China and Hong Kong Shanghai Banking Corporation (HSBC), were likely to bid aggressively And so, it decided to bid less aggressively without fear of losing. Yet to protect its reputation, it wanted to bid aggressively enough to make the short list for this high-profile deal. If it happened to win the mandate, it would have to be on terms that met our earnings thresholds

Making the Short List (2/2) Disney Finance Team met Chase and 16 other banks in HK to review: Key loan terms including the pricing (an unknown) Amount (HK$3.3 bn) Maturity (15 years) Covenants

Chase team emphasized its flexibility on key strategic terms, its credentials as a leading syndication bank and its knowledge of and relationship with the local market. For Pricing, Chase indicated that it needed an underwriting fee of between 100 bp and 150 bp, and that the market would probably require interest rate spreads of 135 to 150 bp over HIBOR to accept the deal. Although Chase expected ultimately to bid to lose, it agreed that the deal would be much more attractive if Disney chose to award a sole lead arranger mandate. Disney shortlisted 5 banks for the mandate and asked them to submit final proposal: Chase, HSBC, Bank of China, ABN Amro, Citi Bank, and Fuji Bank.

Preparing the Final Proposal (1/8) Chase had to assess: Loan s credit risk Decide whether to underwrite the full amount Commit to an underwriting fee and interest rate spread Develop a preliminary syndication strategy

Chase came up with some creative features to improve the chances of winning: For example, they suggested splitting the revolving credit facility into two parts, a HK $250 million portion that would be available for construction cost overruns and a HK $750 million portion that would not be available until construction was completed. While the available portion would carry a market based commitment fee of 37.5 basis points per annum, the unavailable portion would carry a discounted fee of 15 basis points per annum. Such leeway was possible given the loan s seniority and modest size relative to HKTP s total capital.

Preparing the Final Proposal (2/8) Credit Issues: Disney s Term Sheet contained aggressive elements, particularly the 15-year final maturity and a provision that allowed repayments to start as late as three years after opening. Chase expected market to be leery of 15-years tenor as most bank loans were fully repayable in 3-5 years Disney s desire to use operating cash flows for expansion (capital expenditures) Its unwillingness to subordinate management fees and royalties Borrower s principal asset (fallback collateral) was oceanfront land, which would not exist for nearly 2 years.

Stress testing the financial implications, Chase decided these credit issues were adequately mitigated by the borrower s conservative capital structure and the govt. s commitment to the project. Chase resolved to show max. flexibility (align its proposal to Disney s request), include covenants requiring min. DSCR

Preparing the Final Proposal (3/8) Issue: Commitment to underwrite the full amount Exposed the bank to greater risk; sought senior mgmt. approval This proposal would:show Chase s support for the client, signal its confidence in the deal, and provide greater profit for the firm. It might also set Chase apart from other banks that were unwilling to underwrite the deal and increase the probability of winning a sole mandate deal

Internal approval process centred on deciding: Credit exposure chase wanted to hold on its books after general syndication Differentiates b/w underwriting risk and credit risk As a lead arranger, Chase general policy was to hold 10% of the loan (% declined as loan size or risk increased) Chase decided to hold a final position of HK$300 mn, slightly < 10%, was appropriate given the 15-year maturity

Preparing the Final Proposal (4/8)Pricing: Standard procedure: benchmarking Careful analysis reqd. as no two loans were exactly alike, esp. project loans Chase proposed: Initially, the spread would be 100 basis points over HIBOR, stepping up to 125 basis points in year six, and to 137.5 basis points in year 11. Step-up pricing, a common feature on project loans, appeals to borrowers who want lower expenses in the early years and who plan to refinance before the step-ups take effect. It also appeals to lenders, who view the increases as compensation for longer maturities and greater future uncertainty. w.r.t. underwriting fee, they thought a no. b/w 100-150 bp was appropriate

Its fee might be on the high end, but it didn t feel bad about this for 2 reasons: It was not afraid to lose this deal on up-front pricing it cared about deal quality and profitability, not deal volume. Second, if properly marketed, borrowers viewed the up-front fees in terms of their annual cost, not the nominal first-year cost.

Preparing the Final Proposal (5/8)Syndication Process:Option# 1: Chase would be the sole mandated lead arranger Would invite 4 banks to act as sub-underwriters with lead arranger titles in exchange for commitments of HK$660 mn The final allocations in the general syndication for the reqd. total of $3.3 bn would be: Chase and the 4 lead arrangers at HK$300 mn each 4 arrangers at HK$250 mn each 4 co-arrangers at HK$150 mn each and 2 lead managers at HK$100 mn

Advantages: Administrative simplicity: Disney to deal with only 1 lead bank Reduced underwriting risk for Chase Possibly easier syndication given the sub-underwriter support

Preparing the Final Proposal (6/8)Syndication Process:Option# 2: Chase and 2 other banks would share a joint mandate and a joint underwriting commitment, but they would skip the sub-underwriting phase The mandated banks (coordinating arrangers) would each underwrite HK$1.1 bn of the total amount and split the underwriting fee 3 ways The final allocations in the general syndication would be: Chase and the 2 other mandated banks at HK$300 mn each 4 arrangers at HK$250 mn each 6 co-arrangers at HK$150 mn each 5 lead managers at HK$100 mn

This strategy required only 2 additional underwriting commitments instead of 4 prior to the general syndication, but it meant sharing league table status as well as giving up two-thirds of the underwriting fee.

Preparing the Final Proposal (7/8)Syndication Process:Option# 3: (not presented to Disney) Combination of the first 2 options Chase would be the sole mandated bank and it would proceed directly to the general syndication where the final allocations would be: Chase at HK$300 mn 4 arrangers at HK$250 mn each 8 co-arrangers at HK$150 mn each 5 lead managers at HK$100 mn

Relative to the other 2 strategies this strategy would: improve Chase s compensation and league table status , but would expose it to the greatest amount of credit and syndication risk, and would result in the largest syndicated as measured by the no. of participating banks.

Preparing the Final Proposal (8/8) The key to success in this business is being close to the market. This means being in touch with banks on a weekly, if not daily, basis. Started with a universe of approx 90 banks and created a target lender list that might be interested in this deal. Then partitioned the target list into commitment size categories and assigned participation probabilities for each category. This process gave it a sense of liquidity and an indication of whether the deal will clear the market. Based on its analysis for the Disney deal, they expected it would be oversubscribed by 57%. This kind of analysis illustrated its closeness to the market and its confidence in the deal.

Arranging the Loan (1/) Disney chose Chase because: its pricing was competitive, it agreed to underwrite the full amount, and they showed a high degree of flexibility on structuring, particularly their willingness to permit ongoing capital expenditures without burdensome covenants.

Having won the sole mandate, Chase met with Disney to negotiate a commitment letter with final terms, discuss the syndication strategy, and map out a syndication timetable. As with any legal document, the content of a formal commitment letter invariably required negotiation. From experience, Chase knew its standard market flex provision was likely to be one source of contention. The market flex clause that was presented to Disney read: Chase shall be entitled, after consultation with Disney and the Borrower, to change the structure, terms, amount, or pricing of the Facility if the syndication has not been completed due to a change in the Hong Kong Dollar market and if Chase determines, after consultation with Disney and the Borrower, that such changes are advisable to ensure a successful syndication of the Facility.

Arranging the Loan (2/) Although borrowers disliked the provision, its inclusion was argued, particularly in the volatile Asian market: Chase was the pioneer in the use of market flex terms. It makes good business sense to include this clause, even though our competitors sometimes use it against us in competitive mandates, because things can change between the time you sign a deal and the time you try to close it. Unlike the material adverse effect (MAE) or material adverse change (MAC) clauses, which allow us to pull a commitment, the market flex provision is not an out. Instead, it provides room to maneuver, to adjust key terms as with a bond issue. But to date, Chase had never invoked the market flex clause in Asia. Nor did it invoke the MAC clause, even during the Asian financial crisis of 1997-1999, and it told this to clients.

Arranging the Loan (3/) After agreement on the final terms and commitment letter signed, Chase had to select a syndication strategy. Because Chase had committed to a fully underwritten deal, the syndication strategy was technically their decision alone. However, for relationship reasons, Chase knew it was important to accommodate Disney s priorities as much as possible, and these favoured a sub-underwriting approach. Disney requested that some of the short-list banks and some other strong banks that did not participate in the bidding have senior status. Disney also wanted to keep the final bank group down to a manageable size. Syndicate structuring Trade-off: Large syndicate generates more competition for the deal and often results in better execution but asks for sharing of confidential information with more people. Also, it s harder to reach agreement with a larger group of banks. Lead banks hold larger shares was desired.

Arranging the Loan (4/) Chase to Decide: Whether to pursue a sub-underwriting; whom to invite as potential sub-underwriters Should they target local banks for participation

They didn t want the syndicate to get too big and let the commitments get too small; they did want to give interested banks a chance to participate Participation by HK banks, particularly at the sub-underwriter level, would bring greater political support for the deal and send stronger signals for the deal and send stronger signals to foreign and smaller local banks about deal quality. Also easier to fund a HK dollar loan given their ability to raise HK dollar deposits (i.e. to eliminate currency risks).

Arranging the Loan (5/) Chase takes its relationships with investor banks very seriously. It doesn t simply view them as stuffee banks, but rather partner investors with whom a close relationship built on trust is critical. While it could often keep a larger slice of the pie, it didn t want to expend any goodwill with our investors by leaving them with the impression that it had gouged them on fees or denied them an opportunity to acquire a meaningful earning asset.

Case: Part B (1/) Chase opted for sub-underwriting strategy for HK$3.3 billion financing It invited seven banks to make underwriting commitments of HK$600 million in return of lead arranger titles and subunderwriting fee of 25bp Though Chase announced its merger with J.P. Morgan, six banks agrees to participate at HK$600million each, thus forcing it to scale back their exposures to HK$471 million each Though the general syndication, it hoped to reduce the subunderwriters commitments to final hold positions of HK$300 million or less

Case: Part B (2/) Chase launched general syndication and invited 67 banks with three different levels of participation Arranger tier for commitments of HK$250 million, up-front fee of 70bp Co-arranger tier for commitments of HK$150million, up-front fee of 60bp Lead manager tier, between HK$75 million and HK$100 million, fee of 50bp

Commitments had to be pro rata for HK$2.3 billion construction term loan and HK$1 billion revolving credit facility, to be received by October 25th It had rights to close the syndication early if it received sizeable commitments quickly

Case: Part B (3/) General Syndication was success as it generated commitments totaling HK$5.3 billion from 25 banks Considering the HK$4.2 billion in commitments from seven subunderwriters, Chase had approved commitments totaling HK$9.5billion, which was an over-subscription of close to three times