The world's largest toy retailer, U.S. firm Toys R' Us, recently closed an innovative securitization that parcels the license fees that Toys R' Us Japan pays to the parent company. The deal provides dollar funding at the current cheap Japanese interest rates and also locks in the current favorable yen/dollar exchange rate.

The 16 billion ($147 million) transaction monitizes the 3% royalty on gross sales that the Japanese operation pays to the parent for the right to use its brand. Toys R' Us Japan is 48% owned by the U.S. company, which is rated A-minus by Standard & Poor's. The deal has a 3.5-year average life and a five-year final maturity.

The transaction was arranged by Citibank and instead of being sold in the bond markets was placed in the loan market with a group of banks, in the same way that a syndicated loan is parceled out. The banks that participated as co-arrangers were, along with Citi itself, Bank of Tokyo-Mitsubishi Trust, Sumitomo Bank, West LB, Mitsubishi Trust & Banking, Fuji Bank, Lloyds TSB Bank, Commerzbank and Standard Chartered Bank.

The participants advance a 16 billion loan to an SPC called ST Funding, which is then swapped by Citi to give the Toys R' Us parent dollar funding. The license fees are then paid into the same SPC and a fixed level of principal is repaid, plus interest payments referenced to yen-Libor.

A Citi official in Tokyo said that in funding terms the parent company is effectively borrowing at around 2% all-in, rather than the around 6.75% that it would need to pay to borrow on its own name in the U.S. market. He added that the deal also means that the company is no longer exposed to exchange rate fluctuations and benefits from the historically strong yen at the time when the deal was closed.

The point was reinforced by Frank Cavallo, managing director of global securitization at Citi in New York. "Through a new hedging arrangement developed by Citibank, the transaction provides a medium-term economic foreign exchange hedge of future yen revenue flows," he said. "Toys R' Us achieves substantial interest expense savings by locking in U.S. dollar financing at an historically low equivalent yen interest rate."

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