Debt & Bank Finance

Debt Finance

The two principal sources of debt finance are bank loans (in various forms) and the bond markets. We shall examine the differences between them. Historically, US corporations have made greater use of the bond markets due to the higher investor acceptance and the quest by banks for higher returns elsewhere. In Europe, the pressure on banks to increase returns for shareholders, the arrival of the euro (creating a pan-European investor base), and the growing use of credit ratings have led to an increasing use of bonds in the last few years. It is now also the case that investment banks make loans to corporates in order to cement their relationships with key clients and to show a commitment to them. Historically, loans were generally made by commercial banks whose balance sheets therefore are much larger than those of investment banks.

Bank Finance

The distinction between uncommitted and committed facilities is important to make.

An uncommitted facility is one which provides short-term (usually up to one year), temporary or seasonal financing. It is relatively cheap, but can be withdrawn by the bank very quickly. Typical uncommitted facilities would include money market lines, foreign exchange lines and overdraft facilities.

A committed facility is longer term (usually between one and five years) and where the borrower pays a fee to the bank for the facility. This fee may depend on the utilisation of the credit line (how much money has been borrowed). Most companies have committed facilities. The amount, maturity and terms of undrawn committed facilities are key indicators as to the financial health of a company. Uses of committed facilities include financing core working capital, financing fixed assets or providing funds for acquisitions (putting together a committed facility when making a takeover bid is often the first step in the M&A process).

In periods of deteriorating credit conditions, banks need to ensure that they have not committed to lend to too many companies at unfavourable rates (from their perspective) and that they have the ability to raise sufficient finance themselves in order to make the loans.