loans

SMALL AND MEDIUM ENTERPRISES

admin — Sun, 01 Nov 2009 16:45:21 +0000

Small and medium enterprises (SMEs) are other companies or partnerships that fall below the criteria defined for corporates. Individual banks have different definitions of what constitutes a corporate customer rather than an SME. A separate small and medium size enterprise division usually handles smaller companies, and the smaller companies may well be included within retail banking.
There is no hard and fast definition of an SME. Banks, however, generally regard loans to the SME segment as higher risk than loans to corporates. Large corporates are usually tracked by credit rating agencies such as Moody’s and Standard and Poor’s. Corporates usually have alternative ways to raise finance, such as equity and bond issues, other than borrowing from banks. This combination of perceived higher risk and lack of alternatives means that most SMEs are charged more for loans than larger corporates.
Small companies frequently find that larger suppliers demand shorter payment terms, and may even require cash on delivery, but that their larger customers insist on longer credit terms. This pushes up the need for working capital. Successful expanding companies usually find that working capital requirements grow rapidly, most SMEs have no option other than to turn to banks to meet these financing requirements.
Start-ups frequently find that trying to get a loan from a bank is like trying to get blood out of a stone. Most banks insist on a minimum of three years’ audited accounts before they will consider making a loan. Many start-ups fail and banks find it difficult to price the risk of failure in the absence of any operating track record. This means that most start-ups have to rely on equity, and possibly venture capital, for all of their funding requirements.

Transaction costs

admin — Sat, 24 Oct 2009 16:44:09 +0000

There are significant transaction costs relating to the issue of paper into capital markets. Investment banks charge fees for managing and underwriting an issue. The lower upfront costs of borrowing from a bank may well outweigh any savings from a lower level of interest expense from issuing bonds.
Syndicated loans remove one advantage that bond issues may have. A syndicated loan is a loan made by a group of banks to a large borrower (the group of banks is referred to as the syndicate). The advantages of syndicated loans to borrowers are that they can borrow more in one go than they would be able to obtain from one bank alone. In this sense the syndicated loan market is in direct competition with the bond market. Such loans are either very large or higher risk than single-bank loans. Most loans usually have an arrangement fee. They may be traded in a secondary market. The lead manager usually takes responsibility for collecting interest and principal payments from the company and passing it on to the members of the syndicate.
Corporate loans have tended to become more specialized, for example providing short-term funding for an acquisition until the corporate has put in place longer-term funding from the bond or equity markets.
Banks have had to increasingly look at the total relationship with the corporate to justify low margin lending by also looking at the profitability of other fee generating businesses that the bank has with the client. This has become generally referred to as “credit leverage” or “tying” where the bank will only make the loan if the corporate agrees to give it business in another area where the bank can generate a compensating return, such as in investment banking.

Flexibility

admin — Sat, 17 Oct 2009 16:43:14 +0000

Commercial banks are able to offer relatively flexible financing. It is difficult to change restrictions arising from bond issues at a later date because of the number of bond- holders. A bank will also seek such covenants but is likely to be relatively flexible in terms of renegotiating the conditions at a future date. The borrower may also be able to extend the term of the loan, increase its balance or repay the loan earlier than originally agreed depending on changed business conditions.
An example of the sort of flexibility banks can offer is provided by the use of caps and collars. Take the following case as an example. A borrower with a floating rate loan is prepared to accept a level of interest rate risk but wishes to cap that risk at a certain level. If the borrower is prepared to forego some of the potential upside from lower interest rates a cheaper alternative is a collar and in this example the actual rate paid will vary only between 9% and 11%. Caps and collars provide further examples of the use of options.

Equity

admin — Sat, 10 Oct 2009 16:39:51 +0000

Equity is the money that the owners of the company have invested in the business. As equity is effectively perpetual it provides the longest-term financing option. It is also the most expensive form of financing.

Asset securitization.

admin — Sat, 03 Oct 2009 16:39:05 +0000

Over the past 30 years an entire industry has developed, led by investment bankers, to develop and sell asset securitization products. These provide an alternative way for companies to finance their operating assets. We can illustrate this by using a simple example of a company that owns its head office. By entering into a sale and leaseback type of arrangement the company can reduce its assets and hence borrowing requirement.

Convertible bonds

admin — Sat, 26 Sep 2009 16:38:09 +0000

Convertible bonds provide a form of debt financing with an option to convert the debt into equity at some future date.

Other straight debt

admin — Sat, 19 Sep 2009 16:38:03 +0000

Other forms of non-bank debt include subordinated debt and preference shares. These are forms of long-term debt that rank low in terms of seniority. Banks are rarely willing to offer commercial loans with terms greater than three to five years.