Financing on special offer
The statement of the business director of a mid-sized machinery manufacturer provides a good example illustrating this: “The interest terms and the structuring of the covenants were so attractive to my shareholders and me that we decided to choose very long maturities and a loan amount that was greater than we had actually planned.” In early June 2014 institutional lenders extended long-term loans with seven and ten-year maturities to this company for its growth financing. The agreed interest rate for the 7-year range was fixed at 2.4% p.a. and at 2.7% p.a. for the 10-year range. Good credit worthiness and low benchmark rates are the essential factors influencing such favorable business financing.
In the background, some commercial interest rates have fallen markedly. The business customer market is so competitive that even margins are shrinking. German banks and institutional lenders like pension funds and foundations see good engagement opportunities in the segment. The strong competition among lenders is resulting in pressuring profitability and shrinking income. The current low interest rate policy of the central banks and the effects of “Basel III” have had a generally negative impact on the business of lending institutions. Added to that, companies have often no increased needs for financing and, along with restrained loan demand, their interest in commission products has likewise fallen. As a result, banks are losing income in their foreign trade, “cash management”, factoring and derivatives areas. The same holds true on the other side for their deposit taking business with savings and current account deposits.
Despite the tough competition, however, credit terms will remain at their present level for a while longer. No bank willingly surrenders its market position, not least because for many institutions commercial lending is part of their core business. However, if it becomes apparent that increasing income and profitability is impossible, many participants can be expected to withdraw from entire segments and branches. Moreover, higher equity requirements for banks and higher securitization of outstanding loans in individual risk classes could lead to a reduction in loan portfolios. Such a scenario would lead to a credit crunch.
That being the case, in the wake of the introduction of “Basel III” higher prices can be expected for loans with maturities greater than one year. In addition, term-congruent refinancing and low interest rate policies will induce earnings problems that also makes it conceivable that the banking landscape will shrink. Mergers would then be the likely method for making the adjustment.
From the firms’ perspective, the situation is advantageous right now because it strengthens their negotiating position. Many companies even use the opportunity to negotiate lines of credit that will often involve resetting prices, collateral and maturities or extending them in advance. And they reposition their financing over a broader foundation and they use the option of obtaining long-term institutional financings as an additional building block.
In this sense, the stated desire of a CFO to get acquisition financing with a minimum 10-year maturity is perfectly understandable. Since everything looked good, his company in the foods industry got its funding from non-bank lenders. Finally, it has not been that long ago, when loans from banks were significantly more expensive and difficult to get – especially for firms with lower credit ratings. Back then in addition some credit lines were cancelled by banks. Which is reflected today in the fact that, besides maturities and interest rates, the source of credit funds also plays a very important role for companies.
Thus, mid-sized companies should review their needs for the next few years and take advantage now of the low interest rates to secure their financing. The use of new structural elements – for example institutional loans from institutional lenders – will enhance their independence from banks. That diversification will pay off at the latest when the times change once again.