Bank loans for larger companies

Bank loans for larger companies? Life on Mars says John Grout

What are banks for? Recent headlines say the government is concerned to keep credit flowing to consumers and to small businesses. There has been little mention of larger firms.

We are told that, post this credit crunch, the world of finance will have changed a lot: the practice of the years around the turn of the millennium is history.

What will financing look like for larger companies? Perhaps, back to the slightly more distant past.

I started in this game in the early 1970s.

Larger companies had their long-term funding from bond markets (“loan stock” and “debentures”).

Medium-term finance was just the older bonds getting within 2 to 5 years of maturity. Banks provided overdrafts – usually relatively small, repayable on demand and related to working capital.

Banks would discount (buy) trade bills or accept bills drawn on them “in respect of current trade”. The latter were "bankers acceptances". They could be sold or used as collateral for loans. The Bank of England could buy and sell them as part of its money market operations if it wanted to inject liquidity into the market or to withdraw it.

For large companies then, banks were about working capital finance. Additionally they might provide some secured loans for apparently easily marketed items such as machine tools.

By the mid-1970s, a new market started up in the UK.

The American banks arrived. They were happy to extend unsecured ("cash-flow based") medium term finance but wanted to be in it with some other banks. The syndicated loan had landed.

I did an early sterling syndicated loan, at the time the then largest, led by Philip Martin Brown of Citibank (remarkably still there at the last count). It was a fully drawn revolver. It had a “no assignment” clause, so the syndicate was the same for its life.

Significantly, the market quickly began to include in loans a commitment fee to allow un-drawn periods. This was a crucial step. The banks were now providing stand-by finance other than overdraft – medium-term and in much larger quantities.

The banks’ USP is, of course, that they provide standby finance.

Subsequently, banks began to set up leasing subsidiaries (encouraged by the tax provisions) and another source of medium-term funding arrived.

Large companies relatively reduced their use of overdrafts. Trade bills became unusual in domestic trade. The use of acceptances for working capital finance faded out. European companies started to issue commercial paper (short term but they had bank stand-by facilities to ensure medium-term credit availability). The bond market continued but moved away from secured bonds. Medium term bonds (notes) grew. Average duration of companies’ debt shortened.

Now, bank balance sheets will have to contract in the coming years. Furthermore banks will have unwanted equity positions in companies which have undergone “restructuring”.

Probably, corporate financing will have more of an early-70s feel to it.

Average duration of debt is likely to lengthen: more bond finance, plus the more recent floating rate notes, with a bit of leasing; less from drawn medium-term bank loans. Short-term finance will be regarded as a bit unreliable and much less used. It will come from money markets and from revitalised commercial paper markets, both backed by those expensive bank standby lines, plus, perhaps, a revived acceptances market and a smaller helping of overdrafts which will also be more expensive.

Companies will hold more cash – in some cases very large amounts, with investments, even acquisitions, tending more to be pre-financed.

Will we see a revival of secured lending? Recent experience has reminded us of the vulnerability of companies with a high proportion of secured finance (on both fixed assets and working capital, including through leasing). In a crunch there is nothing left to give confidence for new borrowing, even were it available. Some lenders may want it but, in the longer term, I doubt if secured financing will dominate.

It seems, overall, that larger companies are likely to be renting a much smaller amount from banks' balance sheets. What banks will provide will be dominated by expensive options to borrow rather than core drawn finance.

By John Grout