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Debt financing is a central financing resource and the classic supplement to equity financing in Germany. Debt is available for day-to-day business as well as for long-term investments.
The main differences in comparison to equity financing are:
The availability of debt depends on the credit rating of the debtor. The creditor distinguishes between the investment-grade and the non-investment grade.
Debt financing is usually not available for companies with a non-investment grade credit rating.
The main financing instrument for a project is the investment loan. The preferred loan duration is seven years with a one year repayment holiday (1+6); the usual maximum is ten years with a two year repayment holiday(2+8). Interests are charged on an annual or semi-annual basis.
Creditors always require securities against a default of payment. Fixed assets will usually serve as the first source of security. Inventory and receivables can be used as collateral primarily for working capital facilities. In addition to the above-mentioned sources of collateral, shareholder guarantees (recourse) are often required as a means of reducing the bank’s credit risk.
Bridge financing becomes necessary when a company has to substitute (or bridge) a deferred financial inflow, which results in a financial gap.
Usually such gaps follow from having to pre-finance orders, or from time-shifted payments of incentives. The Investment Allowance, for example, has to be bridged as this financial support is paid by the government in the year following the investment.
Interest rates are favorable because the company assigns the claim to the bank.
Working capital loans, including overdraft facilities, provide liquidity for day-to-day business activities. The stock of goods and reserve stock, payment deadlines, and the exploitation of supplier discounts are financed.
Working capital loans are adapted per annum. The interest rates depend on the level of loan utilization and the period of usage. The level of the overdraft amounts to a certain percentage of the net working capital.
The concept of a Hausbank (literally “house bank”) is unique in Germany and refers to a company’s primary banking institution. This term is derived from the long-standing tradition of companies in Germany having a strong financial relationship with one particular bank.
In addition to lending and corporate financing, the Hausbank supports the day-to-day business activities of a company through electronic and international banking services, receivable management, and treasury activities. Special services include rating, advisory, and application support for public funding.
The Hausbank plays an important role with regard to the procurement of public funding. During the application procedure, authorities require the signing of a bank statement that stipulates the total project financing. From that point forward, the bank is responsible for administering the incentive payments and reporting requirements. Should the company need a public guarantee, the bank acts as the applicant.
For all incentive-related tasks the bank must be German or have a German partner.
Today the importance of having one particular Hausbank has begun to diminish in Germany, especially for larger companies, which often prefer a relationship with several banks or to secure financial support through a consortium.
During the incentive application procedure authorities require the signing of a bank statement regarding the total financing. In the following process the bank administers the incentive payment and reporting. Should the company need a public guarantee, the bank acts as the applicant. For such administrative tasks the bank has to be German or has to have a German partner.
Rating is a process through which the default risk of an investment project is assessed. The procedure results in an investment “grade” that describes the risk associated with the project and determines the margin associated with that risk.
Banks financing investment projects conduct these ratings themselves or require external ratings from private rating agencies.
Although the criteria are more or less the same, each bank has its own rating process. They analyze financial data (e.g. annual financial statements, liquidity, financing structure) and qualitative factors (e.g. balance sheet policy, market potential, management, economic framework). The following chart depicts an exemplary rating process of a German bank.
The difference between corporate financing and project financing is determined by the sponsor and terms of liability.
Corporate financing requires the payment of interest and amortization by the company. The credit rating focuses only on the company, its re-payment history, and its ability to earn profit.
Project financing is based upon a more complex financial structure whereby project debt and equity are used to finance the project. Generally, a special purpose entity is created for each project, which shields other assets owned by a project sponsor in the event of failure essentially the project company is considered to have no assets other than the project. In this way, project sponsors are able to greatly limit their liability.
Risk identification and allocation is an essential element of project financing. The possibilities for minimizing risk and thus increasing the chances of securing financing are greater when dealing with:
Financing by a consortium entails combining loans with different terms and conditions from multiple banks (known as a syndicated loan). The result is structured financing with fixed terms and conditions.
The portfolio can consist of:
Usually one of the banks acts as the lead arranger and serves as the primary negotiation partner of the company. The other banks, known as underwriters, participate pro-rata in the financing.
The syndication has the advantage of stability and flexibility over single-bank financing, but can also result in potentially higher margins, complexity, and a longer wait time before approval.
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