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Debt financing is a central financing resource and the classic supplement to equity financing in Germany. It is available for day-to-day business (working capital loans), can help bridge temporary financial gaps (bridge loans) or finance long-term investments
(investment loans).
The main differences in comparison to equity financing are:
Debt is mainly provided by banks. In Germany, universal banks offer the whole range of financial services. In addition, there are also special banks focusing on specific products or clientele.
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 loan financing becomes necessary when a company has to bridge a deferred financial inflow, which usually results in a financial gap. Generally, such gaps follow from having to pre-finance orders, or from time-shifted payments of incentives.
Interest rates for bridge loans 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. They finance the stock of goods and reserve stock, payment deadlines, and the exploitation of supplier discounts
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 availability of debt depends on the default risk of a company or an investment project. This is usually determined through a credit rating of the debtor. Banks conduct these ratings themselves or require external ratings from private rating agencies.
The creditor “grades” the debtor according to a set of certain criteria. The procedure results in an investment grade describing the risk associated with the company or project and determining the margin associated with that risk. Accordingly, pricing is determined risk adequate. For companies receiving a so called non-investment grade credit rating, debt financing is usually not available.
Although rating criteria are more or less the same, each bank has its own rating process, where all financial data (e.g. annual financial statements, liquidity, financial structure) and qualitative factors (e.g. balance sheet policy, market potential, management, economic framework) are analyzed.
A company applying for debt has to be aware that this financial instrument deteriorates its equity ratio which may worsen the credit rating for subsequent financing.
The German “Hausbank” Concept The Hausbank (literally “house bank”) concept is unique in Germany and refers to a company’s primary banking institution. This term is derived from the longstanding 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.
Today the importance of having one specific Hausbank has begun to diminish in Germany; particularly for larger companies who often prefer a relationship with several banks or to secure financial support through a consortium.
Nevertheless, the Hausbank still plays an important role with regard to the procurement of public funding. During the application procedure, authorities require a signed bank statement stipulating total project financing. From this point onward, the bank is responsible for administering incentive payments and reporting requirements. Should the company require a public guarantee, the bank acts as the applicant.
The Hausbank does not need to be a German bank. For financing purposes, and for practical reasons, a subsidiary of a foreign bank in Germany is sufficient. For all incentive-related tasks and services the bank must be German or have at least a German subsidiary and has to be accredited by the German government (as is generally the case for most banks).
Financing by a consortium refers to the participation of several banks in structuring a financing package. 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, are invited by the lead arranger to participate in financing.
Financing by a consortium, also known as syndication, 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:
Financing by consortium has the advantage of stability and flexibility over single bank financing, but can also result in potentially higher margins, complexity, and a longer approval waiting time.
When a company applies for a loan at a bank, the bank first of all has to determine who is liable for paying interest, amortization and providing securities. Based on this, the bank generally makes a distinction between corporate financing and project financing.
Corporate financing requires the payment of interest and amortization by the company itself. The credit rating focuses only on the company, its repayment history, and its ability to earn profit.
Project financing is based upon a more complex financial structure. Generally, a special purpose entity is created for each project, which shields other assets owned by a project sponsor in case of failure - particularly if the project company is considered to have no assets other than the project.
Hence, project financing is preferred if project sponsors wish to significantly reduce their liability or if a young company is not able to produce a sufficient repayment and profit earning history. Risk identification and allocation is an essential element of project financing. The possibilities for minimizing risks and thus increasing the chances of securing financing are greater when:
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