Suppliers of Term Loans - Financial Management

There are numerous sources of term loans, including commercial banks, insurance companies, pension funds, commercial finance companies, government agencies, and equipment suppliers.Many of these sources are discussed in the following subsections.

Commercial Banks and Savings and Loan Associations

Many commercial banks and some savings and loan associations are actively involved in term lending. For example, about one-third of all commercial and industrial loans made by commercial banks are term loans. However, the market share of commercial banks has declined as more firms have issued “junk” bonds, either publicly or in private placements.

In spite of this level of activity, banks generally tend to favor loans having relatively short maturities—that is, less than five years —although some banks will make loans having maturities as long as 10 years or more. In addition, some banks limit their term lending to existing customers. Often banks will form syndicates to share larger term loans; this not only limits the risk exposure for any one bank but also complies with regulations that limit the size of unsecured loans made to single customers.

Life Insurance Companies and Pension Funds

Whereas commercial banks tend to prefer shorter-term loans, insurance companies and pension funds are more interested in longer-term commitments, for example, 10 to 20 years. As a result, it is common for a bank and an insurance company to share a term loan commitment.Under this type of arrangement, the bank might agree to finance the first five years of a loan with the insurance company financing the loan for the remaining years. This arrangement also can be advantageous to the borrower because banks generally can charge a lower rate of interest for loans having shorter maturities.

From the borrowing firm’s perspective, term loan agreements with pension funds and insurance companies have one significant limitation. If a firm decides to retire a term loan with a bank, it usually may do so without penalty. Because insurance companies are interested in having their funds invested for longer periods of time, however, prepayment of an insurance company term loan may involve some penalties. Term loans from insurance companies and pension funds usually are secured, often with a mortgage on an asset, such as a building.

These mortgage -secured loans are rarely made for amounts greater than 65 to 75 percent of the value of the collateral, however. And, finally, term loans from life insurance companies and pension funds tend to have slightly higher stated rates of interest than bank term loans; this is because (1) they are generally made for longer maturities and (2) there are no compensating balance requirements.

Small Business Administration (SBA)

The Small Business Administration (SBA), an agency of the federal government, was established in 1953 to make credit available to small businesses that cannot reasonably obtain financing from private sources.

Normally, an SBA loan is secured by a mortgage on the firm’s plant and equipment, third -party guarantees, or an assignment of accounts receivable and/or inventories. The SBA makes two major types of loans:

  • Participation loans are obtained from a local bank, with the SBA guaranteeing up to 85 percent of the loan amount, up to a maximum guarantee of $1 million for a maximumsize SBA loan of $2 million. SBA loans have a maximum maturity of 7 years for working capital loans and 25 years for real estate. Interest rates may be fixed or variable. Fixed rate loans of $50,000 or more may not exceed prime plus 2.25 percent if the loan maturity is less than 7 years, or prime plus 2.75 percent for maturities of 7 years or more. In addition,the SBA charges loan guarantee and servicing fees at the time of loan initiation and a 0 percent annualized servicing fee. These fees are normally passed on to the borrower.
  • Economic opportunity loans have been made available since 1970 to assist economically and socially disadvantaged individuals who own their own firms.

Small Business Investment Companies (SBICs)

Small business investment companies (SBICs) are licensed by the government to make both equity and debt investments in small firms. They raise their capital by borrowing from the SBA and other sources. The SBICs take an equity interest in the small firms they loan funds to, hoping to profit from their growth and prosperity.

Unlike SBA loans, which are made to any eligible creditworthy small business, SBICs specialize in providing funds to firms that have above -average growth potential.Naturally, these firms often have above -average risk as well. Thus, the interest charge on an SBIC loan is generally somewhat higher than that on a normal bank term loan. SBIC loans have maturities as long as 10 to 20 years.

Industrial Development Authorities (IDAs)

Many states and municipalities have organized industrial development authorities (IDAs) to encourage new firms to locate in their area or to assist existing firms with expansion plans. In a typical financing plan, a local IDA sells tax -exempt municipal revenue bonds and uses the proceeds to build a firm’s new facility. It then leases the plant to the firm, collecting lease payments from the firm that are large enough to pay the principal and interest on the municipal revenue bonds. Because bonds of this nature are tax exempt, the interest on th is generally lower than the interest on bonds issued directly by a private corporation.

As a result, an IDA can charge a firm an attractively low lease rate. The growing need to finance pollution control expenditures has led to the development of pollution control revenue bonds, which are issued by municipalities. Proceeds from these bonds are used to acquire pollution control equipment, which is then sold or leased to local industries. Because interest payments on pollution control revenue bonds are tax -free to investors, a firm’s cost is much lower than it would be if these investments had to be
financed with conventional debt or equity.

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