Diversification of funding in relation to continuity of financing

The previous article focused on the credit profile in relation to funding.

In this article, we discuss the role and importance of diversification of funding to secure continuity in financing. This article focuses on the financing of larger companies, in contrast to SMEs¹.

Overview of the funding market

The funding market for large enterprises can be roughly categorized as follows:

1. The banking market: this is where a company can go for generic credits and loans, but also for specific financing products, such as asset-based lending;
2. The non-banking market: in this market, competitors of the banks operate, often focusing on a single financing product. Examples include independent factoring, or leasing companies (often part of a banking group), or so-called debt funds. Debt funds are active in acquisition financing for the benefit of financial sponsors, but would like to broaden their activities towards corporate financing;
3. The capital market: here, a company can place a loan with an (institutional) investor, either privately or with a listing (public or open);
4. The money market: this is where a company can raise short-term funds, in the form of commercial paper or a cash loan.

What is funding diversification?

Because bank financing has the greatest flexibility at the lowest funding costs, it is obvious that bank financing is the dominant form of funding for most companies in Europe². We distinguish between two forms of funding diversification:

• Inside the banking market: a company can expand the number of banks it works with or attract new funding products from existing banks.
• Outside the banking market: a company expands its funding by acquiring financing in a financing market new to it. 

Necessity or precaution

Why would a company engage in diversification of funding if it has never experienced shortages in the banking market? The relationship with banks is good and diversification of funding requires time and money. However it is crucial to ensure that there will always be sufficient supply of financing to meet the company’s future changing demands. A good funding policy aims to ensure that sufficient additional funding capacity is always available. Either through existing banks still having headroom under their maximum limits, or through access to alternative financing markets. 

Whether sufficient additional financing capacity is available also depends on the company’s future prospects and its relationship with its main banks. Are scenarios conceivable, in which the financing requirement is going to increase significantly? Consider a major investment or an active acquisition strategy. Here, the growth of the company and its financing demand may exceed the capacity of its existing relationship banks. The other way around, in recent years we have also seen a trend of banks reducing their maximum credit limits on individual companies. Combined with growth, a lack of funding capacity then arises more quickly.

Influence of market developments  

The availability of sufficient additional financing capacity also depends on supply-side developments. Think, for instance, of banks parting ways with a sector. We saw this a few years ago when ABN AMRO and BNP rather abruptly decided to withdraw from financing commodity traders. Another example is banks saying goodbye to certain markets. Recent examples include RBS departing from the Dutch market and NIBC stopping corporate lending. Another recent trend is the exclusion of companies on sustainability grounds. Examples are banks excluding (upstream) activities in fossil energy, or real estate financiers exclusively financing property with a minimum energy label.

Conclusion

Based on the above examples, we can conclude that blindly relying on the presence of sufficient financing capacity is not a good strategy. A company will have to actively monitor the development of its funding needs and the available supply of funding. Scarcity should be avoided by diversifying in time.

Get in touch

Would you like to optimize the continuity of your financing, or receive concrete advice on how to diversify your company’s financing? Call us, we will be happy to assist you! 

1. The financing market for SMEs has its own dynamics. SMEs are completely dependent on Dutch banks in the banking market. Larger companies also have access to a wide range of foreign banks operating in the Dutch market. ↩︎
2. Only when funding demand is very high (rule of thumb more than EUR 500 million) does it become relevant for companies to seek access to the capital market and apply for a credit rating. ↩︎

Rolf Michon

Managing Partner Debt Advisory