Summary of Findings

This PDF is a selection from an out-of-print volume from the National

Bureau of Economic Research

Volume Title: Term Lending to Business

Volume Author/Editor: Neil H. Jacoby and Raymond J. Saulnier

Volume Publisher: NBER

Volume ISBN: 0-870-14129-5

Volume URL: http://www.nber.org/books/jaco42-1

Publication Date: 1942

Chapter Title: Summary of Findings

Chapter Author: Neil H. Jacoby, Raymond J. Saulnier

Chapter URL: http://www.nber.org/chapters/c5749

Chapter pages in book: (p. 1 - 8)

Summary of Findings

A "TERM LOAN" IS A LOAN to a business enterprise that is re-

payable, according to agreement between borrower and lender,

after the lapse of more than one year. Such loans fall within

the "medium-term" credit market, which is defined for pur-

poses of this study to include credits that run for more than

one but not more than fifteen years. Since 1933 four types

of financial institutions have directly extended medium-term

credit, so-defined, to American business enterprises on a broad

scale—commercial banks, life insurance companies, the Re-

construction Finance Corporation and Federal Reserve banks.

Findings of broad significance arising from a study of the

present-day market for medium-term business credit are:

1. Term loans by banks and private purchases of medium-

term bonds or notes by insurance companies have experienced

enormous growth and have tended to. displace short-term

loans and public issues of securities through investment bank-

ers as methods of business financing. At the end of 1940 term

loans comprised nearly a third of the commercial and indus-

trial loans and about 12 percent of all loans held by com-

mercial banks.

Private financial institutions are dominant in this field

of credit, the operations of the public agencies being minor

in scope and non-competitive in nature.

3. Term loans have been a method of financing compara-

tively large businesses. The public agencies' borrowers were

much smaller than those of banks or insurance companies, bu.t

even so, more than half the number of loans granted by

public agencies were made to concerns with total assets of

over $100,000.

Term

Lending to Business

4. Term lending institutions have devised new standards

and procedures for appraising credits, in order to determine

whether a borrower can amortize a loan out of available in-

coming cash.

Causes of Growth

Term lending experienced remarkable growth after 1933

as a result of an expansion in business demand for medium-

term loans relative to the demand for short- or long-dated

credit or equity capital, and because of the increased ability

and willingness of financial institutions to supply such credit.

It was given impetus by business demands for funds to

modernize or re-equip plants and to effect savings through

the refunding of outstanding debts at lower interest rates.

The supply of medium-term credit expanded in consequence

of a number of developments: growing excess reserves in

banks, lower yields from high-grade bond investments, broader

access to Federal Reserve credit facilities, deposit insurance,

the example of long-term amortized mortgage loan insurance

offered by FHA, revised practices of bank examination, changes

in the public regulation of bank investments, the Securities

Act of 1933, and the lending operations of public agencies.

Structure of the Market

The annual volume of term loans made by commercial banks

has risen steadily in recent years: $217 million in 1938, $827

million in 1939, and $1,352 million in 1940. Estimates of

the medium-term business credit of all institutions outstand-

ing at year-end indicate a similar growth: $1,081 million in

1937,

$1,547 million in 1938, $2,271 million in 1939, and

$3,199 million in 1940. At the end of 1940 commercial

banks

held

an estimated $2,162 million of term loans, life insurance

companies held about $900 million of medium-term bonds and

notes privately acquired from issuers,

the Reconstruction

Finance Corporation had outstanding business loans of $121

million, and the Federal Reserve banks held outstandings of

somewhat less than $16 million.

Summary of Findings

Twenty-six

large life insurance companies and possibly as

many as 2,900 commercial banks located throughout the

United States held, some medium-term loans at the end of

1940, term lending being concentrated among banks with

deposits of $10 million or more located in the larger centers

of population. These private institutions had made term loans

to about 3,800 business enterprises up to the end of 1940, while

the public institutions had granted term credit to approxi-

mately 11,000 concerns. In total, it is possible that about 10

percent of the more than 130,000 businesses in the United

States with total assets of $100,000 or more have obtained

medium-term credit.

Marked differences are found between the private and pub-

lic lending agencies both in size of borrowers and in average

amount of term loan. Insurance companies acquired medium-

term bonds only from the larger companies, those with total

assets of $1 million or more; only 4 percent of the amount

of commercial bank credit went to borrowers whose total

assets were less than $1 million; on the other hand, 19 per-

cent of the amount of RFC loans and 27 percent of the

amount of Reserve bank loans were made to borrowers whose

total assets were less than $1 million. The average term loan

of insurance companies was $3.8 million and of commercial

banks $664,000, in sharp contrast to the average loan au-

thorization of $56,000 for the RFC and $73,000 for Reserve

banks.

There are also significant differences in the industries of

concerns whose credit needs were met by different term lend-

ing institutions. Manufacturing concerns accounted for a

larger percentage of the credit extended by each type of

agency than did any other major industrial class. But public

utilities, mining and extraction (including oil production) and

financing concerns combined received nearly 60 percent of

commercial bank term credit and over 45 percent of insurance

company credit. Loans to manufacturing, wholesaling, retail-

ing and construction concerns were relatively more important

in the portfolios of the public than of the private agencies.

Term Lending to Business

There is a high degree of cooperation among term lending

institutions, nearly 68 percent of the amount of bank term

loans and about 55 percent of insurance company and Re-

serve bank term credit being split with several institutions.

Less than 16 percent of RFC business credit was particpiated

in by other lenders. Cooperation in term lending performs

an economic function parallel to that of the underwriting

syndicate in investment banking.

Term Loan Characteristics

Loans made by each type of lending institution have their

own characteristics, but loans of the private agencies resemble

each other more closely than they resemble loans of either

public agency.

Term

Although more loans of commercial banks have terms of five

than any ot.her number of years, about 30 percent of the num-

ber and 49 percent of the amount of these loans have terms

exceeding five years. Few loans have terms of more than

ten years. Maturities of RFC loans are generally similar to

those of commercial banks, while Reserve bank loans, legally

limited to five years, for the most part run less than three

years. Insurance companies advance longer credits than other

institutions, only 15 percent of the amount having terms of

five years or less, and over half the amount maturing after

ten years.

Use of Funds by Borrowers

A third of the amount of bank term loans provides borrowers

solely with new money, principally for working capital or

machinery and equipment. About 54 percent is used exclu-

sively for refunding purposes, chiefly to retire bonds. Medium-

term credit of insurance companies appears to have a similar

pattern of use. Reserve bank advances are limited by statute

to working capital purposes, but RFC loans have enabled

Summary of Findings

borrowers to finance capital expenditures or refund outstanding

debt as well as to increase working capital.

Collateral Security

Only a third of the amount of bank and insurance company

loans are collaterally secured, stocks and bonds or machinery

and equipment in the case of bank loans and real estate in

the case of insurance companies being taken most frequently

on secured loans. In contrast, practically all RFC loans and

83 percent of the amount of Reserve bank credits are secured,

usually by a combination of the borrowers' assets. Such security

has been considered necessary by the public agencies to protect

their interests in granting credit to concerns presumably un-

able to obtain financing from other sources.

Repayment Provisions

About 72 percent of the number and 57 percent of the amount

of bank term loans, and about 25 percent of the amount of

insurance company medium-term credits, are repayable in

equal instalments. Nearly all the remaining loans mature in

single amounts or have relatively large final payments ("bal-

loon" notes). In contrast, practically all RFC and Reserve

bank loans are repayable in equal monthly, quarterly, semi-

annual or annual instalments, because of the necessity of gear-

ing repayment closely to the abilities of financially-straitened

borrowers to "throw off" cash. In many instances, instalment

payments are a certain percentage of sales or net income be-

fore depreciation.

Changes in Bank Term Loan

Characteristics and Lending Practices

No marked change has occurred since 1934 in term, size of

borrowers or size of loans made by banks. Such changes in

industry of borrower as have occurred have been dictated

mainly by conditions of demand for credit, durable goods

industries becoming more important borrowers during cyclical

Term Lending to Business

upswings. However, banks are tending to dispense with col-

lateral security, to insist upon amortization of loans in equal

instalments, to split loans among several lenders, and to in-

crease the proportion of credit devoted to business expansion.

Term Lending Operations of Banks

Few banks have set up separate organizations to handle

term loans, but they have frequently employed personnel

trained in long-term investment credits and have assigned the

task of credit analysis to analytical units connected with bond

or trust departments.

Term loans are generally accompanied by agreements,

"tailor-made" to fit the circumstances of each borrower, con-

taining restrictions on the borrower's indebtedness, requiring

maintenance of certain minimum financial conditions,

sub-

jecting management personnel and capital expenditures to con-

trol of the lender, requiring the keeping of accurate books and

records, providing for acceleration of the debt under certain

circumstances, and specifying any collateral security that may

be required.

Credit standards applied by banks relate mainly to the earn-

ing power of a business, whereas those of the RFC and Re-

serve banks necessarily lay relatively greater stress upon

collateral security. In determining whether applicants meet

their credit standards, all agencies conduct thorough investi-

gations and prepare analyses both of financial statements over

the past seven or more years and of the efficiency of the

applicant's production facilities and marketing methods in

relation to those of other concerns in the industry.

Term loans at the end of 1940 formed 22 percent of all

loans held by 50 large commercial banks, and 30 percent or

more of all loans held by five of the largest banks. They com-

prised well over half of the commercial and industrial loans

held by these 50 institutions. The industrial character of its

territory and the attitudes and training of its personnel are

crucial factors in determining the amount of term loans a bank

Summary o/ Findings

can develop. Given these factors, bankers consider the sta-

bility of their deposits, the ratio of capital to deposits, and

the quality and maturities of other assets, in determining what

proportion of total assets should take the form of term loans.

Few, if any, banks have set up special term loan reserves

against which losses may be charged, although the occurrence

of loss is a recognized contingency. Banks infrequently lend

individual borrowers up to the legal limit, preferring to split

very large loans with other institutions.

Interest Rates and Costs in Term Lending

Interest rates charged by private institutions for medium-

term credit have been much lower and more variable than

those of the public institutions. The average bank rate varied

between 2 and 3 percent during 1940 and stood at 2.16 per-

cent at the end of 1941. Yet a larger number of loans carried

5 to 6 percent rates than any other rate, the higher rates

on these small loans reflecting the larger costs of loan ad-

ministration per dollar of funds advanced. To limit these costs,

many banks will not make term loans of less than $50,000 or

$100,000. For the, most part, medium-term issues privately

purchased by insurance companies have yielded 2 to 3 percent.

In contrast, rates of all Federal Reserve banks have varied

within a range of 35/2

to 6 percent, while the standard rate of

the RFC has been 5 percent, a few loans carrying 4 or 6

percent.

Compared with the loan rates of the private institutions,

these rates have not as fully reflected differences in the risks

and maturities of loans and the costs of administering them.

That they have been low, relative to the risks assumed and

the costs of loan administration, is indicated by the possibility

of ultimate loss on RFC business loans as a whole, and the

failure of Reserve banks to realize any considerable net income

from industrial advances. The profitability of term lending to

banks or insurance companies cannot be accurately determined

from the data on hand.

Term

Lending to Business

Term Lending in Defense and War

The rapidly expanding war production program has been

paralleled by a sharp increase in war lending activities. By

the end of 1941 the total loans of Federal Reserve member

banks had risen by 30 percent over mid-1940; between Feb-

ruary 1941 and January 1942 the number of loans made

to finance war production, and secured by assignments of

government contracts, increased by about six times. Com-

mercial banks have made about 90 percent of these contract

assignment loans, the RFC about 5

percent and other agencies

the remainder. That part of the war program that has re-

quired the construction of specialized plants and the creation

of reserves of essential raw materials has been financed to a

large extent by the RFC through its subsidiary corporations.

Up to March 1942, these corporations had made commitments,

including actual advances of cash, totaling nearly $10 billion.

Necessarily, many loans made to finance war contracts have

been term loans. The war program has not, however, altered

the proportion of term loans to all business loans made; this

proportion remains, as in pre-war conditions, at about 21 per-

cent. However, marked changes have occurred in certain of

the characteristics of term loans. Up to mid-1941 all war

term loans were new money loans. A further notable change

has been the extension of term credits of smaller size, pre-

sumably to smaller business concerns. Finally, such term lend-

ing places less emphasis on collateral security and more em-

phasis on the term loan agreement as a means of stipulating

risk-limiting conditions.