Bank debt is basically a long-term liability that a company takes on through borrowing from its own bank. It appears as a liability on the bank’s balance sheet because it is a part of the money that the business owes its various creditors. The amount owed to the bank is actually what the company uses to pay off all of its obligations, such as interest and penalties. It is also one way for a company to raise capital, which it then uses to purchase or develop new products or services.
There are two types of bank debt. One type is in the bond market debt where the company issues a bond that it is willing to pay a specific amount of money in return for a covenant-lite commitment from the bank. This means that the bank will either use the proceeds from the bond as a form of secured borrowing, which is less restrictive than a conventional loan because it uses “covenant-lite” funds that are backed up by the underlying property underlying the bond.
The second type of bank debt is in the form of commercial bridge or notes. These debts use a different type of funding structure. While the typical loan is primarily a fixed interest credit line that pays the full face value of the loan, most commercial notes are traded on futures exchanges or over futures markets. In this process, the principal and interest are paid to the holder on a discount basis while the floating rate on the debt remains the same. The typical maturity date for these types of notes is the year five marks but note holders can choose to write them to any maturity date.
Both bond and commercial bridge notes generally have two primary characteristics. First, they both carry significant non-recourse debt, which means that the loan or its interest will never go to bankruptcy. Second, they both have a fixed rate of return. With a fixed rate of return, interest and principal payments remain at a fixed rate over the course of the bond’s term. This allows investors to accumulate significant “capital,” even in poor economic environments.
One common example of a bank debt is credit card debt. While many people carry credit cards simply to facilitate everyday life, some use their cards in an effort to make larger purchases, such as furniture, electronic goods, etc. With credit cards, the interest rate is often quite low – often well below the prime rate. This lower interest rate is usually secured by a promise to pay on the debt in case you do not make your monthly payment.
A second example of bank debt is mortgage debt. A mortgage is a debt that is secured by a borrower’s property. Typically, mortgage lenders require borrowers to provide collateral in the form of real property. Some mortgagees offer “straw” debt, which is simply a promissory note that gives the bank permission to collect the full amount if the borrower does not make the monthly payment. The most common form of mortgage debt is the residential mortgage, which is secured by the borrower’s home. As with other bank loans, homeowners can choose to take out a reverse mortgage or a debt consolidation loan.
Lastly, corporate bonds are debt financing that is offered by a bank to its customers. A corporate bond issues a lien on a company’s assets; if the company fails to meet certain obligations, the bond holder can force selling of its holdings. Unlike bank debt financing, corporate bonds typically have much lower interest rates because of the higher risk of the company defaulting. Many companies issue corporate bonds as financial hedging strategies. That is, they are used to offset the risk of changing market conditions for the better.
In short, bank debt instruments are much riskier than traditional banking products such as savings and loans. However, they offer a number of benefits and flexibility that can help banks protect their other investment portfolio. Bank debt instruments are also lower cost alternatives to leveraging more risky venture capital or commercial real estate. While bank debt financing offers higher return rates on safe investments, it also carries a significant amount of higher risk, which may discourage some borrowers from making bad financial decisions.
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