For centuries, banks have used rediscounting as a means to create liquidity in a market when there is a high demand for loans. Rediscounting is simply the use of a note or bill or other short-term debt instrument by one financial institution to create an equivalent that can be used to by another financial intermediary to finance a business activity. To do so, the financial institution discounts the debt a second time, providing a financial intermediary the capital it needs with a promise to repay the debt at its full value. The difference between the discounted value of the debt andthe full value is the originating institution’s profit from the transaction.
Today, rediscounting is available to factoring companies through non-traditional financing companies. The process is essentially the same, except the financing company is the one discounting the capital and the factoring company uses it to finance the business activities of its customers. Rediscounting not only provided factor companies with the capital they need to operate, it offers the opportunity to leverage their existing capital to achieve real growth.
How a Rediscount Line Works
A rediscounting line works much the same way that a factoring line works. A factoring company purchases an invoice from a customer for which it advances the customer 80% of the invoice value. The factoring company has access to a rediscount line, which it can use to leverage its capital. To access the line the factoring company resells the invoice to a lender for which it receives an advance of 80% of the amount advanced on the invoice to the customer. The invoice has been discounted twice to create additional liquidity for the factoring company.
For banks, rediscounting is a way to leverage their assets beyond the limitations placed on them by regulations. Factor companies can use rediscounting lines to leverage their capital to enable growth. As an example, if a factoring company purchases an invoice for $50,000, it will advance 80%, or $40,000, to the customer. The factoring company then resells the invoice to a financing company for 80% of the advanced amount, or $32,000, which it can use for more factoring deals. The factoring company has only used $8,000 of its own capital to generate $72,000 in factor capital. With the $32,000 available in its rediscount line, the company can pursue another four factor deals.
How to Obtain a Rediscount Line of Credit
To obtain a rediscount line, a factoring company needs to demonstrate sound financial management and solid factor management. The lender will want to see that the factor’s own finances are in order and that it has taken all necessary steps to put proper operating procedures in place. Before contacting a lender regarding a rediscount line, a factoring company should be well-prepared with the following documentation:
• 3 years of federal tax returns
• 3 years of financial statements
• 3 years of charge-off and delinquency information
• Documentation of loss experience and the company’s ability to manage reserves
• Formal policy and procedures manual, including underwriting guidelines
• Principals’ personal financial statement and personal tax returns for three years
In addition, the lender will consider the diversification and balance of the company’s current portfolio to determine if the company has demonstrated its ability to manage concentration and other portfolio risks. The lender will want to conduct and on-site audit review covering all of these issues while developing sense of the company’s leadership and its ability to handle growth.
Advantages of Working with a Factoring Lender
The obvious advantage of working with a factoring lender is that is presents the only real opportunity for many factoring companies to have access to a rediscount line. That aside, factoring companies benefit from working with a lender who truly understands their business because they too are in the factoring business. They understand the needs and challenges of factors in different industries, so they can tailor their support and resources with the aim of improving the factors’ operational efficiency. More than a source of capital, an experienced factoring lender can become a factoring company’s partner in growth.