What is a Revolving Credit Facility?

What is a Revolving Credit Facility?

A revolving credit facility is a type of credit that enables you to withdraw money, use it to fund your business, repay it and then withdraw it again when you need it. It’s one of many flexible funding solutions on the alternative finance market today.

A revolving type of credit is mostly useful for operating purposes, especially for any business experiencing sharp fluctuations in its cash flows and some unexpected large expenses.

In other words, it is needed for companies that may sometimes have low cash balances to support their net working capital needs. Because of this, it is often considered a form of short-term financing that is usually paid off quickly.

When a company applies for a revolver, a bank considers several important factors to determine the creditworthiness of the company. They include the income statement, cash flow statement, and balance sheet statement.

Revolving Credit Facility Fees

The corporate bank puts together the loan for its corporate clients and charges the following fees:

Upfront fees

Upfront fees are paid by the borrower to the corporate bank for putting the facility together, which are usually sub-10 basis points per year of tenor.

For example, a strong investment grade borrower enters into a 5-year $100 million revolver may pay 30 basis points (0.3%) on the total $100 million facility size on day 1, which equates to 6 bps a year.

The longer the tenor, the higher the upfront fee will be.

Utilization/drawn margin

This refers the interest charged on what’s actually drawn by the borrower.  This is usually priced as a benchmark interest rate (LIBOR) plus a spread.

For example, if the borrower draws $20 million on the revolver, the fee on this drawn amount will be LIBOR + 100 basis points.

The spread will depend on the underlying credit of the borrower via two pricing grid mechanisms:

For investment grade borrowers, their pricing grid will depend on their external credit ratings (from agencies such as S&P and Moody’s).

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Commitment fees

Lastly, the third fee charged are Commitment Fees.  These refer to fees charged on the undrawn portion of the credit facility, and is usually limited to a small % of the undrawn amount (e.g. 20%).

Why charge for something that isn’t being used? Even though the borrower doesn’t take the bank’s money, the bank still has to set aside the money and incur a loan loss provision for the capital at risk. This is also called the undrawn margin or undrawn fee.

Features of a Revolving Credit Facility

1. Cash Sweep

The revolver is often structured with a cash sweep (or debt sweep) provision. It means that any excess free cash flow generated by a company will be used by the bank to pay down the outstanding debt of the revolver ahead of schedule.

Doing so forces the company to make repayment at a faster rate instead of distributing the cash to its shareholders or investors. In addition, it minimizes the credit risk and liability that comes from a company burning through its cash reserves for other purposes, such as making large, excessive purchases.

2. Interest Expense

The borrower is charged interest based only on the withdrawal amount and not on the entire credit line. The remaining portion of the revolver is always ready for use. This feature of built-in flexibility and convenience is what gives the revolver its main advantage.

As for its outstanding balance, a business can have the option to pay the entire amount at once or simply make minimum monthly payments.

The interest rate is usually close to the rate found on the company’s senior term debt. However, it may be variable and is based on the bank’s prime rate plus a premium, with an additional premium determined based on the company’s creditworthiness.

3. Maximum Amount

When a company experiences a shortfall in cash flows to meet financial obligations, it can be corrected promptly by borrowing from a revolver. There is a maximum borrowing amount set by the bank. However, the bank may review the revolver annually.

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If revenues of a business drastically fall, the bank may lower the maximum amount of the revolver to protect it from default risk.

Conversely, if a company has a good credit score, strong cash reserves, a steady and rising bottom line, and is making regular, consistent payments on a revolver, the bank may agree to increase the maximum limit.

4. Commitment Fee

To commence the revolving credit facility, a bank may charge a commitment fee. It compensates the lender for keeping open access to a potential loan, where interest payments are only activated when the revolver is drawn on. The actual fee can either be a flat fee or a fixed percentage.

5. Reusability

This type of loan is named a revolver because once the outstanding amount is paid off, the borrower can use it over and over again. It’s a revolving cycle of withdrawing, spending, and repaying any number of times until the arrangement expires – the term of the revolver ends.

A revolving credit facility is different from an installment loan, where there are monthly fixed payments over a set period. Once an installment loan is fully paid, you can’t use it again like the revolver. The borrower must apply for a new installment loan.

How to interpret Revolving Credit Facilities?

  • Many US companies use such credit flexibility, and you will usually find that they report back on their balance sheet.
  • Let’s say a company has taken a revolving credit facility from a bank. Where would the company report its revolving credit in the financial statements They would first set up their balance sheet. They will go to the debt section, and then usually, they will mention a note below the balance sheet where they will report what exactly happens in regards to a revolving line of credit.
  • Now, what if they don’t mention it?
  • Then it would be difficult for an investor to determine where the debt (the figure) came from. If the company has done the calculation but doesn’t show the calculation and the exact narration of how it happened under the balance sheet, it wouldn’t be possible for the investor to understand it.
  • The filing system under sec filings ensures that the investors’ interest is secured. Not showing or mentioning a revolving line of credit will be treated as non-disclosure and will not help the investor.
  • In the example below, we will show you how you would be able to do that.
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Revolving credit facility eligibility

Lenders will offer a maximum facility size based on the financial strength of the business and any security offered. Typically the only security will be a director’s personal guarantee.

In some cases, there is a commitment fee taken up front for ‘right to access’ the facility, plus the standard ongoing monthly interest charged on the funds drawn down at any one time.

Because of their convenience and flexibility, revolving credit facilities tend to have higher fees than fixed term loans. The term will also likely be limited to between 6 months and 2 years — however, if all goes well, a lender will typically offer a renewal at the end of the term.

The amount a lender will look to offer is typically calculated as one month’s revenue, however in the case of strong businesses or repeat customers they may offer a top-up or an increase in the limit after just a few months.

An Example of a Revolving Credit Facility

Seasonal Industry

In the hospitality industry, which is considered seasonal, a ski resort may experience a shortage in operating income during the summer months; therefore, it may not be able to cover its payroll. Additionally, if it’s making most of its sales on credit, then the company will be waiting to cash its receivables before making inventory expenses.

Having a revolver will allow the company to be able to access funds at any time when it requires money for its day-to-day operations.