Friday, February 17, 2012

Types of Loan Agreements: Revolving Credit Facilities

Finally this month we consider revolving credit facilities. In many ways, a revolving credit facility shares features of both a term loan and an overdraft which have both been discussed in previous issues.

Common features of revolving credit facilities

A revolving credit agreement is similar to a term loan because it is usually a committed facility that provides a maximum amount of capital over an agreed period. (A committed facility is one that once the facility agreement has been executed, the lender is under an obligation to advance money when requested by the borrower, subject to compliance with certain pre-agreed conditions by the borrower.)

However, it is also similar to an overdraft because the distinguishing feature of a revolving credit facility is that the availability period extends for almost the entire life of the loan (except at the end when the final tranches need to be repaid). This means that the borrower may draw and repay tranches of the available funds whenever it chooses throughout the life (or “term” as it is commonly known) of the loan.

The revolving element of the loan facility is reflected in the fact that the borrower may take a tranche for an interest period and at the end of that interest period decide whether to repay that tranche or "roll over" into the next interest period, provided that an event of default has not occurred and is continuing.

Further funds can be drawn down at any time with interest periods running in parallel. As with term loans, the borrower must give the lender a drawdown notice and the borrower must specify its chosen interest period. Interest periods are usually 3 or 6 months long.

Revolving facilities tend to be used if a borrower requires a substantial advance but gives the borrower greater flexibility than if it used a term loan.

Advantages of a revolving facility

A revolving facility is usually a committed facility but its advantage from the borrower’s perspective is maximum flexibility; it can draw as much or as little as it requires at any time, and if cash flow is sufficient it can repay outstanding tranches that are no longer required and thereby reduce its borrowing costs.

Disadvantages of a revolving facility

A revolving facility is likely to include more restrictions than an overdraft. For example, there may be minimum notice periods before a sum is advanced; the lender may set upper and lower limits on the amounts which may be drawn at any one time or the number of interest periods that may exist in parallel at any one time (in order to reduce the administrative burden on the lender) and the lender may reduce the available funds towards the end of the term. As the availability period for draw downs is long, the total commitment fees will be higher. (Commitment fees are fees payable to a lender on available but undrawn amounts and is calculated as a percentage of those undrawn funds from time to time. The commitment fee is not as much as interest because the lender is not actually taking any risk on the money.)