What Is a Credit Facility?
A credit facility is a type of loan made in a business or corporate finance context. It allows the borrowing business to take out money over an extended period of time rather than reapplying for a loan each time it needs money. In effect, a credit facility lets a company take out an umbrella loan for generating capital over an extended period of time.
Various types of credit facilities include revolving loan facilities, committed facilities, letters of credit, and most retail credit accounts.
- A credit facility is an agreement between a lender and a borrower that allows for greater flexibility than traditional loans.
- Types of credit facilities include revolving loan facilities, retail credit facilities (like credit cards), committed facilities, letters of credit, and most retail credit accounts.
- A credit facility often allows a company to have greater control over the amount of debt, timing of debt, and use of funds compared to other types of lending agreements.
- However, a credit facility usually comes with debt covenants, additional maintenance fees, withdrawal fees, and is more difficult to secure.
- Credit facilities' terms and particulars, like those of credit cards or personal loans, are dependent on the financial condition of the borrowing business and its unique credit history.
How Credit Facilities Work
Credit facilities are utilized broadly across the financial market as a way to provide funding for different purposes. Companies frequently implement a credit facility in conjunction with closing a round of equity financing or raising money by selling shares of their stock. A key consideration for any company is how it will incorporate debt in its capital structure while considering the parameters of its equity financing.
The company may take out a credit facility based on collateral that may be sold or substituted without altering the terms of the original contract. The facility may apply to different projects or departments in the business and be distributed at the company’s discretion. The period for repaying the loan is flexible and like other loans, depends on the credit situation of the business and how well they have paid off debts in the past.
The summary of a facility includes a brief discussion of the facility’s origin, the purpose of the loan, and how funds are distributed. Specific precedents on which the facility rests are included as well. For example, statements of collateral for secured loans or particular borrower responsibilities may be discussed.
A credit facility is not debt. A credit facility gives the holder the right to demand loan funds in the future, and the borrower is only indebted when they draw on the credit facility.
Special Considerations for Credit Facilities
A credit facility agreement details the borrower’s responsibilities, loan warranties, lending amounts, interest rates, loan duration, default penalties, and repayment terms and conditions. The contract opens with the basic contact information for each of the parties involved, followed by a summary and definition of the credit facility itself.
The terms of interest payments, repayments, and loan maturity are detailed. They include the interest rates and date for repayment, if a term loan, or the minimum payment amount, and recurring payment dates, if a revolving loan. The agreement details whether interest rates may change and specifies the date on which the loan matures, if applicable.
The credit facility agreement addresses the legalities that may arise under specific loan conditions, such as a company defaulting on a loan payment or requesting a cancellation. The section details penalties the borrower faces in the event of a default and steps the borrower takes to remedy the default. A choice of law clause itemizes particular laws or jurisdictions consulted in case of future contract disputes.
Types of Credit Facilities
Credit facilities come in a variety of forms. Some of the most common include:
A retail credit facility is a method of financing—essentially, a type of loan or line of credit—used by retailers and real estate companies. Credit cards are a form of retail credit facility.
A revolving loan facility is a type of loan issued by a financial institution that provides the borrower with the flexibility to draw down or withdraw, repay, and withdraw again. Essentially it's a line of credit, with a variable (fluctuating) interest rate.
A committed facility is a source for short- or long-term financing agreements in which the creditor is committed to providing a loan to a company—provided the company meets specific requirements set forth by the lending institution. The funds are provided up to a maximum limit for a specified period and at an agreed interest rate. Term loans are a typical type of committed facility.
A credit facility can either be classified as short-term or long-term. Short-term credit facilities often use inventory or operating receivables as collateral and have more favorable loan terms due to their short-term nature. Long-term credit facilities are more costly to compensate for risk, though they provide a company the greatest flexibility.
Pros and Cons of Credit Facility
Credit facilities or other lines of credit offer tremendous flexibility for companies that are not sure what their future credit needs will be. However, securing a line of credit may be difficult and expensive. Here are the advantages and disadvantages to a credit facility.
Pros of Credit Facilities
A credit facility offers the greatest level of flexibility for a company's financing needs. When a company wants to take out a traditional loan, it must often cite a specific reason, determine a specific amount, and identify a specific timeframe for the debt to occur. Credit facilities are available upon demand and, should the company change its plans, don't have to be used at all.
Though credit facilities are generally not for use to support day-to-day operations and ensure a company's survival, a credit facility gives a company more resources to operationally thrive. Saving operating cash flow for strategic expansion allows the company to grow, while credit facility cash flow can be used for one-time or emergencies. A credit facility also bolsters a company's ability to remain solvent should their business be cyclical or seasonal.
Companies that secure a credit facility may see a boost in their creditworthiness with other lenders. If the company wants to secure other debt or additional lines of credit, already having secured a credit facility potentially eases the administrative burden.
A credit facility is also usually established between a company and financial institution that have a strong business relationship. By partnering with a bank (or syndicate of lenders), the company holding the credit facility may generate favorable terms with the lender. This relationship may be key in securing future debt or securing flexibility on debt covenants.
Cons of Credit Facilities
A credit facility isn't a line of unlimited money. A credit facility is often capped at an amount that a company generally doesn't need to draw fully. However, lending institutions may impose restrictions on the timing or amount pulled from the credit facility especially if debt covenants are not being met.
A company may experience an additional administrative burden in managing the credit facility requirements. As part of the loan agreement, a company must often track and maintain financial covenants and disclose certain metrics as part of external financial reporting. After pulling on a line of credit, the company is often entered into an installment plan agreement requiring ongoing maintenance, even if the immediate payment due is only interest.
To compensate for the flexibility of a line of credit, a company must often pay additional fees for the debt. While lender fees vary from agreement to agreement, there may be monthly maintenance fees, annual administrative agency fees, and one-time setup fees to create the line of credit. As the lender doesn't have as much control of the timing or use of the line of credit, the credit terms such as interest rate may be more unfavorable compared to other loans.
Last, a credit facility can be difficult to secure. Lenders will want to see multiple years of business history and positive creditworthiness as part of the application. The lender will often inspect a company's formation documents, organization structure, industry performance, cash flow projections, and tax returns. While a lender may still decide to extend a line of credit, it may decide to impose a low credit ceiling or compensate for risk through higher interest rate assessments.
Provides a company financial flexibility
Strengthens the relationship between a financial institution and a company
Often increases the credit rating of a company
May require less administrative burden to secure future debt
Often results in additional maintenance and withdrawal fees
May be difficult for younger or riskier companies to secure
Often requires a burdensome process to secure
May require additional administrative burden to maintain loan covenants
Credit Facility Example
In 2019, Tradeweb Markets collaborated with financial institutions to secure a $500 million revolving credit facility. Proceeds from the facility were intended to be used for general corporate purposes, and the lead legal arranger for the facility was Cahill Gordon & Reindel LLP. As of December 31, 2021, Tradeweb Markets had drawn $0.5 million with remaining availability of $499.5 million.
Due to the significant nature of the credit facility, the indebtedness is with a syndicate of banks with the lead administrative agent being Citibank, N.A. The credit agreement imposes a maximum total net leverage ratio and minimum cash interest coverage ratio requirement. Subject to satisfaction of certain conditions, Tradeweb Markets can increase the credit facility by an additional $250 million with consent from all syndicate lenders.
Tradeweb Markets also notes risks related to this indebtedness, including:
- "The credit agreement that governs the Revolving Credit Facility imposes significant operating and financial restrictions on us and our restricted subsidiaries.
- "Any borrowings under the Revolving Credit Facility will subject us to interest rate risk.
- "The phase-out, replacement, or unavailability of LIBOR and/or other interest rate benchmarks could adversely affect our indebtedness."
What Are the Types of Credit Facilities?
There are several credit facilities a company can secure. A revolving loan facility allows a company to take out a loan, repay the loan, then utilize the same loan agreement again as long as there are principal funds available to borrow. A retail credit facility is often used to provide liquidity for cyclical companies that rely on inventory or high turnover of sales. A committed credit facility is a specifically negotiated set of terms that obligates a lender to borrow money to a borrower should the borrowing company meet specific criteria.
What Is the Difference Between a Loan and a Credit Facility?
A loan is often a more rigid agreement between a bank and a borrower. The borrower usually has to apply for a loan for a specific reason, citing how the funds will be used and being charged an interest rate related to that given level of risk. Traditional loans award funds to the borrower upfront; the borrower is then assessed an amortization schedule of payments to return the principal and interest charges back to the lender.
A credit facility is more flexible, as the agreement allows a borrower to take on debt only when it needs. In addition, the borrower often has more flexibility around how much it can take and the reasons to use debt. While a loan burdens a company with debt, a credit facility allows a company to be burdened with debt should it need additional financing in the future.
What Is a Credit Card Facility?
A credit card facility is different than a credit facility. The term credit card facility is often used to describe features of a credit card that a cardholder receives when a credit card is opened. For example, a credit card may come with technology allowing for transactions to be automatically paid, split into tracking categories, or transferred to other cards. Although another example of a credit card facility is the ability to withdraw cash, a credit card facility doesn't always tie back to the cardholder being able to borrow or get more money.
Is Credit Facility Used in Debt?
A credit facility is a way for a company to take on debt. It's an agreement between a company and a lender that, should the company need funds in the future, it can draw on the facility and borrow money. Just because a company has a credit facility doesn't automatically mean they have incurred debt. Having a credit facility grants the company the right to demand loan funds.