Question

1. Why do companies have revolving credit facilities (lines of credit)? How do they use them? Are these facilities typically a short-term or long-term debt?

2. Why would a company potentially prefer to raise money in the bond market as opposed to drawing down on its revolving credit facility?

3. Why would a company potentially seek funding by way of its revolving credit facilities as opposed to the bond market?

4. Why did recently many companies issue bonds to pay down their revolving credit facilities despite the fact that the rates on bonds are significantly higher than the rates on revolving credit facilities?

Answer 1

1) A revolving credit facility (lines of credit) is a line of credit which is arranged between a business and a bank. Through this facility a business can borrow money when-ever there is a need and they want to fund their working capital and other operations. A revolving credit facility is mostly useful at the time of revenue fluctuations. Operating expenses, bills or any other unexpected expenses can be paid by drawing from the loan.

These type of facilities are typically a considered as short-term financing that is usually paid off quickly.

2) A company potentially prefer to raise money in the bond market when they require funds for a longer term. As the fund borrowed through revolving credit facility comes up with a quite high interest rates, they are preferred to be paid quickly. Also if in case, the cost of raising money in the bonds are low, a company can choose to raise the money from the bond market as opposed to drawing down on its revolving credit facility

3) A company potentially seek funding by way of its revolving credit facilities when its revenue is very fluctuating. Revolving credit is generally useful for entities that is expected to have sharp fluctuations in their cash flow or could face unexpected expenses. Borrowing from the bond market requires a fixed number of payments over a set period of time while a revolving credit requires only the interest payments plus any applicable fees.

4) In the early days of the pandemic, many companies/businesses drew down their lines of credit to increase the liquidity and prepare for a potential market collapse. Now after a few month later, they are paying back the billions for the funds they borrowed. But according to a data provider, between April 1 and August 31, companies raised over $900 billion through U.S. bonds This is more than double the volume from the last year. This is because, many of these companies have used some or all of these funds to pay down their revolving credit facilities. This has been done to allow the business to tap the revolving credit facilities again if needed as having such facilities always helps at the time of a financial storm. Businesses have to meet certain financial criteria once they draw down their revolving credit facilities. They have to go through a procedure called covenant or maintenance testing which could occur as frequently as once a quarter. This is not the case with the bond market which gives the companies more freedom as they don’t have to demonstrate their financial fitness again until the debt matures. Even though bond issuances can be more expensive than the charged of a line of credit, but still many companies are issuing bonds to pay down their revolving credit facilities so that they can use these facilities again if needed.