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What is a Credit Facility?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 29 October 2016
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A credit facility is a type of loan or debt strategy that is often used in a business or corporate setting. Often, this kind of credit is used as part of the overall process of arranging equity financing. Credit facilities can involve several different forms of credit, ranging from revolving credit to a line of credit that is available for the company as a source of standby funding.

While there are several reasons why a company would establish some type of credit facility, the strategy is usually a means of creating a backup source of revenue for various projects. For example, a corporation may choose to issue a bond as a means of raising money for a specific project. Along with establishing the bond issue, the corporation arranges a standby line of credit or possibly a term loan to function as a backup in the event that the project fails to generate enough revenue to honor the terms of the bond.

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There are several ways to structure a credit facility. The strategy can involve one loan, or include a series of loans, all associated with the same facility. All loans involved in the process may be short-term, meaning they are paid in full within one calendar year, or be structured for repayment over a longer period of time. Depending on the financial stability of the company, it may be possible to establish a line of credit as the credit facility, allowing the company to only draw on the balance of that line of credit when and as needed. It is even possible to create a facility that includes a combination of revolving credit solutions, short-term loans, and long-term loans.

One of the benefits of a credit facility is that it does not have to be associated with one project. This type of financial arrangement can actually provide a steady flow of capital for multiple projects, all of them with various completion dates. The projects may be related in some manner, or have no connection at all. An umbrella approach of this type eliminates the need to obtain financing for each project, and over time can help to minimize the amount of interest that is repaid with the principle.

Another advantage is that a credit facility can often allow the substitution for collateral if necessary. This means that a business can sell property that is pledged as collateral on any of the loans involved with the facility, provided they are able to pledge a different asset that meets the approval of the lender. The ability to substitute collateral eliminates the need to rework the loan contract, saving both the lender and the borrower a lot of time.

Flexibility is also a key advantage to a credit facility. Since the resources associated with the facility can be used for anything the business desires, it is relatively easy to divert funds wherever they are needed. Should the project that was originally undertaken become unprofitable, the business can launch another project that shows more promise and divert the resources to covering the expenses of the new project. There is no need to notify the lender of the changes, since the facility is secured based on the credit-worthiness of the company, not on the profitability of a given project.

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Post 1

Although there are many advantages to obtaining a credit facility, there can be drawbacks, as well.

In many cases, the covenants in a credit facilities are quite restrictive, and default on one debt instrument can cause a cross default on all of the company's debt.

For example, if the company cannot pay on the bond mentioned in the article, there would probably be a provision in each of the components of the credit facility that would trigger cross default if payment on the bond is accelerated.

As a result, all of the debt, both under the bond and the facility, would be due immediately, leaving the company in dire circumstances.

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