Revolving Credit

A revolving credit is a formal commitment by a bank to lend up to a certain amount of money to a company over a specified period of time. The actual notes evidencing debt are short term, usually 90 days, but the company may renew them or borrow additionally, up to the specified maximum, throughout the duration of the commitment. Many revolving credit commitments are for 3 years, although it is possible for a firm to obtain a shorter commitment. As with an ordinary term loan, the interest rate is usually .25 to .50 percent higher than the rate at which the firm could borrow on a short term basis under a line of credit. When a bank makes a revolving credit commitment, it is legally bound under the loan agreement to have funds available whenever the company wants to borrow. The borrower usually must pay for this availability in the form of a commitment fee, perhaps .50 percent per annum, on the difference between the amount borrowed and the specified maximum.

Because most revolving credit agreements are for more than 1 year, they are regarded as intermediate term financing. This borrowing arrangement is particularly useful at times when the firm is uncertain about its funds requirements. A revolving credit agreement has the features of both a short term borrowing arrangement and a term loan, for the firm can borrow a fixed amount for the duration of the commitment. Thus the borrower has flexible access to funds over a period of uncertainty and can make more definite credit arrangements when the uncertainty is resolved. Revolving credit agreements can be set up so that at the maturity of the commitment, borrowings then owing can be converted into a term loan at the option of the borrower. Someday your company may introduce a new product and face a period of uncertainty over the next several years. To provide maximum financial flexibility, you might arrange a 3 year revolving credit that is convertible into a 5 year term loan at the expiration of the revolving credit commitment. At the end of 3 years, the company should know its funds requirements better. If these requirements are permanent, or nearly so, the firm might wish to exercise its option and take down the term loan.