Short-term funding for companies: credit lines, secured loans and commercial paper

What are the bank lines of credit?

A company that needs cash for a few weeks or months, for example to bridge the gap between paying suppliers and collecting from customers, usually starts with its bank. It has three choices, ranked by how sure the company can be that the cash will be there. Banks charge a market reference rate (MRR) plus a borrower-specific spread, only on the amount drawn.

Short-term funding for a companycash needed during the cash conversion cycle

• Bank lines of credit Memorize MRR + spread on the amount drawn
  • Uncommitted line Memorize least reliable, no fee, bank may refuse
  • Committed (regular) line Memorize written promise, usually 364 days, commitment fee
  • Revolver Memorize most reliable, multiyear, fee and covenants
• Asset-based funding Use it for borrowers that cannot borrow unsecured
  • Secured loan Use it asset pledged, lender files a lien
  • Assignment of receivables Use it receivables are collateral, company still collects
  • Factoring Use it receivables sold at a discount, factor collects
• Commercial paper Memorize short-term unsecured notes sold to investors
  • US commercial paper Know the idea large, liquid market
  • Eurocommercial paper Know the idea smaller deals, less liquid

An uncommitted line of credit is the least reliable. The bank agrees to lend up to a set amount for a set maximum period, but keeps the right to refuse any request. The company pays interest only on what it borrows, with no other fee, so under normal conditions it is the cheapest and most flexible source. Banks offer these unsecured lines to clients who keep stable cash deposits with them, because falling balances warn the bank early that something is wrong. The catch: the bank is most likely to say no exactly when the company is in trouble and alternative funding is expensive.

A committed (regular) line of credit is a formal written commitment, so it is more reliable. It is usually unsecured and can be repaid without penalty. Commitments of under a year (usually 364 days) keep the bank’s capital charge low, so these lines must be renewed, and renewal is the weak point for a borrower whose credit is slipping. The company pays a commitment fee on the unused amount (sometimes on the full line) for the commitment period. For larger borrowers a group of banks often shares the line in a syndicate. Once drawn, the line is a short-term liability (usually notes payable). Uncommitted lines and revolvers are more common in the United States; committed lines are more common elsewhere.

A revolving credit agreement (revolver) is the most reliable source of short-term bank funding. It is a multiyear commitment, with pricing and commitment fee like a committed line, but lenders also ask for covenants that require or restrict borrower actions, as in a bond indenture.

	Uncommitted line	Committed line	Revolver
Bank’s promise	None, may refuse to lend	Written, usually 364 days	Written, multiyear
Cost beyond interest	None	Commitment fee	Commitment fee
Covenants	None	Few or none	Yes
Reliability	Lowest	Middle	Highest
Typical user	Strong client with stable deposits at the bank	Larger borrowers (often a bank syndicate); backup for commercial paper	Firms that need assured access

Exam tip ”You pay for certainty”: every step up in reliability adds a fee or a covenant.

How do you cost a committed line?

The all-in cost has two pieces: interest on the amount drawn, and the commitment fee on the amount left unused. The fee is owed even if nothing is drawn, which is why the all-in rate on the money actually used is higher than the quoted interest rate.

$$\text{Cost} = D \times (\text{MRR} + s) + (L - D) \times f$$

Here $L$ is the size of the line, $D$ the amount drawn, $s$ the bank’s spread and $f$ the fee rate on the unused part.

$$r_{\text{all-in}} = \frac{\text{Cost}}{D}$$

Read the question for the fee base. “On the unused amount” means $L - D$; some lines charge the fee on the full line instead, which gives a bigger fee. The fee on the full line would be 50m × 0.30% = USD 150,000 in the example above.

What if the company cannot borrow unsecured?

Use it

Companies without enough credit quality for unsecured loans arrange a secured loan , also called an asset-based loan. The lender takes collateral, such as fixed assets, high-quality receivables, inventory or marketable securities, and files a security interest (a lien) against it. The lien appears on the borrower’s credit record.

Receivables get two special treatments, and the exam tests the difference:

• In an assignment of accounts receivable , the receivables are collateral for a loan. The company stays responsible for collecting them.
• In factoring , the company sells its receivables to a lender, the factor, usually at a discount. The factor takes over credit-granting and collection. The size of the discount reflects the credit quality of the accounts and the cost of collecting them.

What is commercial paper?

A commercial paper (CP) note is a short-term unsecured note sold by a large, highly rated issuer, in the public market or by private placement. It usually matures in under three months. Companies use it for working capital, seasonal cash needs and bridge financing (interim funding until permanent financing is arranged). For the strongest issuers it can be cheaper than a bank loan, which is why they use it. Financial institutions, governments and supranational agencies are also large issuers.

Maturing paper is normally repaid with the proceeds of new paper. If the market will not buy the new paper, the issuer cannot repay. That is rollover risk . Investors therefore usually require a backup line of credit from banks (also called a liquidity enhancement), which ensures the maturing paper can be repaid in full if a rollover is not possible. A credit rating does not remove rollover risk, and bridge financing needs more issuance, so it adds to it.

Paper issued in the international market is Eurocommercial paper (ECP). It is similar to US paper, but typical deals are much smaller and the market is less liquid.

Go deeper Why banks offer uncommitted lines at all

Uncommitted lines need almost no regulatory capital until they are drawn. They keep the relationship alive, and the borrower’s deposit balances let the bank monitor its health. Often the funding comes from stable deposits that customers rarely touch. That mix of low cost to the bank and low cost to the client is why they are common, especially in the United States.

Go deeper Why committed lines are often 364 days

A commitment shorter than a year attracts a lower capital requirement for the bank. The price of that saving is renewal risk: when the line comes up for renewal, a heavily drawn borrower whose credit has weakened may find the bank unwilling to extend it. Revolvers solve this with a multiyear term, at the price of covenants.

Go deeper Inventory as collateral

Inventory can back a loan in several ways, with the lender holding a lien over the stock. The curriculum mentions the idea only briefly. Know that inventory is one of the assets that can be pledged, alongside receivables and fixed assets.