What it means
A company or government that needs funds for several years could borrow through a conventional long-term loan. A note issuance facility offers another route.
The borrower sets up an agreement, typically lasting five to seven years, under which it can issue short-term notes, for example every three or six months, up to a maximum amount. Each time the notes mature, the borrower issues new ones to repay them, a process known as rolling over.
Investors buy the notes in the market at an interest rate linked to a reference rate. The borrower benefits when short-term rates are lower than long-term rates, because it pays the lower cost on each issue.
The key feature is the underwriting commitment from banks. If the market is weak and investors will not buy the notes at an acceptable price, the banks must either buy the notes themselves or provide a loan.
This backup guarantees that the borrower will not be left without funding, and for this protection the borrower pays a fee. NIFs became popular in the international markets in the 1980s as a way for borrowers to raise money more cheaply than through syndicated bank loans.
Over time, they were largely replaced by other forms, such as commercial paper programmes and committed credit lines, although the underlying idea is still used. Some versions are known as revolving underwriting facilities.
Borrowers need to weigh the benefits and risks. The facility offers cheap funding and certainty, but it exposes the borrower to changes in interest rates every time the notes roll over.
It also needs a good credit rating, since investors will not buy notes from a weak borrower at a reasonable rate. For banks, the facility is a way to earn fees for taking on contingent risk, since they only fund if the market fails.
This kind of risk can be underestimated. In stressed markets, banks may have to lend large amounts at short notice, which is why regulators pay close attention to such commitments.
In practice
Real-world examples.
Example
A shipping company arranges a $100,000,000 facility for five years to finance a new vessel. It issues three-month notes and rolls them over each quarter. Interest costs are lower than for a long-term loan, and the banks stand ready to fund if the market closes.
Example
A utility company in need of working capital sets up a $30,000,000 facility with six-month notes. Demand from investors is strong, so the banks never have to lend. The utility pays a fee of $75,000 a year for the security.
Example
A national government agency uses a facility to bridge the period before it receives tax revenue. In a nervous market, investors refuse the notes at the target price. The underwriting banks purchase them, and the agency continues operating.
Formula
Calculation
All-in annual cost = interest on notes issued + underwriting and commitment fees
All-in cost rate = all-in annual cost / amount of notes outstanding
A company sets up a $50,000,000 note issuance facility. It issues notes at an interest rate of 4.0% a year, so interest is $50,000,000 x 0.04 = $2,000,000. The banks charge an underwriting fee of 0.25% a year on the facility, which is $50,000,000 x 0.0025 = $125,000. All-in cost = $2,000,000 + $125,000 = $2,125,000, and the rate is $2,125,000 / $50,000,000 = 4.25%.Case study
Seen in the real world.
Meridian Cement is a fictional manufacturer used for illustration. In this illustrative story, it needed $40,000,000 to build a new plant and chose a seven-year note issuance facility instead of a long-term bond. Short-term rates were low, and the finance director expected to save about 1% a year compared with fixed-rate borrowing.
After two years, interest rates rose by 2 percentage points, and the cost of rolling the notes increased by $800,000 a year. The company used an interest rate swap to fix the rate on half of the amount, which limited further risk. The finance director later told the board that the facility had delivered flexibility but that the exposure to rate changes should have been hedged from the start.
Watch out
Common mistakes.
- Assuming the borrower has a fixed interest rate. Rates reset each time notes are rolled over, unless hedged.
- Ignoring the fees. Underwriting and commitment fees add to the all-in cost.
- Believing the banks always fund the notes. They only step in if investors do not buy them.
Questions
People also ask.
Is a NIF the same as commercial paper?
No, commercial paper is simply short-term debt, whereas a NIF adds a multi-year framework and a bank backstop.
Why do banks agree to underwrite?
They earn fees for taking on the risk that the market might not absorb the notes.
Who uses these facilities?
Large companies, banks and governments with good credit standing have been the typical users.
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