What it means
A company that needs funds for several years might prefer to borrow in short-term markets, where rates are often lower, but worry that the market could close to it at a bad moment. A revolving underwriting facility is designed to remove that worry.
A group of banks promises to provide the money if investors do not. The borrower issues short-term notes, typically for three or six months, and replaces them as they mature.
This is why the facility is called revolving: the borrower keeps rolling over short-term debt for the life of the facility, which might be five to seven years. A tender panel of banks or investors usually bids for the notes each time.
The underwriting banks act as a safety net. If the notes cannot be sold at or below a maximum margin over the reference rate, the underwriters must buy the unsold notes or lend the money at the pre-agreed margin.
In return they earn an underwriting fee on the whole facility, whether or not it is used. For the borrower, the benefits are certainty of funds and a cost that is usually below traditional bank loans when markets are healthy.
The cost is the underwriting fee, which is paid even when the banks never have to lend. The borrower also takes the risk that rates move between roll dates, since the notes reprice each time.
For the banks, it is a way of earning fees while lending only when needed. However, they take on the risk that a borrower's credit worsens just when investors stop buying its notes.
This is the situation in which the underwriting commitment becomes expensive. Similar structures were known as note issuance facilities, and the labels were used loosely.
Over time, the markets moved towards other tools, such as commercial paper programmes backed by standby credit lines and syndicated revolving credit facilities. The principle of a committed back-up source of funds remains central to corporate treasury.
In practice
Real-world examples.
Example
A multinational manufacturer wants a five-year source of funds for working capital. It arranges a RUF so that it can issue three-month notes and roll them over, with a bank group standing behind it. The treasurer likes the fact that the facility is available even in a tight market.
Example
A shipping company issues short-term notes under a RUF and finds that investors buy them at a rate below the maximum margin. The underwriting banks do not have to lend, but they still collect their annual fee. The finance director treats the fee as the cost of insurance.
Example
A regional utility compares a RUF with a standard bank loan. The RUF has a lower expected interest cost but adds an underwriting fee and the risk of changing rates at each roll. The utility chooses it because it values flexibility.
Formula
Calculation
Annual cost = (facility size x underwriting fee) + (notes taken up by underwriters x margin)
Suppose a company arranges a $100,000,000 facility with an underwriting fee of 0.15% a year. The fee = 100,000,000 x 0.0015 = $150,000. In one year, $20,000,000 of notes cannot be sold, so the banks take them up at a margin of 0.50% over the reference rate. The margin cost = 20,000,000 x 0.005 = $100,000. Total annual cost = 150,000 + 100,000 = $250,000, on top of the base interest.Case study
Seen in the real world.
Marlin Telecom is an illustrative, fictional company that arranged a $200,000,000 RUF with a six-year life. The underwriting fee was 0.20% a year, so the fee was 200,000,000 x 0.002 = $400,000 annually.
In the third year, a rating downgrade made investors nervous, and $30,000,000 of its notes went unsold. The banks took up the notes at the agreed maximum margin of 0.75%, which cost the company 30,000,000 x 0.0075 = $225,000 a year in margin.
The company still had its funds when other borrowers were shut out of the market. The illustrative lesson is that the facility is a form of insurance, and its fee buys certainty at difficult moments.
Watch out
Common mistakes.
- Treating the underwriting fee as wasted money in years when the banks never lend, when it pays for the guarantee.
- Assuming the facility fixes the interest rate, when the notes reprice at each roll.
- Ignoring the risk that the underwriters' commitment could be limited if the borrower's credit deteriorates sharply.
Questions
People also ask.
How is a RUF different from a normal loan?
In a RUF the borrower normally raises money from investors by issuing notes, and the banks only lend if the notes cannot be sold.
Who pays the underwriting fee?
The borrower pays it to the banks on the full facility amount, whether or not the banks are called on to lend.
Is a RUF still widely used?
It is less common today, as borrowers tend to use commercial paper programmes and syndicated revolving credit facilities, but the idea of committed back-up funding is still central.
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