Prime Underwriting Facility

Understanding Prime Underwriting Facilities: A Comprehensive Guide

Prime underwriting facilities play a pivotal role in providing businesses with access to revolving lines of credit, offering financial flexibility in times of need. In this article, we delve into what prime underwriting facilities are, how they work, and their significance in corporate finance.

What Is a Prime Underwriting Facility?

A prime underwriting facility is a type of revolving underwriting facility, typically a short-term note, in which the lender’s yield is pegged to the bank prime rate. This credit option allows businesses to have access to cash when and if they need it due to financial instability or other reasons.

Key Takeaways

• A prime underwriting facility is a revolving line of credit pegged to a bank's prime rate.
• This credit allows businesses to have access to cash when needed due to financial instability or other reasons.
• The federal prime rate has varied over the last decade, and the rate is 3.5% as of May 2021.
• Usually, when a company has a prime underwriting facility, it is managed by a bank or other financial institution.
• Like most lines of credit, using the funds in the loan brings down the available balance, and making payments on the debt brings up the amount of credit available for use.

How a Prime Underwriting Facility Works

A prime underwriting facility is most often a short-term note with a maturity of one to three years. It is an example of a revolving underwriting facility (RUF), with the yield, in this case, tied to the prime rate.

The prime rate is the interest rate commercial banks make available for their best customers with excellent credit ratings. Many of a bank's most creditworthy customers are large corporations. The prime interest rate is primarily determined by the federal funds rate, which is the overnight rate banks use for lending to each other.

The prime rate has been at historic lows for the last decade. For example, the prime rate in 2018 rose almost to 5%, and as of May 2021, the prime rate is 3.5%. But it is nowhere near the historical highs. For example, in March of 1970, the prime rate was 8%, and just nine years later, in April of 1981, the prime rate hit 20%.

The volatility seen in the prime rate during the 1970s was especially troublesome for the economy. Sudden, large movements in interest rates will always make business planning and borrowing very difficult. For instance, in October 1972, the prime rate was just 5.75%, but by October 1984, it was at 12%, according to historical data.

Short-term prime loans offer better rates than most revolving credit loans and are good solutions for corporations intending to pay them off quickly under flexible payoff terms.

Revolving Loan Facilities

Revolving loan facilities allow a borrower to issue, as required, short-term paper for periods of less than one year. In the event the borrower is unable to sell the paper, a group of underwriting banks will buy it at previously agreed-upon rates or provide funds through other lending arrangements.

Businesses need working capital to fund their fixed and variable costs. A revolving loan facility provides them the flexibility of accessing additional capital when and if needed. For example, businesses project annual revenue and expense forecasts based on likely market conditions. When those conditions change suddenly during an unanticipated recession, gaining access to these revolving loan funds provides the company a cushion while reevaluating the changed circumstances.

Drawing against the loan brings down the available balance, whereas making payments on the debt brings the balance up.

A lender will most often examine the company’s income statement before issuing a loan. The good news? As long as the company is in excellent financial shape, with a good credit score, they are likely to be approved.