Meaning
Credit extension occurs when a lender provides funds that exceed the limit dictated by the current value of the collateral. This out of formula advance is typically a short term arrangement designed to help a borrower through a specific liquidity crisis. It sits outside the normal lending parameters defined in the credit agreement.
Temporary Liquidity
Businesses request these funds to cover urgent obligations such as payroll or critical supplier payments. The out of formula advance bridge the gap until inventory is sold or new capital is raised. It is a discretionary tool used by lenders to support a potentially viable client.
Approval Procedure
Requests for this type of funding undergo intense scrutiny by senior credit officers. Because the out of formula advance is not fully secured by assets, it carries a higher risk of loss for the bank. The lender often requires additional reporting or a higher interest rate in exchange for the accommodation.
Repayment Schedule
Lenders usually set a strict deadline for the borrower to bring the loan back into compliance with the formula. An out of formula advance might be reduced gradually over several weeks as the company generates cash. Failure to meet the reduction targets can result in a declaration of default.
