What is a credit facility (short definition)
– A credit facility is a contractual arrangement between
a lender (or syndicate of lenders) and a borrower that sets terms allowing the borrower to draw funds up to a committed limit during a specified period. The agreement defines pricing (interest and fees), how and when draws and repayments occur, collateral and guarantees (if any), covenants (promises about the borrower’s conduct or financial ratios), and events that trigger repayment or default.
Key features to know
– Commitment amount: the maximum principal available under the facility.
– Availability period / maturity: when draws are permitted and when the facility expires.
– Pricing: interest rate on drawn amounts (often expressed as a reference rate plus a spread) and fees on undrawn commitments.
– Types of borrowing: revolving (reusable up to the limit), term loans (one-off draw with scheduled repayments), or a combo.
– Collateral: assets pledged to secure borrowing; unsecured facilities have no collateral.
– Covenants: financial covenants (e.g., leverage or interest-coverage ratios) and negative covenants (limits on additional indebtedness, asset sales).
– Events of default and remedies: circumstances that allow the lender to accelerate repayment.
– Agent and syndicate structure: where multiple banks participate, one bank typically acts as administrative agent.
Common types of credit facilities
– Revolving credit facility (revolver): borrower can draw, repay, and re-draw up to the limit during the availability period. Common for working capital.
– Term loan: fixed amount borrowed once or in tranches with a set amortization schedule.
– Secured facility / asset-based loan: borrowing capacity tied to the value of pledged assets (receivables, inventory, equipment).
– Letter of credit facility: bank issues letters guaranteeing payments to third parties on behalf of the borrower.
– Overdraft / bank line: short-term arrangements allowing a current account to go negative up to a limit.
How pricing usually works (simple formulas)
– Interest on drawn funds (simple interest):
Interest = Principal_drawn × Annual_interest_rate × (Days_outstanding / Day_count_basis)
Typical day-count basis: 360 or 365; many commercial loans use 360.
– Commitment fee on undrawn portion:
Commitment_fee = Undrawn_amount × Commitment_fee_rate × (Days / Day_count_basis)
– Example assumptions (worked numeric example)
– Committed revolver: $100,000,000
– Drawn amount: $30,000,000 for 90 days
– Reference rate (e.g., SOFR): 1.00% per annum
– Spread: 2.00% (200 basis points), so total interest rate = 3.00% p.a.
– Commitment fee on undrawn: 0.25% (25 bps) per annum
– Day-count basis: 360
Interest on drawn funds:
Interest = 30,000,000 × 0.03 × (90 / 360) = $225,000
Commitment fee on undrawn ($70,000,000):
Commitment_fee = 70,000,000 × 0.0025 × (90 / 360) = $43,750
Total cost over the 90-day period = $225,000 + $43,750 = $268,750
Checklist for reviewing a credit facility term sheet
1. Confirm committed amount and availability period.
2. Identify types of borrowing allowed (revolver, term, letters of credit).
3. Verify pricing: reference rate, spread, step-ups/step-downs, floors.
4. Calculate fees: upfront (arrangement, underwriting), commitment, agency, legal.
5. Read covenants carefully: financial ratios, testing frequency, cure periods.
6. Check events of default and cross-default language.
7. Note collateral, guarantors, and intercreditor arrangements.
8. Understand amortization/prepayment, including penalties for early repayment.
9. Confirm reporting obligations and notice periods.
10. Assess conditions precedent to the initial borrowing.
Risks and practical considerations
– For borrowers: covenant breaches can force acceleration, and unused
unused commitment fees can be significant even if you never draw the full line. Other borrower risks and considerations:
– Covenant risk. Financial covenants (e.g., leverage, interest coverage) are tested periodically; breaches can trigger technical defaults, require waivers, or force accelerated repayment. Know measurement windows and cure periods.
– Fee drag. Commitment, facility, and agency fees are paid on unused amounts or for the facility’s existence; they reduce the economic benefit of having standby capacity.
– Pricing variability. Floating-rate loans track a reference rate (e.g., LIBOR, SOFR) plus a spread. Reference-rate transitions and floors can materially change cost.
– Collateral and priority. Secured facilities take collateral and may subordinate other creditors. Understand lien coverage tests and trigger events that expand security interests.
– Cross-default and change-of-control. Broad cross-default clauses can pull in other obligations. Change-of-control clauses may require prepayment or renegotiation.
– Refinancing/rollover risk. Single-maturity facilities create refinancing risk if market conditions worsen at maturity.
– Currency and FX exposure. Facilities denominated in foreign currencies expose borrowers to exchange-rate volatility.
– Operational risk. Reporting failures, late notices, or administrative errors can lead to technical defaults.
Lender risks and practical considerations
– Credit risk. Probability of borrower default and expected loss given default drive pricing and collateral requirements.
– Collateral valuation and concentration. Illiquid or volatile collateral increases loss severity; lenders monitor haircuts and concentration limits.
– Interest-rate and liquidity risk. A facility can create funding mismatches if draw patterns change.
– Legal and documentation risk. Ambiguities in intercreditor, guarantor, or collateral language increase enforcement uncertainty.
– Regulatory and reputational risk. Compliance with capital, borrower suitability, and anti–money-laundering rules matters.
– Operational risk. Errors in margining, monitoring covenants, or administering fee billing create losses or disputes.
Practical negotiation checklist (step-by-step)
1. Quantify needs. Determine committed amount, likely draw schedule, and desired availability period.
2. Benchmark pricing. Collect quotes for comparable facilities (same size, sector,
sector, tenor, collateral and covenant package). Adjust for borrower credit-rating differences and market conditions.
3. Choose structure. Decide between revolver (revolving credit), term loan, delayed-draw, or a multi-tranche mix. For revolvers specify availability periods, sublimits (e.g., letters of credit), and whether the facility is evergreen or subject to periodic renewal.
4. Define pricing mechanics.
– Base rate. Choose reference rate (e.g., SOFR, LIBOR legacy fallback) and specify fallback mechanics. Define day-count convention (e.g., ACT/360).
– Margin. Expressed in basis points (bp = 0.01%). This is added to the base rate on drawn amounts.
– Commitment fee. Fee on undrawn (committed) portion; often paid quarterly. Define whether it applies to total commitment or undrawn only.
– Utilization fee/step-ups. Additional spread if utilization exceeds thresholds (e.g., +25 bp above 75% draw).
– Upfront/arrangement fees. One-time fees payable at signing; allocate among arrangers if syndicate.
– Floor or minimum rate. If contract includes a spread floor (e.g., minimum effective rate even if base rate falls).
5. Draft covenants (promises). Covenants are affirmative (actions borrower must take), negative (actions borrower must avoid), and financial (ratios).
– Financial covenants: define calculation detail (numerator, denominator, look‑back periods), testing frequency (quarterly, trailing 12 months), cure periods, and measurement adjustments (non-cash items, pro forma adjustments).
– Material adverse change (MAC) clause scope. Narrow language reduces lender exit risk; broad language benefits lenders.
– Reporting covenants: specify required statements, audit requirements, delivery deadlines, and delivery of compliance certificates.
6. Collateral and guarantees.
– Specify collateral type (real estate, inventory, receivables), perfection steps (e.g., UCC-1 filing in U.S.; land registries), valuation method, allowed liens, and substitution mechanics.
– Haircuts and concentration limits: define collateral valuation haircuts and single-counterparty concentration thresholds.
– Guarantee language: limited or full recourse; solvent‑person or enhanced guarantee wording. Identify guarantor order of liability if multiple.
7. Conditions precedent (CPs) to initial and subsequent draws.
– Include required documentation (incorporation docs, board resolutions, legal opinions), perfection evidence, officer certificates, and the absence of material adverse changes.
– Specify timing for CP satisfaction and whether lenders can waive particular CPs.
8. Legal documentation and intercreditor arrangements.
– Syndicated facilities require agent bank appointment, voting thresholds, and amendment/waiver mechanics.
– If other creditors exist, negotiate intercreditor agreements clarifying enforcement priority, standstill periods, and collateral sharing.
9. Operational mechanics and monitoring.
– Payment mechanics: specify payment dates, sweep mechanisms, and application of receipts.
– Events of default (EoD): enumerate EoDs, cure rights, cross-default and cross‑acceleration thresholds.
– Covenant testing and monitoring: set up templates for covenant compliance certificates and automated data delivery where possible.
– Margining and collateral verification schedule if margin calls apply.
10. Fees, expenses and indemnities.
– Allocate legal, agent, and arranger fees; specify expense recovery for actions on default.
– Clarify reimbursement for hedging or swap breakage if interest-rate swaps are required.
11. Negotiation checklist timeline (example)
– Week 0–1: RFP and benchmark quotes.
– Week 2: Term-sheet (commercial heads) agreed.
– Week 3–5: Lender legal markups and collateral analysis.
– Week 6–8: Final documentation, due diligence, conditions precedent agreed.
– Week 9: Signing and initial closing; first funding date scheduled.
Adjust timing by deal complexity and jurisdiction.
Worked numeric example — annual cash cost of a simple committed revolver
Assumptions:
– Committed amount = $50,000,000
– Average utilization = 60% (drawn = $30,000,000; undrawn = $20,000,000)
– Base rate assumed for example = 1.00% (for illustration only)
– Margin on drawn = 250 bp = 2.50%
– Commitment fee on undrawn = 50 bp = 0.50%
– Utilization fee = none for this example
Formulas:
– Interest on drawn = drawn × (base rate + margin)
– Commitment fee =
undrawn × commitment fee rate.
Compute the amounts (annual):
1) Interest on drawn
– Formula: interest = drawn × (base rate + margin)
– Numbers: drawn = $30,000,000; base = 1.00%; margin = 2.50% → total interest rate = 3.50%
– Interest = $30,000,000 × 3.50% = $1,050,000
2) Commitment fee on undrawn
– Formula: commitment fee = undrawn × commitment fee rate
– Numbers: undrawn = $20,000,000; commitment fee rate = 0.50%
– Commitment fee = $20,000,000 × 0.50% = $100,000
3) Total annual cash cost
– Formula: total cost = interest + commitment fee
– Total = $1,050,000 + $100,000 = $1,150,000
Useful effective-rate metrics
– Effective annual cost as a percent of drawn (useful if you think in terms of money actually borrowed):
= total cost / drawn = $1,150,000 / $30,000,000 = 3.8333% ≈ 3.83%
– Effective annual cost as a percent of committed amount (useful for facility budgeting):
= total cost / committed = $1,150,000 / $50,000,000 = 2.30%
Quick sensitivity: change in utilization
– If utilization falls to 30% (drawn = $15M; undrawn = $35M):
Interest = $15,000,000 × 3.50% = $525,000
Commitment fee = $35,000,000 × 0.50% = $175,000
Total = $700,000 → effective on drawn = $700,000 / $15,000,000 = 4.67%
– If utilization rises to 90% (drawn = $45M; undrawn = $5M):
Interest = $45,000,000 × 3.50% = $1,575,000
Commitment fee = $5,000,000 × 0.50% = $25,000
Total = $1,600,000 → effective on drawn = $1,600,000 / $45,000,000 = 3.56%
Observations and caveats
– Commitment-fee base: some lenders charge the commitment fee on the entire committed amount rather than only on undrawn balances; this raises the borrower’s fixed cost and reduces sensitivity to utilization. Verify your facility wording.
– Other fees: arrangement fees, upfront fees, utilization fees, agency fees, breakage costs and legal expenses can materially change first-year and ongoing costs.
– Interest indexing: base rate in practice can be LIBOR (legacy), SOFR, or another reference rate; the example used a generic “base rate” for illustration.
– Accounting and regulatory treatment: loan commitments and commitment fees can have different accounting/tax implications (e.g., amortization of upfront fees under IFRS/GAAP); consult accounting guidance or your finance team.
Practical checklist when modeling a revolver or committed facility
– Confirm fee bases (undrawn only vs. full commitment) and exact rates.
– Identify reference rate (SOFR/LIBOR/other) and any floor on the base rate.
– Include all one‑time and recurring fees (arrangement, agency, legal, commitment, utilization).
– Model several utilization scenarios (low, expected, high) and compute effective rates on both drawn and committed amounts.
– Consider covenant triggers and pricing
– Consider covenant triggers and pricing step-in events (e.g., step‑up in margin on covenant breach). – Confirm tenor, renewal and notice provisions (automatic rollover vs. lender consent). – Check collateral, security and ranking (first lien, pari passu, unsecured) and any haircut or valuation mechanics. – Identify sublimits and accordion features (ability to expand the facility). – Confirm availability periods (when the borrower can draw) and any seasonal or capex carve‑outs. – Understand prepayment and early termination provisions, including breakage costs for term-out. – Verify default interest rates, cure periods and cross-default or cross‑acceleration clauses. – Map interactions with other debt (intercreditor terms, guaranty structure, cash‑sweep triggers). – Tax and withholding considerations on fees and interest (gross‑up clauses if applicable). – Documentation timing: planned signing, conditions precedent (CPs) and required certificates or opinions.
Modeling steps (practical, step‑by‑step)
1) Gather deal terms: committed amount, availability period, base/reference rate (e.g., SOFR), spread, commitment fee (basis: undrawn, drawn, or full commitment), utilization fee, upfront/arrangement fees, amortization schedule, and covenant thresholds.
2) Choose scenarios: low (10–30% utilization), base (expected), and high (near 100% utilization). Model monthly or quarterly cash flows if pricing resets frequently.
3) Build fee waterfalls: calculate interest on drawn balances, recurring commitment fees on the stated base, utilization fees if any, and amortization of upfront fees. Include any agency or legal recurring fees.
4) Compute effective cost metrics: interest expense, all-in spread, and effective interest rate (defined below). Run sensitivity tables for reference rate moves, utilization and covenant breaches.
5) Implement accounting treatment assumptions: whether upfront fees are amortized over expected life, and whether commitment fees that are compensation for lenders are recognized as expense or liability amortization under applicable GAAP/IFRS. Document assumptions.
6) Test covenant triggers: forecast covenant ratios under each scenario and flag timing of potential breaches. Model remedies or step‑ups that would change economics.
7) Present outputs: table of cash flows (interest + fees), effective rates by scenario, and break‑even utilization where the revolver becomes cheaper than alternatives.
Key formulas and definitions
– Reference rate: market benchmark rate (e.g., SOFR — Secured Overnight Financing Rate).
– Spread: lender margin quoted in basis points (bps); 100 bps = 1.00%.
– Commitment fee (CF): recurring fee on unutilized or full commitment; expressed as % per annum.
– Interest on drawn amount = (reference rate + spread) × drawn balance.
– Commitment fee amount = CF_rate × fee_base_balance. Fee_base_balance depends on contract (undrawn only, full commitment, etc.).
– Effective interest rate on drawn funds (simple) = (Interest expense + Allocated commitment fee + Amortized upfront fees) / Average drawn balance.
Example allocation methods for commitment fees:
– If commitment fee is charged on undrawn only: annual CF = CF_rate × (Committed − Drawn). To compute an effective cost on drawn dollars you can allocate the CF to the drawn balance: Allocated_CF_to_drawn = annual_CF × (Committed / Drawn) is one conservative approach but distorts economics; a clearer alternative is to compute effective cost on the full commitment (drawn + undrawn) or report separate metrics for drawn vs. committed availability.
Worked numeric example (illustrative)
Assumptions:
– Committed revolver = $100,000,000.
– Drawn today = $20,000,000.
– Reference rate (SOFR) = 1.50% p.a.
– Spread = 200 bps = 2.00% p.a.
– Commitment fee on undrawn = 100 bps = 1.00% p.a. (applies