Commitment Fee: a Worked Example

A committed facility is a contract under which the bank must lend when asked, so long as the conditions are met. The undrawn part of the facility earns no interest, but it is not free to the bank. Capital rules count part of the promise as if it were already a loan, through a credit conversion factor: in the Basel framework 40% for commitments and 10% for those the bank can cancel at any time without notice, with each market setting its own table. The bank's treasury also has to be able to fund the drawings, which tend to arrive at the worst moment, when a business in difficulty takes everything it was promised.

The fee is lower than the margin because the bank has not put money out, and has not taken the full credit risk of a loan. It exists because the alternative is a bank that earns nothing on a promise that still uses its balance sheet. A facility with no commitment fee usually carries the cost somewhere else: in a line fee, or in a promise that is not a promise at all, as with an uncommitted facility.

Four drafting points decide the bill. The first is what counts as drawn: letters of credit and guarantees issued under the line usually reduce the undrawn amount, and any part carved out as an ancillary facility may or may not. Some tariffs measure the gap against the highest balance on the day rather than the closing one. The second is the rate. It can be a fixed percentage, or in UK and other loan-market agreements a fraction of the margin, in which case a margin ratchet moves it too. The third is the day count: commonly 365 for New Zealand and Australian dollars and sterling, 360 in many US dollar agreements. The fourth is when it starts and stops. Fees commonly accrue from signing, are paid quarterly in arrears, and end on any commitment the borrower cancels.

The name varies as well. Undrawn fee, non-utilisation fee and undrawn margin are all used for a charge on the unused amount. Many mid-market bank facilities in New Zealand and Australia carry a line fee on the whole limit, though a charge on the unused part also appears on revolving lines there. A commitment fee is the more usual form in UK revolving facilities and in syndicated loans.

A blender of spices and seasonings for food manufacturers, constructed for this page like every figure in it, has a US$30m committed revolving facility. Interest is a base rate of 4.00% plus a margin of 2.00%; the commitment fee is 0.80% a year on the undrawn amount, on actual days over a 365-day year. These rates are the example's, not a market norm. Drawings are shown as a quarterly average for brevity; the agreement works day by day, in US$m.

The fee is highest in the quarter the business needs the bank least, and adds 0.85 percentage points to the cost of the money it actually used. The same facility looks quite different at other levels of use, which is why a quote at one balance is not much of a quote:

The blender's busiest quarter averaged US$24m drawn. If it cancelled US$4m of the limit it would save US$32,000 a year (4m × 0.80%), and would give up headroom in the one quarter it needs headroom. Whether that trade is worth making depends on how far a daily peak can run above a quarterly average, which is the question to put to the daily balances before anyone cuts anything.

A commitment fee shrinks as the line fills. A line fee does not move, because it is charged on the limit. A utilisation fee moves the other way: it starts or rises once drawings pass a stated share of the commitment. An agreement can carry a commitment fee and a utilisation fee together, so that an idle line and a full one each pay something extra. An establishment fee is different again. It is paid once for setting the facility up, and it is not reduced by drawing or by cancelling later.

DEFINED IN ONE PARAGRAPH → · THE ALL-IN RATE → · PRODUCT FILE: REVOLVING CREDIT FACILITY →

On the borrower's side the fee is an argument about limit size. A business that asks for a larger line than it can use pays for the difference every day of the term, and the honest way to compare offers is to set them side by side at several balances. On the lender's side the fee is one input to the return on the facility, and a line that sits almost empty for years earns its capital poorly, which tends to come up at the annual review.

The undrawn amount also matters to a credit officer for a reason that has nothing to do with income. It is the amount the bank can be called on to lend when the borrower is at its weakest, which is why exposure at default counts part of the undrawn limit as well as the balance. A low commitment fee can look like a small concession. The promise behind it is the size of the undrawn line.

HOW BANKS PRICE A LOAN → · CREDIT CONVERSION FACTOR →