Lenders not only earn interest on the amounts lent, which needs to be sufficient not only to cover the lender’s cost of capital but also provide a sufficient return, but they also typically receive, depending on their role, transaction related fees, e.g., agency fees, commitment fees, upfront fees, arrangement fees, etc. These fees are negotiated at the Term Sheet stage of the transaction and may be set forth in the facility agreement or in one or more fee letters. Often these fees are calculated as a percentage of the commitment amount and, with respect to commitment fees, the number of days the commitment is outstanding.
Types of Fees
Arrangement Fees. The financial institution arranging the lending transaction for the borrower will receive a fee as compensation for structuring the transaction, e.g., negotiating the term sheet, bringing additional lenders into the transaction, etc. The arrangement fee is usually calculated as a percentage of the final total commitments secured by the arranger at closing.
Agency Fees. One of the most basic types of fees is an agency fee paid to the administrative agent. This fee, which is typically paid either quarterly or annually in advance, is meant to compensate the administrative agent for the services it provides in administering the facility, e.g., processing borrowing requests, bundling the loan proceeds from the lenders for remittance to the borrower, acting as an interface between the borrower and the lenders, calculating commitment fees, etc. The fee may be described in the facility agreement or kept confidential in a fee letter between the borrower and the administrative agent.
Upfront Fees. Upfront fees are paid at closing, typically by netting such amount from the loan proceeds. The fee is paid to each lender as compensation for making the term and/or revolving loans available and is calculated as a percentage of each such lender’s loan commitment or advance. Like agency fees, the fee may be reflected in the facility agreement or in a fee letter.
Commitment Fees. Commitment fees are compensation to the lenders for making loan commitments available to the borrower and most often charged on revolving credit facilities but may also be payable on term loans if there is a long availability period in which the borrower may make borrowing requests. The fees are payable to each lender in arrears (typically quarterly) and are calculated on each such lender’s unused commitments.
Letter of Credit Fees. Letter of Credit fees may take two forms. The first fee, like a commitment fee, is calculated as a percentage of each revolving lenders commitment to make loan proceeds available to cover a drawing under a Letter of Credit. While one lender will issue the Letter of Credit, because the Letter of Credit utilizes revolving loan commitments, each other revolving loan lender is a participant in that Letter of Credit up to the pro rata commitment amount. The other fee, which is a fronting fee, is payable to the lender which issues the Letter of Credit. If there is a demand made on the Letter of Credit, the issuing lender will need to fund not only its pro rata portion of the Letter of Credit, but it also must front the other revolving lenders’ commitments. This second fee is meant to compensate the issuing lender if the borrower fails to reimburse the issuing lender for the Letter of Credit and one or more of the other revolving lenders does not compensate the issuing lender for their pro rata commitment.
Utilization Fees. As mentioned above, revolving lenders are compensated for making their revolving loan commitments available to the borrower by receiving a commitment fee based on the unused portion of their commitments. In some cases, however, the parties may expect the revolving line to be highly utilized and, in these situations, an additional utilization fee may be payable based on the outstanding portion of the revolving loan. Typically, the utilization fee, which is calculated in arrears, will not become due until a certain percentage utilization threshold is exceeded, e.g., 50%, and then the fee is calculated as a percentage on all outstanding amounts (not just the amount over the threshold). This fee is paid in arrears, typically quarterly.
Accrual of Fees
One basic question is how to calculate the amount of fees or interest due. For example, if interest is payable from the first day of the interest period to the last day of the interest period, are both the first and last day counted in the interest (or fee) calculation? Market convention is that interest is calculated from and including the first day to and excluding the last day of the interest period.
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