What it means
A bank that commits to lend $50 million on demand for five years has made a promise that costs it something even if the money is never drawn. Regulators require it to hold capital against the commitment, it must manage its liquidity to be able to fund a drawing at any time, and it has forgone other uses of its lending capacity.
The commitment fee is the charge for that promise. The facility agreement states a fee rate, applied to the undrawn balance, usually calculated daily and paid quarterly.
If a $50 million revolver is drawn to $20 million, the borrower pays interest on $20 million and the commitment fee on $30 million; if nothing is drawn the fee applies to the full $50 million. The rate is often set as a proportion of the loan margin (a third to a half is common) and may step up if the facility is less utilised, since low utilisation means the bank is holding capital for little return.
Related charges have different names and timings: an arrangement or upfront fee is paid once when the facility is signed, a utilisation fee is charged on the drawn portion when utilisation exceeds a threshold, and a ticking fee accrues on an acquisition facility between signing and completion. A facility fee, on some large syndicated loans, applies to the whole commitment whether drawn or not, replacing the commitment fee, with a lower margin on drawn amounts.
The borrower's all-in cost combines them all with the interest margin, and comparing facilities requires the full set. The borrower's decision is whether the assurance is worth the fee, since a committed facility that costs 0.30% a year on $50 million ($150,000) is expensive insurance if the borrower will never need it and cheap if it prevents a single liquidity crisis.
Businesses with seasonal needs, acquisition plans, commercial paper programmes (which require backup facilities) or thin cash reserves value commitment highly, while businesses with stable surplus cash may not need it. Uncommitted facilities (overdrafts repayable on demand, or lines the bank may withdraw) carry no commitment fee but offer no certainty, and treating them as available in a stress scenario is the classic liquidity error.
Fees also shape behaviour. A borrower paying a high fee on undrawn amounts may size the facility more tightly or accept a smaller facility with an accordion option, and a lender uses fee step-ups to discourage borrowers from holding large unused commitments.
In syndicated markets the commitment fee is a competitive term, quoted alongside margin and arrangement fee, and it rises and falls with bank capital costs and market conditions. On the accounting side, under IFRS 9 and US GAAP, commitment fees on facilities that are unlikely to be drawn are recognised as expense over the commitment period.
Fees that are in substance part of the cost of a loan the borrower expects to draw are deferred and amortised into the effective interest rate once drawn, and lenders mirror this treatment as income.
In practice
Real-world examples
Example 1
A company with a $500 million commercial paper programme pays 0.15% on a $500 million backup facility it has never drawn, as the rating agencies require.
Example 2
A property developer's construction loan charges 1% on undrawn tranches, encouraging the developer to draw only as the build progresses.
Example 3
A retailer negotiates a facility fee of 0.40% on the whole commitment with a lower margin, having calculated that its utilisation will exceed 60%.
Think of it
A commitment fee is what you pay to keep a credit line available-even if you don't use it.
Formula
Calculation
Commitment Fee (period) = Undrawn amount x Fee rate x Days / 360 (or 365, per the agreement)
All-in cost of a facility = Interest on drawn amount + Commitment fee on undrawn amount + Arrangement fee amortised + Other fees; divide by the average drawn amount for an effective rate
Worked example. A distribution company has a $30,000,000 five-year revolving credit facility. Terms: a margin of 2.00% over a benchmark rate of 4.50% in this example, so 6.50% on drawn amounts; a commitment fee of 0.70% (35% of the margin) on undrawn amounts; and an arrangement fee of 0.50% ($150,000) paid at signing.
Year 1 usage: $8,000,000 drawn for 4 months, $15,000,000 for 5 months and $3,000,000 for 3 months. Average drawn = ($8,000,000 x 4 + $15,000,000 x 5 + $3,000,000 x 3) / 12 = ($32,000,000 + $75,000,000 + $9,000,000) / 12 = about $9,667,000.
- Interest = $9,667,000 x 6.50% = about $628,300
- Commitment fee = ($30,000,000 minus $9,667,000) x 0.70% = $20,333,000 x 0.70% = about $142,300
- Arrangement fee amortised = $150,000 / 5 = $30,000
- Total cost = about $800,600
- Effective rate on average drawn = $800,600 / $9,667,000 = 8.28%, against a headline 6.50%; the commitment fee and arrangement fee add 1.78 points
Alternative: a $15,000,000 facility would just cover the five-month peak with no headroom. Its commitment fee would be ($15,000,000 minus $9,667,000) x 0.70% = about $37,300 and its arrangement fee $75,000 / 5 = $15,000, so total cost would be $628,300 + $37,300 + $15,000 = about $680,600. The larger facility costs about $120,000 a year more, and that extra cost buys headroom above the peak, so the treasurer keeps it but negotiates the commitment fee down to 0.50% at the next review, saving about $40,700 a year ($20,333,000 x 0.20%).
Value test: the treasurer estimates the probability that the company would face a liquidity shortfall of $10,000,000 or more in any year at 5%, and the cost of such a shortfall without a committed facility (emergency funding at penalty rates, lost supplier discounts, possible distress) at $2,000,000. Expected cost avoided = 5% x $2,000,000 = $100,000 a year, plus the unquantified benefit of never being in that position. The commitment fee of about $142,000 is close to that expected value and well below the risk-adjusted value, so the facility is retained.Case study
Seen in the real world
This is a fictional, illustrative scenario. A packaging manufacturer with steady cash flow and $4,000,000 of cash held a $20,000,000 committed revolving facility it had drawn only once in six years, paying a 0.60% commitment fee of $120,000 a year. Its finance director argued for cancelling the facility to save the fee and relying on the overdraft. The chief executive asked what the overdraft's terms were: $5,000,000, repayable on demand, reviewable annually.
The board debated and reduced the facility to $10,000,000 at a renegotiated 0.45% fee ($45,000 a year), keeping the overdraft. Fourteen months later the company's largest customer, a third of its sales, entered administration owing $3,200,000, and the bank, on the news, cut the overdraft to $2,000,000 and asked for a plan. The company drew $8,000,000 of the committed facility the same day, funded three months of trading while it replaced the customer, and repaid the drawing within a year. The finance director's later paper calculated that the $75,000 a year saved by the reduction had been well judged, since $10,000,000 had proved sufficient, and that the further $45,000 a year the board had considered saving by cancelling the facility altogether would have cost the company its existence.
Watch out
Common mistakes
- Comparing facilities on margin alone, ignoring commitment, arrangement and utilisation fees that can add one to two points to the effective cost.
- Treating an uncommitted overdraft as equivalent to a committed facility because it has no commitment fee. The fee is the price of the commitment; without it there is none.
- Cancelling a committed facility to save the fee without assessing the cost of the liquidity risk it covered.
Questions
People also ask
What is a typical commitment fee?
Between 0.10% and 0.75% a year on the undrawn amount, commonly set at 30% to 50% of the loan margin; higher for lower-rated borrowers and in tighter markets.
Is the commitment fee charged on the drawn amount?
No. It applies to the undrawn portion; interest applies to the drawn portion. A facility fee, by contrast, applies to the whole commitment.
How are commitment fees accounted for?
Fees on facilities unlikely to be drawn are expensed over the commitment period. Fees on facilities expected to be drawn are deferred and included in the effective interest rate of the loan when drawn.
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