The Total Costs of Corporate Borrowing in the Loan Market ...
The Total Costs of Corporate Borrowing in the Loan Market: Don't Ignore the Fees
Tobias Berg
Anthony Saunders January 31, 2013
Sascha Steffen*
Abstract Fees are an important part of the total cost of corporate borrowing. More than 80% of US syndicated loans contain at least one fee type and payments from fees can easily exceed interest payments. We find that the scope of relationship benefits extend beyond spreads, in particular, relationship loans are associated with lower upfront fees and lower letter of credit fees and these relationship benefits are similar in magnitude to those observed for spreads. We also find evidence consistent with a liquidity insurance view of lines of credit where relationship banking facilitates the smoothing of payments between no-liquidity-shock states and liquidity-shock states. Importantly, we propose a new measure for the total cost of corporate borrowing that accounts for fees and the fact that most loans are not immediately drawn down at origination. This measure produces higher costs of borrowing than has hitherto been recognized in the academic literature to date.
We thank Viral Acharya and Michael Roberts for valuable comments and suggestions.
Humboldt University Berlin and New York University. Email: tobias.berg@hu-berlin.de Tel: +49 177 314 2164. Stern School of Business, New York University. Email: asaunder@stern.nyu.edu Tel: +1 212 998 0711. * European School of Management and Technology (ESMT). Email: steffen@ Tel: +49 30 181 1544.
1
In this paper, we analyze the total costs of borrowing for US public firms in private debt markets. Prior research focuses almost entirely on the All-In-Spread-Drawn (AISD) paid by the borrower for each dollar borrowed without analyzing the type and size of fees included in the AISD and whether the AISD ignores other fees charged to the borrower to complete deals, which would add to the total cost of borrowing. This is surprising as the theoretical literature highlights the importance of fees relative to spreads (Boot et al. (1987), Thakor and Udell (1987), and Morgan (1994)). A similar concern about the importance of fees was also mentioned by Roberts (2012). The total cost of borrowing is challenging to estimate empirically because it comprises various fees which are customized in each contract, for example, some are shared among all syndicate lenders and some are privately negotiated between the borrower and the lead arranger and kept by the latter, such as the upfront fee. Moreover, only a small percentage of loans are immediately paid out. Sufi (2009) reports that 82% of public firms' borrowings in the US are credit lines and even 32% of otherwise all equity financed firms also have credit lines. The design and utilization of loans and credit lines govern to what extent spread and fees eventually apply and thus the total cost of corporate borrowing.1
As an example of the importance and scale of fees, on June 18th, 2009 Eddie Bauer Holdings, a clothing store chain and debtor-in-possession at that time, negotiated a USD 100mn revolving credit facility with a maturity of seven months.2 With an annual spread over LIBOR of 400 bps and an upfront fee of 275 bps, the income from the upfront fee over the maturity of the loan exceeded the cumulative spread income over the seven-month life of the loan. Furthermore, the contract contains a letter of credit fee of 425 bps for drawings under the letter of credit sub-
1 Fees are also an important income component for banks. In the first quarter of 2012, based on regulatory filings from the largest five bank holding companies in the US (JP Morgan Chase, Bank of America, Citigroup, Wells Fargo and US Bankcorp) 42% of total revenues were non-interest revenues. 2 The credit agreement is available online at . Information on spreads and fees can be found in Article 1 and Article 3.
2
limit and a commitment fee of 100 bps payable on undrawn amounts. The total cost of the revolving credit facility ? the upfront fee, the spread, the commitment fee and the letter of credit fee ? significantly exceeds the AISD, which in this case contains only the spread,3 and the All-inSpread-Undrawn (AISU), which in this case only contains the commitment fee.4 This example indicates that aggregates such as the AISD and AISU might not be sufficient to describe the total cost of corporate borrowing. To preview our results, we find that ignoring fees significantly underestimates the costs of syndicated loans to borrowing firms.
Given the limited research available on fees in the syndicated loan market we start by providing two stylized facts. First, fees are important; in our sample of US term loans and revolvers from 1986 to 2011 more than 80% of the loans have at least one type of fee. In particular, almost 50% of the loans carry a commitment fee, one third contain a letter of credit fee, almost 25% a facility fee and some syndicated loans even specify a "collateral monitoring fee" (see Figure 1). The mean values for these fees over the 1986-2011 period range from 16 bps (facility fee) to 177 bps (letter of credit fee) and are sizable compared to the average AISD of 190 bps. Indeed, for lines of credit, where fees are most prevalent, a borrower may pay for setting up the line of credit (upfront fee), for not using the line of credit (commitment fee), for using the line of credit (spread), for going above or below a certain threshold (utilization fee), for extending the line of credit (extension fee) and for cancelling the line of credit (cancellation fee).
[Figure 1]
3 The AISD contains the spread and the facility fee. Since no facility fee is specified in this contract, the AISD reduces to the spread for this contract. 4 The AISU contains the commitment fee and the facility fee. Since no facility fee is specified in this contract, the AISU reduces to the commitment fee for this contract.
3
Second, we find that parameters used in the prior literature, such as the AISD and the AISU, are only aggregates of certain spread and fee components and ignore certain features of the overall borrowing costs. Figure 2 is a graphical illustration of the key spread and fee components that comprise the total cost of corporate borrowing in the syndicated loan market. In general, AISD comprises the spread and the facility fee, while AISU comprises the facility fee and the commitment fee. For a typical term loan a borrower pays a one-time upfront fee and an annual spread on the total borrowed amount. Thus, the AISD (spread plus facility fee) includes the spread, but ignores the upfront fee.5 A typical revolver loan comprises i) an upfront fee, ii) either a commitment fee (payable on undrawn amounts) or a facility fee (a fee payable both on undrawn and drawn loan amounts), iii) a spread on drawn amounts, iv) a letter of credit fee if the revolver loan contains a limit for letters of credit. Thus the AISD (spread plus facility fee) ignores both upfront fees and fees payable under drawn letters of credit. The AISU (commitment fee plus facility fee) ignores the upfront fee.
[Figure 2]
There is a broad literature on the effect of relationships on loan spreads both for small as well as large publicly traded firms.6 However, little or nothing is known about possible relationship benefits for fees. It is a testable hypothesis that these benefits also extend to discretionary fees charged by lenders. Our results corroborate this hypothesis. More specifically, we find that loan lending relationships reduce upfront fees (-16 bps) and letter of credit fees (-6 bps). These relationship effects are similar to the magnitude we observe for the AISD (-11 bps).
5 In very few cases ( ................
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