Unused or undrawn capital fees, sometimes called commitment fees, are fees charged by lenders to borrowers on the undrawn or unused portion of a credit facility. They are generally charged on revolving credit facilities like revolving credit lines or revolving loans that allow a borrower to drawdown, repay and re-draw loans up to a maximum credit limit.
These fees are structured as a percentage fee charged every year or quarter on the portion of the facility that remains undrawn. For example, if a company has a $10 million revolving credit facility and has currently drawn $5 million, the lender will charge a commitment fee percentage on the remaining $5 million undrawn portion.
Why Do Lenders Charge These Fees?
Lenders charge commitment or undrawn fees to compensate themselves for keeping capital ready and available for clients to draw upon in the facility, even if it remains unused. This allows borrowers the flexibility to draw loans on demand when needed. The fee covers the lender’s cost of securing low-cost capital and reserving it for the client.
From the lender’s perspective, keeping capital ready but undrawn is an opportunity cost because that capital could be deployed elsewhere to earn a return. Charging a fee on the undrawn portion allows them to earn some income instead of none.
What Do They Depend On?
The undrawn fee percentage usually depends on:
- Creditworthiness of Borrower: More creditworthy firms usually pay lower fees. Startups and weaker firms often pay higher fees.
- Interest Rates: When base lending rates in the economy are higher, undrawn fees also tend to rise.
- Facility Size & Term: Larger facilities and longer term facilities often have lower fee percentages compared to smaller or shorter term facilities.
- Industry Practices: Some industries have evolved benchmarks for undrawn fees based on the type of lending product.
On average, undrawn fees range from 0.15% to 0.75% per year on the unused portion. So a $10 million facility with $5 million drawn may incur $30,000 to $150,000 in non-utilization fees every year.
Undrawn Fees Vs Other Fees
Besides the undrawn fee, some other fees are also typically charged on credit facilities:
- Upfront Fee: One-time flat or percentage fee charged upon setting up the facility
- Drawdown Fee: Small charge every time a drawdown of loan occurs from the available credit facility limit
- Early Termination Fee: Charged if borrower wants to cancel the credit line before maturity date
So in summary – undrawn fees are charged throughout the tenure of the facility as long as portions remain undrawn, while other fees are one-time or event-based charges.
How Should Borrowers Evaluate Undrawn Fees?
As a significant recurring cost, undrawn fees must be properly evaluated by borrowers considering a credit facility:
Project Usage
Realistically estimate what portions of the facility will remain undrawn during its tenure, based on your projected capital needs. This will determine the potential fee costs.
Coverage Ratio Impact
Estimate the impact on key coverage ratios like interest coverage ratio if you factor in undrawn fees in addition to interest costs arising from drawn amounts.
IRR Impact
When analyzing the return on capital for your portfolio, factor in undrawn fees payable on the associated debt facility to evaluate the impact on IRR.
How to Lower the Cost of Undrawn Fees?
Being charged unused fees is a part of every large facility. At least some amount of unused fees is generally non negotiable by the lenders. Because lenders are keeping capital aside that could be otherwise deployed, a large unused pool of capital brings down their effective yield.
To lower the cost of unused fees, startups have a couple of options:
Comparison Benchmarking
Compare undrawn fee quotes from different lenders to find the best deal. Seek quotes from non-bank lenders also in addition to banks.
Negotiate Discount
Explore negotiating a discount or waiver on the undrawn fee, either for an initial period or in return for keeping substantial balances undrawn.
Lower the Facility Size
Sometimes, it’s best to start with a smaller facility size to reduce the ongoing costs of unused fees. If you meet projections and your portfolio grows, lenders are generally willing to increase the facility size at the same or better terms.
Proper planning and benchmarking can help minimize financing costs arising from undrawn fees. The flexibility and backup funding offered by the facility also needs to be weighed against the fee costs.
Key Takeaways and Conclusion
In summary, key points to note around unused and undrawn fees:
- Charged by lenders on undrawn limits of credit facilities to compensate for reserving capital
- Typically 0.15% to 0.75% per annum depending on client risk profile
- Sizeable global market estimated at $55 billion currently, forecast to steadily rise
- Must be evaluated by borrowers as part of IRR impact and coverage ratio stress testing
Evaluating options to negotiate lower non-utilization fees where possible or minimize undrawn balances, while weighing flexibility benefits can help optimize costs for borrowers.
For lenders, this income helps buffer pressures from low base lending rates but may attract greater regulatory scrutiny of balance sheet usage going forward around facilities commanding only undrawn fee yields.