The Art of Pricing Loans (Last of a Series)

Last week we noted the coincidence between “Pi Day” and the birth date of Albert Einstein, but pondered any π connection with that other March 14 celebrity, Billy Crystal. One astute TLL reader (and keen observer of the pop scene) solved that riddle for us: Https:// Well done.

In closing out our series on loan pricing, we also promised our readers a brief primer on key ingredients of pricing itself. Let’s start with the most obvious: Libor spread.

Term loans are priced with a set spread over Libor, say 400 bps. But which Libor? The borrower typically can choose among several options as detailed in each credit agreement, ranging from 30 to 180 days. Revolving credits carry both a Libor spread (on the drawn amount) and a commitment fee (on the undrawn amount) of 50 bps for leveraged borrowers.

A related mechanism is the Libor floor. Born of the credit crisis, floors were introduced by arrangers as a subsidy to lenders when Libor plummeted from 4% to near zero. Floors were set initially around 2-3% so that when combined with actual Libor, the overall yield stayed relatively steady. As markets loosened and underwriting became more competitive, floors tightened. Despite fears they would disappear altogether, with the exception of some bank-only facilities for less-leveraged companies, that hasn’t happened. Floors are around 1% today.

A third component of pricing is upfront fees. These are the share of the underwriting fee –