Lesson 22 of 25 · 7 min
Why an uncommitted facility is the cheaper one
The discount is the price of an option the institution kept, quoted back to the borrower as a thinner spread.
It reads backwards at first. The facility with fewer protections costs less, and the one that obliges the lender to perform costs more. The arithmetic is straightforward once the exchange is named.
An uncommitted facility hands the institution two options: the option to decline a draw, and the option to demand repayment. Options have value to whoever holds them. The institution does not hold them for nothing — it competes for the business, and the way it passes back part of that value is a thinner spread and no commitment fee.
So the price gap is a measurement. On illustrative terms, a committed line at the index plus 285 basis points with a 25 basis point fee against an uncommitted line at the index plus 195 is a difference of 90 basis points on what is drawn plus the fee on what is not. That total is what the option is being sold for, expressed in the only units a rate sheet has.
Reading it this way resolves the apparent paradox. The cheaper facility is not the friendlier one and the more expensive one is not a penalty. Each price is the cost of a different bundle of obligations, and the difference between them is the market value of the lender's freedom to change its mind. It also connects to the previous lesson's arithmetic: the institution is not charging more for the committed line out of caution, it is recovering a carrying cost it genuinely incurs on money nobody has borrowed.
Key terms
- Optionality
- The right, without the obligation, to act. On an uncommitted facility the lender holds the rights to decline and to demand, and both have value.
- All-in cost
- Interest on the drawn balance plus any fee on the undrawn portion. The only basis on which two facility structures can be compared.
- Undrawn balance
- The limit less the amount borrowed. Free on an uncommitted line and charged for on a committed one.
Worked example
The same borrowing under two structures
A $2,600,000 limit with $1,460,000 drawn. Index 4.55 percent. Committed at 285 bp with a 25 bp fee; uncommitted at 195 bp with no fee. Illustrative.
- Committed interest, rate 7.40%
- $108,040
- Commitment fee on $1,140,000 undrawn
- $2,850
- Committed all-in cost
- $110,890
- Uncommitted interest, rate 6.50%
- $94,900
- Uncommitted all-in cost
- $94,900
- Annual difference
- $15,990
$1,460,000 × 0.0740.
$1,140,000 × 0.0025.
$1,460,000 × 0.0650.
No fee on the undrawn portion.
The $15,990 is not a premium for a better lender. It is the annual price of an obligation to advance and a date the facility cannot be demanded before.
Check yourself
A committed line is priced at the index plus 310 basis points with a 30 basis point commitment fee. An uncommitted line is priced at the index plus 205 with no fee. The limit is $4,200,000, the drawn balance is $2,750,000, and the index is 4.12 percent. Compare the annual cost.
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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.