LLCR ¼ Xsþn
6.3 Fee Structure
range of activities to include advisory services than it is for an investment bank to increase its lending potential.2
for arranging services. These fees are only paid to the advisor/arranger, who then transfers part of them to other banks participating in the pool based on their role.
So sponsors only have to make payments to two parties—the financial advisor and the MLA—unless of course both roles are covered by the same bank, in which case fees are paid to only one party. The lead arranger then pays other banks in the pool by returning part of the fees received to them. The terms governing this procedure are established by the lead arranger in a fee letter that, if accepted, is returned countersigned by each bank participating in the pool.
6.3.1 Fees for Advisory Services
The structure of fees payable by sponsors to the financial advisor (apart from sums reimbursed for expenses incurred) includes retainer fees and success fees.
. Retainer fee:This covers the advisory’s costs during the study and preparation phase of the deal. Justification for the advisor’s request for a retainer fee is based on the need to use analysts’ time to study the feasibility of the deal and maintain contacts with parties initially involved in planning it. In certain cases, however, preliminary studies can take a long time, and this leads to costs that will not be paid if the project cannot be funded. The retainer fee is intended to cover such costs partially; market standards for this fee call for a monthly payment by sponsors ranging from 15,000 to 25,000 euro, established on a lump-sum basis.
. Success fee:This fee is paid by sponsors once the study and planning mandate has led to a successful conclusion. As opposed to the retainer fee, the success fee is established on a percentage basis, to provide an incentive for the advisor not only to structure the deal but also to organize it based on the most favorable terms and conditions for sponsors. As for market standards, success fees range from 0.5% to 1% of the debt value—not the project value.
There are two possible explanations for this practice.
1. Intuitively, it wouldn’t make sense for sponsors to pay a fee on funds they contribute themselves, which would be the case if the percentage were calcu- lated on the total investment. It is much more logical to base the success fee on the loan value.
2. Linking the fee to the loan amount gives incentives to the advisor to plan deals with the highest possible debt-to-equity ratio, with obvious benefits on the rate of return for the SPV’s sponsors.
The percentage negotiated between the advisor and the sponsors will depend on various factors. The size of the project and the degree of innovativeness of the venture will be two determining factors. The level of the success fee will be inversely propor- tional to the size of the project; a smaller project will command a higher percentage.
The degree of innovation inherent to the project will, in contrast, affect the fee directly; an extremely innovative venture will require a greater effort by the advisor and therefore will justify the request for a more generous fee.
If advisory and arranging services are provided by the same intermediary, then there will be a single fee structure to remunerate both roles. Again in this case there will be reimbursement of expenses and a retainer fee for the study and preliminary 158 C H A P T E R u 6 Financing the Deal
planning phase. However, the success fee will be established as a single percentage.
Furthermore, it is normal practice for the arranger to discount part of the retainer fee (usually the equivalent of fees for two/three months) from the success fee agreed on with the sponsors of the venture.
6.3.2 Fees for Arranging Services
Sponsors pay a one-time arranging fee to the MLA as compensation for activities to finalize structuring of the financing. In certain cases a retainer fee is paid too, although this doesn’t happen very often. Again, in this case the arranging fee is established as a percentage of the debt (for the same reasons discussed with reference to advisory fees). Market standards range from 0.7% to 1% of the syndicated debt.
The arranging fee can in turn concern the following.
. A pure arranging fee:In this case the MLA operates on a best-effort basis. The arranger commits to sponsors that best efforts will be made to syndicate the loan but without guaranteeing a market response sufficient to cover fully the financing requirements for the project.
. A fee for underwriting and arranging services: In this case the mandated lead arranger operates on a committed basis. That is, as in the previous case, every effort will be made to syndicate a pool of lenders. However, in this case there is the guarantee that the necessary funds will be made available in the event it becomes impossible to find intermediaries interested in participating in the deal.
This guarantee is undoubtedly beneficial for the borrower but has a cost in the form of a higher arranging fee.
After the sponsors pay the arranging fee, the mandated lead arranger returns part of it to other banks participating in the pool. If the deal calls for other arrangers (coarrangers), then they are paid part of the arranging fee, usually proportional to the amount underwritten. The percentage, however, is usually lower than that earned by the lead arranger (on average between 0.5% and 0.8% of the part of the loan underwritten). In essence the lead arranger earns a percentage of the arranging fee, calculated on the amount it has underwritten, and the spread between the percentage paid by sponsors and that recognized for coarrangers, calculated on the part not underwritten by the lead arranger.
6.3.3 Fees to Participants and the Agent Bank
Participating banks (lead managers, managers, and comanagers) receive an up-front management fee ranging from 20 to 40 basis points on the amount each of them lends. The up-front management fee also comes out of the arranging fee paid by sponsors to the MLA.
Participants are also entitled to a commitment fee, calculated on the basis of time, with reference to the difference between the maximum amount made available to the SPV (committed amount) and the amount disbursed at the beginning of each reference period (for instance, a half-year). This means
CF¼(CLEt)cf t 360
Fee Structure 159
where CF is the commitment fee paid, CL is the maximum committed loan to the borrower, cf is the percentage of the annual commitment fee, Et is the amount disbursed at the beginning of periodt, andt is the number of days for calculating the reference period. In essence, the SPV pays lenders interest calculated at the agreed rate on that part of the loan effectively used, whereas it pays a commitment fee on the amount committed but not used. The reason for this payment is that while lender banks may not have materially disbursed certain funds, they are required to set aside part of their capital for committed loans based on equity coefficients established by each country’s banking supervisory authority (see Chapter 8). Given that the bank’s equity capital should be remunerated, the commitment fee should enable lenders to obtain compensation to cover part of this notional cost. The SPV pays the commit- ment fee periodically to the agent bank, which then returns it to banks participating in the pool based on funds each of them has committed. Lastly, the agent bank receives a fixed annual payment ranging from 40,000 to 100,000 euro. The amount of this agency fee will depend on the number of banks participating in the pool because this is the variable determining the intermediary’s administrative task.
6.3.4 Example of Fee Calculation
Table 6-3 shows salient information as regards the structuring and syndication of a project finance loan for an amount of 200 million euro. The deal has been organized by an advisor (Bank A) as a syndicate in which Banks B and C are respectively mandated lead arranger and coarranger on a committed basis (so the latter jointly underwrite the entire loan amount). Banks D, E, and F participate in the role of managers for an amount of 150 million euro. This means that after the selling process, the mandated arranger and coarranger will participate as lenders for the remaining 50 million euro (subdivided based on the underwriting agreement for an amount of 25 million each).
Amounts recognized for each participant are calculated as follows. The ad- visor receives a success fee of 75 basis points calculated on 200 million, therefore
TABLE 6-3 Participating Intermediaries and Structure of the Deal Syndicated amount 200,000,000.00 euro
Advisor success fee 0.75%
Arranging fee 1%
Coarranging fee 0.80%
Up-front management fee 0.20%
Members of the Syndicate Role Fee
Underwritten Amount (euro)
Financed Amount (euro)
Bank A Advisor Success fee n.a. n.a.
Bank B Lead arranger Arranging fee 100,000,000.00 25,000,000.00
Bank C Coarranger Arranging fee 100,000,000.00 25,000,000.00
Bank D Manager Up-front fee n.a. 40,000,000.00
Bank E Manager Up-front fee n.a. 50,000,000.00
Bank F Manager Up-front fee n.a. 60,000,000.00
160 C H A P T E R u 6 Financing the Deal
1.5 million euro. The mandated lead arranger receives a total of 2 million euro (1%
of 200 million) and then proceeds to return the fee to the other participants as indicated in Table 6-4.
In essence the arranger’s position is as outlined in Figure 6-4.
Clearly the percentage return on capital invested (calculated in Table 6-5) is certain for managers, whereas it depends on the amount of the loan financed by participants for the arranger and coarranger. This can be seen by comparing amounts in the last line of Table 6-4 with those shown in the column ‘‘Financed Amount’’ in Table 6-3.
It should also be noted that the mandated lead arranger’s strong negotiating position means it can return lower percentages for coarranging fees and up-front management fees, respectively, to coarrangers and managers. In the preceding example, the sum of coarranging fees and up-front management fees is exactly 1%.
TABLE 6-4 Return of the Arranging Fee (in euro)
Fee Bank B Bank C Bank D Bank E Bank F
Arranging fee 2,000,000.00
Coarranging fee 800,000.00 800,000.00 n.a. n.a. n.a.
Up-front management fee 350,000.00 50,000.00 80,000.00 100,000.00 120,000.00
Total fees 850,000.00 850,000.00 80,000.00 100,000.00 120,000.00
Arranging fee: 2 million/euro
Co-arranging fee: 0.8 million/euro Up-front management fees: 0.35 million/euro
Total received by mandated arranger:
0.85 million/euro
F I G U R E 6-4 Fees Gained by the MLA
TABLE 6-5 Percentage Return on Capital Invested for Members of the Pool
Bank B Bank C Bank D Bank E Bank F
3.40% 3.40% 0.20% 0.20% 0.20%
Fee Structure 161
And so the MLA’s return on the deal is exactly the same as that of the coarrangers if their bargaining power is so strong that they manage to wrest the entire 1% from the lead arranger. Using the same example, but in this case assuming that only 0.7% is returned to coarrangers as their fee and that the up-front management fee is 0.15%, the distribution of income and percentage returns would be as shown in Table 6-6.