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Base rate benchmarks: bank rate and SONIA
Variable-rate commercial loans are priced as a margin over a reference rate. Since the discontinuation of LIBOR, the predominant benchmark for sterling-denominated facilities is SONIA — the Sterling Overnight Index Average — published daily by the Bank of England. Some lenders still reference the Bank of England base rate directly rather than SONIA, though the two track closely. Fixed-rate facilities lock the total rate for the term, eliminating interest rate risk for the borrower at the cost of typically paying a premium above the current variable rate.
Directors should confirm which benchmark applies to any variable facility and understand how quickly the payable rate adjusts when the benchmark moves. Some facilities use a daily compounded SONIA calculation; others use a term SONIA rate fixed at the start of each interest period.
Credit margin and risk-based pricing
The credit margin is the lender's risk premium, added to the benchmark rate. It reflects the lender's assessment of the borrower's creditworthiness, the strength of security, the facility term, and the sector risk profile. Lower-risk borrowers with strong security, long trading history, and solid DSCR headroom attract tighter margins; higher-risk or early-stage businesses pay wider margins to compensate the lender for the additional risk of loss.
Margins on secured SME term lending in the UK mid-market have historically ranged from 2% to 7% over the reference rate, but this varies significantly with credit quality, security, and market conditions. Any specific figure in a term sheet is indicative and reflects that specific lender's assessment of that specific borrower; it is not a market offer or guarantee of terms.
Fees: arrangement, monitoring, exit, and commitment
Arrangement fees — typically expressed as a percentage of the facility amount — are charged at drawdown and represent an upfront cost that must be amortised across the facility term when calculating effective annual cost. A 2% arrangement fee on a £500,000 two-year facility adds approximately 1% per annum to the effective cost of borrowing, all else equal (illustrative, not a quote).
Other fees to examine include: commitment fees on undrawn revolving credit (typically 0.5–1% per annum of the undrawn balance); annual monitoring or management fees; exit fees payable on final repayment; and prepayment or early repayment charges. The facility agreement will specify each fee and the conditions that trigger it; directors should model the total cash cost of fees over the expected holding period before accepting terms.
Comparing the true cost across facilities
When comparing competing facility offers, directors should calculate a total cost of capital figure for each option: sum all interest charges (modelled over the expected term at the all-in rate), all fees, and any expected exit costs, then express the total as a percentage of the principal borrowed. This removes the distortion of flat versus reducing-balance rate quotations and enables a genuine like-for-like comparison. A facility with a lower stated interest rate but a higher arrangement fee may be more expensive in total than a higher-rate facility with no upfront fee, particularly if the facility is repaid early.
Frequently asked questions
What is a margin ratchet?
A margin ratchet is a mechanism in the facility agreement that adjusts the credit margin up or down based on a financial metric — typically the leverage ratio — tested at each covenant date. As the company reduces its leverage, the margin falls; if leverage rises, the margin increases. Ratchets are most common in leveraged and mid-market facilities.
Are commercial loan fees tax-deductible for the borrowing company?
The tax treatment of loan arrangement fees and interest depends on the structure of the facility and the company's circumstances. As a general principle, interest and certain financing costs are deductible against trading profits, but confirm the position with your tax adviser, particularly where the facility involves connected parties or the company is subject to the corporate interest restriction rules.
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