Pricing and Covenants
Spreads: In virtually all cases, loans are floating rate obligations that are priced at a spread over LIBOR (L+400 equates to 4.00% plus the applicable LIBOR rate). The applied LIBOR rate is reset at the issuer’s option in intervals of one-month to one-year (in most cases, rates are locked in for one to three-months).
Libor Floors: To counter-act the current zero rate environment, almost all new loans are issued with LIBOR floors. A LIBOR floor acts as the minimum rate that is applied to the loans spread to achieve the all-in-rate. For example, if a loan has a spread of L+400 and a 1.50% LIBOR floor and current LIBOR rates are around 0.50%, the all-in-rate on the loan will be 5.50% (4.00% + 1.50% = 5.50%) because the LIBOR floor (1.50%) is higher than the market LIBOR rate (0.50%).
Covenants: A covenant is a promise (included in the credit agreement or formal debt agreement) that the borrower will or will not carry out certain activities. Among other things, covenants can include: limits on total leverage ratio, minimum level of interest coverage ratio, restrictions on future capital market transactions, and mandatory pre-payments. The purpose of a covenant is to provide an additional layer of security for lenders.