How Capital Is Priced: Inside a Credit Decision

Sponsors tend to treat pricing as the beginning of a negotiation. From this side of the table it is the end of an analysis.

What the number is made of

A margin is an assembly. It contains the cost of the funds being deployed, an allowance for expected loss over the life of the facility, a charge for the capital that has to be held against the exposure, an allocation of the cost of originating and monitoring it, and a return. Only the last of those is a matter of appetite. The rest are arithmetic, and they are largely determined before anyone reaches the point of quoting.

This is why haggling over the margin is generally unproductive, and why changing the structure is generally productive. A sponsor who reduces the expected-loss component — by improving security, shortening the exposure, or transferring the volatility that drives it — has altered the arithmetic. A sponsor who argues for a better rate has not.

The two questions behind every credit paper

Strip away the format, and a credit committee is answering two questions. Will the cash be there when the obligations fall due, under conditions materially worse than the base case? And if it is not, what is the path to recovery, how long does it take, and what does it yield?

Everything in the file exists to answer one of those questions. Sensitivities, offtake contracts, hedging arrangements and reserve accounts speak to the first. Security, jurisdiction, enforceability, asset liquidity and the identity of the parties speak to the second. Material that speaks to neither — market growth narratives, comparable transactions, the sponsor's enthusiasm — occupies space without moving the decision.

Where sponsors lose the argument

• A base case with no honest downside. A model that never breaks tells the reader that the downside has not been examined, which invites the reader to construct one unaided.
• Unreconciled numbers. Where the model, the information memorandum and the accounts disagree, the lowest figure is assumed and the file loses credibility on every other point.
• Risks presented as resolved without evidence. "Planning is not an issue" is a claim; a decision notice is evidence. The gap between the two is priced.
• Late disclosure. A material fact surfacing after the credit paper is drafted costs more than the same fact disclosed at the outset, because it forces a reassessment of everything already accepted.

What actually moves pricing

Three things reliably improve terms, and they are all structural. Reducing the period over which the lender is exposed to uncertainty — through phasing, staged drawdown, or a shorter tenor with a defined refinancing route. Improving the position on default — through cleaner security, better jurisdiction, or a guarantee from a stronger credit. And removing volatility from the cash flow through contract or hedge, so that the downside case the committee is required to run is less severe.

Each of these is available to the sponsor before terms are sought and largely unavailable afterwards, which is the practical argument for structuring early rather than negotiating late.

The provider's constraint

It is worth saying plainly that capital providers are themselves constrained. Mandates specify sectors, jurisdictions, ticket sizes and risk grades. A transaction outside the mandate is not declined on merit; it is declined because it cannot be held. Sponsors frequently interpret such a decline as a judgement on the project, and adjust the project in response. The better response is to find the provider whose mandate the transaction fits, which is a matter of targeting rather than redesign.

Price is not a negotiation about money. It is a conclusion about risk.