A five-step leverage grid run quarter by quarter, with the opening margin, the 45-day certificate lag and the boundary that decides a full step.
A margin ratchet reprices a leveraged loan from a grid: each quarter's compliance certificate reports net leverage, and the margin for the following period is read off the grid from the date the certificate is delivered. On an illustrative €300 million term loan stepping from E + 475 to E + 375 as leverage falls from 5.20x to 3.40x, the borrower pays €26,531,250 of margin over two years against €28,500,000 at a flat opening margin, a saving of €1,968,750. The 45-day certificate lag alone keeps €281,250 of that with the lenders.
Worked in full in How to Read a Credit Agreement by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The pricing section of a credit agreement usually sets an opening margin that holds until the first compliance certificate is delivered, then a table of leverage bands, each with its own margin. Three drafting points decide the arithmetic, and all three are in the definition of Applicable Margin rather than in the term sheet:
Most grids add two lender protections: the margin reverts to the top of the grid while an event of default is continuing or a certificate is late, and an overpayment clawback applies if a certificate is later found to be wrong.
| Net leverage | Margin (bp) |
|---|---|
| Above 5.00x (and opening margin) | 475 |
| Above 4.50x, up to 5.00x | 450 |
| Above 4.00x, up to 4.50x | 425 |
| Above 3.50x, up to 4.00x | 400 |
| 3.50x or below | 375 |
The loan is €300 million, held flat for simplicity, with interest paid quarterly. Leverage falls every quarter for two years, from 5.20x to 3.40x. Each certificate is delivered 45 days after its quarter end, so each quarter is priced half on the older certificate and half on the newer one. One 25 basis point step on €300 million is worth €750,000 a year, €187,500 a quarter.
Margin paid in quarter q = (45 / 90) × grid(leverage at q − 2) + (45 / 90) × grid(leverage at q − 1)
Margin interest = loan × margin × 0.25
Excel, with the band floors 0, 3.5, 4.0, 4.5 and 5.0 in a range named Floors and the margins beside them in Margins: =INDEX(Margins,MATCH(D4-1E-9,Floors,1)) returns the grid margin for "above" bands, and the paid margin is =0.5*C6+0.5*D6 on the two certificates in force.
| Quarter | Net leverage at quarter end | Grid margin it earns (bp) | Margin paid in the quarter (bp) | Margin interest (€) |
|---|---|---|---|---|
| Q1 | 5.20x | 475 | 475.0 | 3,562,500 |
| Q2 | 4.90x | 450 | 475.0 | 3,562,500 |
| Q3 | 4.70x | 450 | 462.5 | 3,468,750 |
| Q4 | 4.40x | 425 | 450.0 | 3,375,000 |
| Q5 | 4.10x | 425 | 437.5 | 3,281,250 |
| Q6 | 3.90x | 400 | 425.0 | 3,187,500 |
| Q7 | 3.80x | 400 | 412.5 | 3,093,750 |
| Q8 | 3.40x | 375 | 400.0 | 3,000,000 |
| Total | 442.2 average | 26,531,250 |
Read the columns against each other. In Q2 leverage has already fallen to 4.90x, yet the borrower pays 475 for the whole quarter: the opening margin holds until the Q1 certificate arrives halfway through Q2, and the Q1 certificate itself reports 5.20x. In Q8 leverage is 3.40x and the grid says 375, but the borrower pays 400, because that quarter is priced on the Q6 and Q7 certificates. The 375 is first paid from the middle of Q9. The ratchet always runs one to two quarters behind the business.
Over two years the borrower pays €26,531,250 of margin, an average of 442.2 basis points, against €28,500,000 if the margin had stayed at 475. The saving of €1,968,750 is the value of the ratchet to the borrower in this period. From Q9 the loan runs at E + 375, €3,000,000 a year less than the opening margin, for as long as leverage stays at or below 3.50x.
| Margin changes | Margin interest, two years (€) | Saving vs flat 475 (€) | Average margin (bp) |
|---|---|---|---|
| At the quarter end (no lag) | 26,250,000 | 2,250,000 | 437.5 |
| 45 days after the quarter end | 26,531,250 | 1,968,750 | 442.2 |
| A full quarter later | 26,812,500 | 1,687,500 | 446.9 |
On a falling leverage path every day of lag is paid by the borrower: €281,250 over two years for a 45-day lag, €562,500 for a full quarter. On a rising path the same lag works the other way and protects the borrower, which is why borrowers sometimes ask for downward steps to apply from the quarter end and upward steps only from delivery. A lender who agrees to that asymmetry is giving away exactly the figures in this table.
The usual modelling error is to price each quarter off its own leverage: Q8 at 375 because Q8 leverage is 3.40x. That is not what any agreement says: a quarter's leverage can only set the price once the quarter has been measured and certified. Priced that way, the two years cost €25,500,000, which understates the borrower's margin by €1,031,250, more than half the true value of the ratchet. The second error is at the boundaries. A borrower whose net debt of €300 million sits against EBITDA of €75.0 million is at exactly 4.00x, and on this grid pays 400, not 425. One rounding convention in the certificate, two decimals or three, can move a quarter's margin by a full step. A borrower at 4.10x needs 2.50 per cent more EBITDA, or the equivalent debt reduction, to reach that line, which is the kind of target a sponsor will manage towards.
A ratchet is a forecast of the credit written into the price. The lender gives back margin as leverage falls on the assumption that the falling leverage is real. If the leverage in the certificate is flattered by add-backs, the ratchet pays the borrower for a deleveraging that has not happened.
The margin grid of the facility in the free workbook for this case moves with each quarter's certificate, with the lag on the downward steps as an input. The add-back question behind the leverage figure is worked in how to calculate covenant headroom.
Usually from the date the compliance certificate is delivered, which can be 45 days or more after the quarter end, and in some agreements only from the next interest payment date. On a €300 million loan with leverage falling every quarter, a 45-day lag costs the borrower €281,250 over two years against pricing from the quarter end, and a full quarter's lag €562,500.
Multiply the step by the loan. A 25 basis point step on €300 million is €750,000 a year, or €187,500 a quarter. Moving from the top of a 475 to 375 grid to the bottom is 100 basis points, worth €3,000,000 a year for as long as leverage stays in the lowest band.
Most grids revert to the highest margin, here E + 475, while an event of default is continuing or a certificate is overdue, and include a clawback if a certificate later proves wrong. That protects the lender against a borrower who would otherwise keep paying the low margin earned by a leverage figure it can no longer certify.
This article is one calculation from How to Read a Credit Agreement. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: credit, private credit and distressed debt → · All 681 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.