Margin ratchet

A margin ratchet is the clause in a credit agreement that adjusts the interest margin according to a financial indicator of the borrower, such as the leverage ratio (net debt to EBITDA). On a floating rate loan, the margin is added to Euribor; the grid sets several leverage steps, each associated with a margin. The loan template of the Euro PP Charter of October 2019 provides for a margin adjustment clause, upwards, downwards or both, triggered automatically when defined ratios are crossed. The Charter leaves its drafting to each case, depending on the borrower, its business and the economics of the transaction. For the borrower, the grid reduces the margin without renegotiation as soon as leverage falls below a step. The test relies on the compliance certificate delivered with the accounts. Some grids provide for an initial period during which the margin stays fixed (ratchet holiday). In an amend and extend, private debt lenders ask to revise the grid steps and to restart this initial period. The negotiation covers the number of steps and the gap between them, the definition of EBITDA and net debt, the date of the first test and the margin applicable during an event of default.

A €100m unitranche pays Euribor plus 5.75% while leverage exceeds 4.5x, plus 5.50% between 4x and 4.5x and plus 5.25% below 4x. The company brings its leverage down from 4.8x to 3.9x in two years; its margin falls by 0.5 percentage point, or €500,000 less interest per year.

• The number of steps and the margin gap between two steps.
• The definition of the tested ratio: EBITDA used, net debt, cash deducted.
• The length of the initial period without adjustment.
• The margin level applicable during an event of default.