Fronting fee: Overview, definition, and example
What is a fronting fee?
A fronting fee is a fee paid by one lender (typically the borrower or participant in a syndicated loan) to another lender—usually the issuing bank or fronting bank—that issues a letter of credit or similar credit support on behalf of the borrower. The fronting bank takes on the administrative and credit exposure risk of issuing the instrument, and the fronting fee compensates the bank for that service. It is typically charged as a percentage of the face amount of the letter of credit or guarantee.
Why is a fronting fee important?
A fronting fee is important because it compensates the bank that is on the front line of risk and execution. When a fronting bank issues a letter of credit or guarantee in a syndicated facility, it exposes itself to credit and operational risk—even though other lenders may ultimately share in the exposure. The fronting fee recognizes this additional responsibility and ensures that the fronting bank is incentivized to perform its role. It also helps clarify cost-sharing among all parties in the transaction.
Understanding a fronting fee through an example
In a syndicated credit facility, the borrower requests a $10 million letter of credit. Bank A acts as the fronting bank and issues the letter. Even though the credit exposure is ultimately shared among all participating lenders, Bank A is directly responsible for making payment if the letter is drawn. The borrower agrees to pay Bank A a fronting fee of 0.25% annually on the $10 million face amount—so $25,000 per year—as compensation for assuming this responsibility.
Example of how a fronting fee may be referenced in a credit agreement
Here’s how a fronting fee may appear in a loan or letter of credit agreement:
"The Borrower shall pay to the Fronting Bank a fronting fee equal to 0.25% per annum on the daily outstanding amount of each Letter of Credit, payable quarterly in arrears, for the period from and including the date of issuance to the date of expiration or termination."
Conclusion
A fronting fee is a standard charge in syndicated credit arrangements that involve letters of credit or similar instruments. It compensates the fronting bank for taking on direct exposure and administrative responsibilities. Borrowers should be aware of this cost when negotiating credit terms, and lenders should clearly outline how the fee is calculated and paid within the agreement.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.