Syndicated Loan or Loan Syndication

Meaning of Syndicated Loan or Loan Syndication

A syndicated loan is a type of loan offered by a group of lenders (named a syndicate) who work jointly to provide funds for a single borrower.

The borrower could be in the form of a corporation, a large project, or sovereignty (such as a government).

The loan may involve fixed amounts, a credit line, or a combination of the two.

Interest rates can be fixed for the term of the loan or floating based on a benchmark rate such as the London Interbank Offered Rate (LIBOR).

Usually, there is a lead bank or underwriter of the loan known as the ‘arranger’, ‘agent’, or ‘lead lender’.

This lender may be putting up a proportionally bigger share of the loan or performing duties like dispersing cash flows amongst the other syndicate members and administrative tasks.

It is also known as a "syndicated bank facility."

Objectives/Reasons of Syndicated Loan Lending

The main goal of syndicated lending is to spread the risk of a borrower default across multiple lenders, such as banks or institutional investors like pension funds and hedge funds.

Because syndicated loans tend to be much larger than standard bank loans, the risk of even one borrower defaulting could cripple a single lender.

Syndicated loans are also used in the leveraged buyout community to fund large corporate takeovers with primarily debt funding.

Syndicated loans can be made on a "best efforts" basis, which means that if enough investors can't be found, the amount the borrower receives will be originally lower than anticipated.

These loans can also be split into dual trenches for banks (who fund standard revolvers or lines of credit) and institutional investors (who fund fixed-rate term loans).

It is the process of involving several different lenders in providing various portions of a loan.

Mainly used in extremely large loan situations, syndication allows any one lender to provide a large loan while maintaining a more prudent and manageable credit exposure because the lender isn't the only creditor.

Syndicated loans are large loans made by the joint agreement of two or more institutions (Dennis and Mullineaux, 2000).

The main reason behind the joint lending is the high risk of these credits due to the size of the loan and the regulator’s limitation on the maximum ratio of any single loan to the bank's equity capital.

Several other motivations are documented for joint lending.

Roles within the Syndication Process

1. ARRANGER/LEAD MANAGER:

This is the bank that has been awarded a mandate by the prospective borrower, and he is responsible for placing the syndicated loan with other banks.

Arranger has to ensure that issue is fully subscribed.

2. UNDERWRITING BANK:

The bank that commits to supply the funds to the borrower—if necessary, from its own resources or if the loan is not fully subscribed.

Underwriter may be the arranging bank or another bank.

It should be noted that not all syndicated loans are fully underwritten.

The risk is that the loan may not be fully subscribed, and the underwriter has to supply funds committed.

3. PARTICIPATING BANK:

The bank that participates in the syndication by lending a portion of the total amount required.

4. FACILITY MANAGER/AGENT:

This is the person that takes care of the administrative arrangements over the term of the loan (e.g., disbursements, repayments, compliance, etc.). He acts for the banks.

Benefits of Loan Syndication to the Borrowers

As stated earlier, a borrower in the case of a syndicated loan facility doesn't need to deal with each and every lender. 

Borrower has to deal with lead manager or a single bank only.

This saves time and administrative expense for the borrower because it is quicker and simpler than other ways of raising capital.

Borrowers can alternatively raise capital through other sources.

He can issue shares, debentures, etc. But this entire route involves substantial cost and time. Syndication is a better option in this regard.

Benefits of Loan Syndication to the Lead Banks

Good arrangements and other fees can be earned without committing capital.

Lead manager earns fees because of his services to the borrower.

This can be done without committing any capital.

Enhancement of bank's relationship with the client: Because lead banker deals with client, his relationship with client enhances, which can bring business for bank in the long term.

Benefits of Loan Syndication to the Participating Banks

They have access to lending opportunities with low marketing costs.

It gives opportunities to participate in future syndications; in case the borrower runs into difficulties, participating banks have equal treatment.

Stages Involved in Syndicated Loan Lending

1. PRE-MANDATE PHASE:

The prospective borrower may liaise with a single bank, or it may invite competitive bids from a number of banks.

The lead bank needs to identify the needs of the borrower and design an appropriate loan structure.

Then develop a persuasive credit proposal to obtain internal approval.

2. PLACING THE LOAN:

The lead bank can start to sell the loan in the marketplace.

He needs to prepare an information memorandum, a term sheet, and legal documentation, and then approach the selected banks and invite participations.

Lead manager needs to negotiate with borrowers at this stage to satisfy participants’ concerns, if any.

3. POST-CLOSURE PHASE:

The agent now handles the day-to-day running of the loan facility.

In addition, another benefit of loan syndications for borrowers is the provision of loans to the borrowers with a more complete menu of financing options.

In effect, the syndication market completes a continuum between traditional private bilateral bank loans and publicly traded bond markets.

This has resulted in a more competitive corporate finance market, which has permitted issuers to achieve more market-orientated and cost-effective financing.

Educationists’ Observations on Loan Syndication or Syndicated Loan

A syndicated facility is a lending facility defined by a single loan agreement in which several or many banks can participate.

A borrower wants to raise a relatively large amount of money quickly and conveniently.

The amount exceeds the exposure limits or appetite of any one lender.

The borrower does not want to deal with a large number of lenders.

So what should he do? Even the lender doesn't want to miss this opportunity.

They can simply use the loan syndication facility.

By this approach, the borrower gets the desired amount without dealing with multiple lenders, while lenders do not miss a profitable loan proposal due to the low exposure limit and minimise their risk.

The market for syndicated loans is huge.

These are the Educationists’ Observations on Loan Syndication or Syndicated Loan:

*Davis (1995) asserts that the development of the syndicated credit reduces the sunk cost that banks need to incur in order to enter the international markets, as a single deal could involve many banks with only one set of documentation and credit appraisal.

*Waheed and Mathur’s (1993) emphasize is on the diversification effect of international lending and say that it might provide risk reduction benefits for lender banks or institutions in addition to those that could be achieved from domestic loans alone.

*Armstrong (2003) points out the fees and commissions that the lead banks collect are beneficial to the lenders.

*At the borrower’s side, Kim (1993) claims that the syndication is a way to raise large amount of funds on competitive terms within a short period of time.

*Gasbarro, Le, Schwebach and Zumwalt (2004) assert that syndication may be a better alternative than a bond issue because if a repayment problem occurs, it is easier to renew it compared to a bond alternative.

*Karaoğlu (2005) defines the securitization as the process of transferring loans to third parties through the issuance of debt whose cash-flows are collateralized by the loan pool.

*Senior (2006) defines the same process as: securitization is a process that converts illiquid assets into the liquid assets and provides an attractive funding source, because its cost is lower compared to the alternative funding schemes.

Securitization is not only related to the assets in the balance sheet but also to future flow of the receivables (Kethar and Ratha, 2001) and may be used as a tool for risk management (Karaoğlu, 2005).

Syndicated loan announcements and their effect on the borrower firm’s share value has been the subject of many academicals studies.

*Fery, Gasbarro, Woodliff and Zumwalt (2003) analyse the effect of loan agreements for the Australian firms, listed on the Australian Stock Exchange market for the January 1983 to December 1999 period.

Their results indicate that all corporate loan announcements (196 cases) produce a positive and significant Cumulative Average Excess Return (CAER) at the 5% confidence level.

When they group the data as published and non-published, they find that CAER of the published loan announcements (45 cases) lead to a positive and significant return in the market while non-published announcements produced no statistically significant CAER.

They further investigate the effect of lender status and find that a single lender provides a positive CAER for published announcements.

Multiple lenders for published agreements and all other non-published announcements produce insignificant effects.

*Billett, Flannery, and Garfinkel (1995) primarily focus on the lender characteristics in order to determine the market effect.

Analysis shows that all loans produce a positive and significant return.

The sub-section of the sample indicates that bank loans have a positive effect and non-bank loans seem to be insignificant.

Banks rated AAA create a positive CAER, but banks rated BAA and lover produce insignificant returns.

*Aintablian and Roberts (2000) studied the effect of corporate loan announcements on the value of Canadian firms.

Their results indicate that bank loans produce a significant and positive AR, while private placements do not bring any significant AR.

They also analyse the new loans and find that new loans with the same bank produce the significant AR, but new loans with the new bank and unknown bank do not bring any significant AR.

One more finding of this study is that conditional renewals produce statistically insignificant negative AR, and favourable and mixed renewals produce a positive and significant AR.

Example of Loan Syndication or Syndicated Loan

For instance, suppose you need 1,000 crore rupees for an investment project.

You go to a bank; they tell you that they cannot finance more than 100 crore rupees, and so you move to a new lender.

Here again you find the same difficulty.

So now you have the option to take loans from multiple lenders.

In this case, you have to deal with multiple lenders for a single investment project.

Here, the borrower can use the loan syndication facility. He needs to appoint one arranger or lead manager.

This bank places the syndicated loan with other banks and makes sure that syndication is fully subscribed.

In 2003, banks extended close to USD 2 trillion in syndicated loans.

The standard theory for why banks join forces in a syndicate is risk diversification.

The banks in the syndicate share the risk of large, indivisible investment projects.

Syndicates may also arise because additional syndicate members provide informative opinions of investment projects or additional expertise after the funding has been extended.

Conclusion

Merely looking at the objectives and benefits of syndicated loans to the borrowers, lead banks, and participating banks, it is obvious that this is the most simple and easy to operate loan type or process than the normal bank loan so as to diversify the risks involved in a particular lending.

Also, the time involved and administrative expenses to be incurred by the intending borrower are safe and low compared to other means of raising funds in order to finance an identified business.

I hope you have learnt one or two things from this post.