Lecture 4 - Syndicated - Loans
Lecture 4 - Syndicated - Loans
Lecture 4 - Syndicated - Loans
• Syndicated loans are large sums of credits granted by a group of banks to a single
borrower.
• Syndicated loans are hybrid instruments combining features of relationship lending and
publicly traded debt.
• They allow the sharing of credit risk between various financial institutions without the
disclosure and marketing burden that bond issuers face.
Firstly, participant lenders rarely negotiate with the borrower, keeping an “arms length”
relationship with the borrower through the lead arranger. It is the responsibility of the
lead arranger to establish and maintain a relationship with the borrower and to
undertake the primary information collection and monitoring activities.
Secondly, the lead arranger typically holds a higher fraction of the loan than any of the
participant lenders.
✓ Led by several lenders acting as mandated arrangers, arrangers, lead managers &
agents.
✓ Appointed by the borrower to bring the syndicate together to lend according to the terms
specified by the loan.
✓ Formed around the arrangers who look for junior participants.
Senior banks may have several reasons for arranging a syndicate.
Junior banks
✓ Number of junior banks depends on size, complexity & pricing of the loan, &
willingness of borrower to increase the range of its banking relationships.
✓ Junior banks are motivated by lack of loan origination capabilities & they earn a margin
but no fees.
✓ They hope to be rewarded later by the borrower.
4.2 PURPOSE;
The purpose of the syndicated loan market is to provide medium-to-long-term finance on a
committed basis to cater for a range of needs such as:
• Project finance
• Bridging finance, pending clearance/re-arrangement for another source.
• Large capital expenditure transactions.
• High value acquisitions.
• High-value permanent medium-to-long-term committed working capital needs.
BORROWER
The syndication process is initiated by the borrower, who appoints a lender through the
grant of a mandate to act as the lead bank or Arranger (also often called a Mandated
Lead Arranger or lead manager) on the deal. There is often more than one Arranger on
any transaction but for the purposes of this lecture we will refer to this role in the
singular.
LEAD MANAGER
The lead arranger is responsible for advising the borrower as to the type of facilities it
requires and then negotiating the broad terms of those facilities.
By the very nature of this appointment, it is likely that the Arranger will be a lender
with which the borrower already has an established relationship, although it does not
have to be.
At the same time the Arranger is negotiating the terms of the proposed facility, one of
the Arrangers is appointed by the Borrower to act as Bookrunner also starts to put
together a syndicate of banks to provide that facility.
The lead manager is responsible for placing the syndicated loan with other banks and
ensuring that the syndication is fully subscribed. This bank charges arrangement fees
for undertaking the role of lead manager.
Its reputation matters in the success of syndication process as the participating banks
would agree or disagree based on the credibility and assessment expertise of this bank.
In other words, since the appraisal of the borrower and its proposed venture is primarily
carried out by this bank, onus of default is indirectly on this bank. Thus this bank carries
‘reputation risk’ in the syndication process.
UNDERWRITING BANK
Syndication is a process of arranging loans, success of which is not guaranteed. The lead
bank may underwrite to supply the entire remainder (unsubscribed) portion of the
desired loan and in such a case lead bank itself plays the role of “underwriting bank”.
Alternatively a different bank may underwrite (guarantee) the loan or portion
(percentage of the loan). This bank would be called the “underwriting bank”. It may be
noted that all the syndicated loans may not have this underwriting arrangement .Risk of
underwriting is obviously the “underwriting risk”. It means it will have to carry the
credit risk of the larger portion of the loan.
CO-ARRANGER
Syndication is often done in stages, with an initial group of lenders agreeing to provide
a share of the facility. This group of lenders is often referred to as Co-Arranger.
Although other titles may be used - however, we shall refer to this group of lenders as
Co-Arrangers for the purposes of this lecture.
The Co-Arrangers then find more lenders to participate in the facility, who agree to
take a share of the Co-Arrangers' commitment.
The participating banks will lend a portion of the total amount required. These banks
charge participation fees. These banks carry mostly the normal credit risk i.e. risk of
default by the borrower, like any normal loan.
These banks may also be led into passive approval and complacency risk. It means that
these banks may not carry rigorous appraisal of the borrower and has proposed project
as it is done by the lead manager and many other participating banks. It is this banker’s
trust that so many high profile banks cannot be wrong. This may be seen in the light of
reputation risk of the lead manager.
AGENT/FACILITY MANAGER;
The Agent bank takes care of the administrative arrangements over the term of the loan
(e.g. Disbursements, repayments and compliance). The agent facilitates the process of
administering the loan on a daily basis, thus one bank from the syndicate is appointed
as Agent.
It acts for and on behalf of the banks (lenders) not of the borrower. In many cases the
arranging (underwriting) bank itself may undertake this role. In larger syndications co-
arranger/co-manager may be used.
- Postman and Record-keeper: it is the agent to whom the borrower is usually required
to give notices.
- Paying Agent: the borrower makes all payments of interest and repayments of
principal and any other payments required under the Loan Agreement to the Agent. The
Agent passes these monies back to the banks to whom they are due. Similarly the banks
advance funds to the borrower through the Agent.
Note;
The terms of a syndicated loan agreement empower the Agent to undertake the roles
described above in return for a fee. Any decisions of a material nature (for example,
the granting of a waiver) must usually be taken by a majority, if not by the whole
syndicate.
Whilst the Agent carries the standard duties and responsibilities of any agent under
English Law, the facility agreement will contain a number of exculpatory provisions
(clauses) to limit the scope of the Agent's relationship with the syndicate lenders and
with the borrower.
This group usually consists of members of the syndicate at the relevant times that hold
a specified percentage of the total commitments under the facility.
By delegating some of the decision-making, the mechanics of the loan are able to work
more effectively than if each and every member of the syndicate had to be consulted
and subsequently reach unanimous agreement on every request from the borrower.
BENEFITS/ADVANTAGES OF SYNDICATED LOANS:
• Raising a loan which would exceed the capacity of a single bank thus provides
the borrower with access to large sum of money.
• Cutting down on management capacity since the borrower communicates only
with the arranger/agent. (Deals with a single bank)
• Broadening the financing base through the participation of other banks.
• Typically less costly than numerous lines of credit through multiple institutions.
• It helps to enhance broader financial relationships.
• Quicker and simpler than other ways of raising capital. E.g. Issue of equity or
bonds.
• Flexible in terms of maturity.
• Syndicated Loans can be provided in available currency (multi-currency
option).
Benefits to the lead banks
• Fund arrangement and other fees can be earned without committing capital.
STAGES IN SYNDICATION:
The manner in which syndicated loans are raised results in the unique overall structure
of syndicated loans. The loan syndication process involves three stages.
1) THE PRE-MANDATE PHASE-where the borrower solicits competitive offers
from banks to arrange and manage the syndication or it may liaise with a single
bank. From the bids the borrower chooses the lead arranger whom it mandates to
form the syndicate.. Once the lead bank is selected and mandated by the borrower,
the lead bank has to undertake the appraisal process. The lead banks needs to
identify the needs of the borrower, design an appropriate loan structure, and develop
a persuasive credit proposal. The lead bank then negotiates a preliminary loan
agreement.
2) THE POST-MANDATE PHASE, the lead bank begins the syndication process by
drafting the preliminary loan contract and preparing a documentation package for
the potential syndicate members.
The lead arranger also invites the potential participants to participate in the
syndicate. The borrower and the lead arranger jointly produce an information
memorandum for potential participants that contain information about the
borrower’s creditworthiness and loan terms. The potential participants are given the
opportunity to discuss the memorandum with the lead bank/arranger. A series of
negotiations with the borrower are undertaken if prospective participants
raise concerns.
After the marketing of the deal the lead bank/arranger then makes formal invitations
to potential participants with preference being given to the participants with the
largest appetite for the loan. The lead bank then determines loan allocations for each
participant.
In the event of an oversubscription the lead bank can scale down the allocations or
the borrower can take up a larger loan. In the event of an under subscription the lead
bank/arranger can take up the difference if they have a firm commitment contract
with the borrower or they can ask the borrower to change the terms and remarket
the deal.
3) THE ACTIVE PHASE. This is where the loan becomes operational and lenders
receive a closing fee to compensate them for credit approval. Loan is disbursed in
phases as agreed in the loan contract. Loan is disbursed in ‘no-lien’ account i.e. a
bank account created exclusively to disburse loan. This account and its withdrawals
are monitored by banks. This is to ensure that the loan is used only for the purpose
defined in the loan agreement and that the funds are not diverted to any other
purpose.
The lead bank/arranger earns the arrangement fee and participant lenders may
receive a participation fee for joining the syndicate.
Deals can take varying forms; however, the following is an outline of a typical sequence
of events leading to ‘drawdown’:
i. The borrower identifies its needs and advises its relationship banks, and possibly
others, with a view to them bidding for lead manager status;
ii. Offers are submitted to the borrower, who then selects lead and co-managers;
iii. The information memorandum is prepared and circulated to nominated prospective
syndicated members, with a view to their taking a slice of the finance required;
iv. Legal advisers are involved in drawing up the loan agreement;
v. Offers are received from invited syndicate members, and the lead manager conducts
a selections process. The entire syndicate is formed;
vi. The formalities are completed and there is execution of the loan agreement at the
signing ceremony;
vii. Publicity and publication of the ‘tombstone’ announcement;
viii. Drawdown, in accordance with the terms stated in the loan agreement.
The borrower appoints the lead arranger via a mandate letter (sometimes also called a
Commitment Letter). The content of the Mandate Letter varies according to whether
the Arranger is mandated to use its "best efforts" to arrange the required facility or if
the Arranger is agreeing to "underwrite" the required facility.
B) Term Sheet:
The mandate letter will usually be signed with a Term Sheet attached to it. The term
sheet is used to set out the terms of the proposed financing prior to full documentation.
It sets out the parties involved, their expected roles and many key commercial terms
(for example, the type of facilities, the facility amounts, the pricing, the term of the loan
and the covenant package that will be put in place).
All in all, the term sheet restates the loan conditions.
C) Information Memorandum:
Typically prepared by both the lead arranger and the borrower and sent out by the lead
arranger to potential syndicate members.
The lead arranger assists the borrower in writing the information memorandum on the
basis of financial and economic information provided by the borrower during the due
diligence process.
It is not a public document and all potential lenders that wish to see it usually sign
confidentiality undertaking.
The loan agreement sets out the detailed terms and conditions on which the facility is
made available to the borrower. The loan agreement also establishes the rights &
obligations of all parties involved.
E) Fee Letters:
In addition to paying interest on the loan and any related bank expenses, the borrower
must pay fees to those banks in the syndicate who have performed additional work or
taken on greater responsibility in the loan process, primarily the Arranger, the Agent
and the Security Trustee. Details of these fees are usually put in separate side letters to
ensure confidentiality.
The Loan Agreement should refer to the Fee Letters and when such fees are payable to
ensure that any non-payment by the borrower carries the remedies of default set out in
the Loan Agreement.
F) Fee structure;
The cost of a syndicated loan also known as fee structure consists of interest and a
number of fees-management fees, participation fees, agency fees and underwriting fees
when the loan is underwritten by a bank or a group of banks. Spreads over LIBOR
depend upon borrower's credit worthiness, size and term of the loan, state of the market
(e.g. the level of LIBOR, supply of non-bank deposits to the EURO banks,) and the
degree of competition for the loan.
• The price charged on loan facility should reflect the perceived market receptivity &
risk-return trade off.
• The price set should be relative to other loans in the market & those forthcoming.
The development of the market for syndicated loans, and has shown how this type of
lending, which started essentially as a sovereign business in the 1970s, evolved over the
1990s to become one of the main sources of funding for corporate borrowers.
The syndicated loan market has advantages for junior and senior lenders. It provides an
opportunity to senior banks to earn fees from their expertise in risk origination and manage
their balance sheet exposures
Primary Markets;
Dominated by commercial banks at senior & junior levels although investments
banks and multilateral agencies also participate.
Loan origination of the facility happens in the primary market.
Secondary Markets;
The secondary market is characterized by standardized loan documentation, and
high liquidity.
Loans can be transferred.
In secondary market prices adjust to reflect credit quality and market conditions
Players & their strategies;
Active traders- commercial investment banks, specialist debt traders & vulture
funds.
• The loan agreement clearly specifies the remedies in case of default. Default arises from
non-payment of the loan, downslide in financial ratios, bankruptcy or Insolvency,
noncompliance with covenants, warranties and non-payment by the borrower (sponsor)
of any other loan when due.
• However, all events of default must pass the materiality test in order to be considered
as event of default. The remedies include loan cancellation, right to accelerate the loan
limitation of distributions to borrower sponsors and step-in-rights.
• All participating banks have the same rights to enforce these provisions, however some
loan agreements provide right of enforcement to some banks.
The Sharing Clause;-
• The clause is aimed at protecting the minority banks from the majority participating
ones. This ensures fair distribution of benefits to all participating banks and leads to
successful syndication.
• The loan agreement contains provisions for decision making by the participating banks.
In this regard, the voting clauses are included to ensure that the syndicate obtains
majority consensus before making a decision.
• Voting is according to bank participation and a majority vote would usually be obtained
through a 50% simple majority or a 66% absolute majority rule, and whichever the case,
this must be expressly provided in the syndication agreement.
• This power to exercise the syndicate voting rights must be exercised in the interest of
the syndicate, but not to the detriment of the voter. If adequately addressed in the credit
decision making interests of the parties to the credit agreement. In case of major
decision. Like calling up a loan, step-in-right enforcement; syndicate democracy
prevails if the events of default pass the materiality test.
Negotiation;-