Syndicated form of raising finance came into existence when the size of individual loans got bigger and banks thought fit to share the risks with other lenders. The concept of sole bankers was no longer feasible when a large amount of funding was involved. Moreover the syndicated mode of financing has two important features, namely, amount (risks) and administrative saving (documentation to be one principal lender). There will be one principal lender who will finance and the other participant lenders in the syndicate will share the risks in a predetermined share. Governments of countries as well as the corporate sector are tapped the syndicated loan route.
As the size of the individual loans increased, individual banks found it difficult to take the risk single handed-regulatory authorities in most countries limit the size of the individual exposures. Hence the practice of inviting other banks to participate in the loan, to form a syndicate, came into being; thus the term “Syndicated loans” A syndicate is a general term describing any group that is formed to conduct some type of business. For example, a syndicate may be formed by a group of investment bankers who underwrite and distribute new issues of securities or blocks of outstanding issues. Syndicates can be organized as corporations or partnerships. A syndicate only works together temporarily. They are commonly used for large loans or underwritings to reduce the risk that each individual firm must take on.
A loan syndicate refers to the negotiation where borrowers and lenders sit across the table to discuss about the terms and conditions of lending. At present large groups of banks are forming syndicates to arrange huge amount of loans for corporate borrowers. The need for syndication arises as the size of the loan is huge and a single bank cannot bear the whole risk of lending. Also the corporate going for the issue is not aware about the banks which are willing to lend. Hence syndication assumes significance. In the case of syndication the risk gets diversified.
A Syndicated loan or syndicated bank facility is a large loan in which a group of banks work together to provide funds for a borrower. There is usually one lead bank (the “Arranger” or “Agent”) that takes a percentage of the loan and syndicates the rest to other banks. The loan syndication work involves identification of sources where from funds would be arranged, approaching these sources with requisite application and supporting documents and complying with all the formalities involved in the sanction and disbursal of loan. A syndicated loan is the opposite of a bilateral loan, which only involves one borrower and one lender (often a bank or financial institution. Syndicated loans provide 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 market.
The process of syndication starts with an invitation for bids from the borrower. The borrower mentions the funds requirement, currency, tenor etc. the mandate is given to a particular bank or an institution that will take the responsibility of syndicating the loan by arranging for financing the banks. The syndication is available for both, fund-based facilities as well as non-fund based facilities like Letters of Credit and Documentary Credits. As the syndicated loans are arranged a little quickly, these are popular with corporate entities. The fees payable on syndicated loans consist of management fees payable by the borrower on signing the loan documents or on first draw down, commitment fees payable, underutilized portion of the loan during the period when the loan was available and fees payable to the principle bank who has arranged for syndication to cover all their administrative expenses.
Parties to a Syndicated Loan Agreement
- Lead Manager(s)/Arranger(s): Those who receive an authority from the borrower to form a syndicate for the required loan. Normally it is a bank which is mandated by the prospective borrower and 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.
- Underwriters: These banks including the lead bank will underwrite the total amount of the facility and will try to get banks to take up the entire share of loan including them but with no share or even major share. The arranger bank may underwrite to supply the entire unsubscribed portion of the desired loan and in such a case arranger 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-Manager: They have to participate but with a lesser share than that of leader. Co-managers takes care of the administrative arrangements over the term of the loan (e.g. Disbursements, repayments and compliance). It acts for and on behalf of the banks. In many cases the arranging/underwriting bank itself may undertake this role. In larger syndication’s co-arrangers may be used.
- Participants: All those banks/lenders who participate in the syndicated program, as well as the leader/underwriter would try to see that it is fully allocated. These banks charge participation fees. These banks carry mostly the normal credit risk i.e. risk of default by the borrower as 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.
Creator of Memorandum of Information: Lead Manager/Arranger who will undertake to formulate the memorandum based on the financial and other details of the borrower which function include agreeing to the memorandum, publishing and arranging and signing the same and the final documentation.
Principal Document Loan Agreement: It is the responsibility of the Lead Manager to get it drafted and get it approved from all participants and is signed by all the participating banks and the borrower. The agreement gives the details of loan or the facility, its nature, amount, purpose, maturity, amortization, draw-down arrangement, interest, all types of fees, warranties, undertakings, law and its justification, default rules, etc.
Stages of Loan Syndication
Broadly there are three stages in syndication, viz., Pre-mandate Stage, Placing the Loan and Disbursement and Post-closure Stage.
- Pre-mandate Stage: This is the initiated by the prospective borrower. It may liaise with a single bank or it may invite competitor’s bids from a number of banks. The borrower has to mandate the lead bank, and the underwriting bank, if desired. 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.
- Placing the Loan and Disbursement: At this stage, the lead bank can start to sell the loan in the marketplace i.e. to prospective participating banks. this means that the lead bank needs to prepare an information memorandum, prepare a term sheet, prepare legal documentation, approach selected banks and invite participation. A series of negotiations with the borrower are undertaken if prospective participants raise concerns. To conclude this stage the lead bank must achieve closing of the syndication, including signing. If need be, underwriting bank has to sign the balance portion of the loan. 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.
- Post-closure Stage: This is monitoring and follow-up phase. It has many times done through an escrow account. Escrow account is the account in which the borrower has to deposit it’s revenues and the agent ensures that the loan repayment is given due priority before payments to any other parties. Hence in this stage, the agent handles the day-to-day running of the loan facility.
Features of Syndicated Loan and its Composition
- The borrower finalizes the amount and the currency of the loan required and invites offers from the banks to arrange for finance.
- Banks who give their quotes for interest rates, fees, etc and undertakes the responsibility of arranging syndication is normally called the lead Bank/Manager/Arranger.
- Borrower will examine the offers of the various banks and will choose the best available offer, which is best suited to its needs. After deciding or selecting the bank, the borrower gives authority to that bank which acts as the leader to arrange the loan.
- Then the borrower and the arranger bank will formulate a memorandum of information, giving financial and other details of the co-lender. This is the important document on the basis of which the Arranger will seek participation of other interested banks/ lenders.
- While seeking/inviting banks to participate in the syndication, the Arranger will have to give details of sharing of fees, securities, etc. and it is expected to share in the proportion of the share to be picked by members in the consortium. In case of any shortfall in the participation of lenders, then the such portion of loan is expected to be taken up by the leader of the syndicate.
- Once the entire tie-up is done and finalized, the borrower and lender finalize the loan agreement and the borrower executes the same.