WHAT IS THE ROLE OF LOAN

SYNDICATION IN PROJECT FINANCING?

FRANCIS N. TWINAMATSIKO*

ABSTRACT: Loan syndication as a project financing mechanism has increased over the last decade
despite the diverging needs of the lenders. The incentive for lenders to join the syndicate is obscured, though
many international project deals are financed through loan syndication. The objective of the paper is to
investigate the role of loan syndication in project financing. The motivation for this research paper stems from
the importance of credit in the project financing structure and the growing importance of syndicated loans in
project financing. The paper critically analysed the literature on the subject to derive the conclusions. The
findings indicate that the role of syndication is diverse however, mobilisation of funds and risk diversification
prevail over others.

_________________________
* The author completed an MSC in Energy Studies, with a Specialising in Energy Finance, at the Centre for
Energy, Petroleum and Mineral Law and Policy (CEMPLP) at the University of Dundee. He holds an MA in
Economic Policy and Planning and a BSC (Economics) from Makerere University, Kampala-Uganda, and a
Diploma in Petroleum Policy and Resource Management from PETRAD, Norway. He has also attended various
short courses in Taxation from different countries. He is Head of Research and Statistics Division, Tax Policy
Department, Ministry of Finance, Planning and Economic Development, Kampala-Uganda. Email:
fntwine@yahoo.com.

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.........................................................................................2 Financing Structures Selected Projects.......................2 2........9 5.............................................................................0 THE OBLIGATIONS OF PARTIES TO THE SYNDICATE..............................................................4 Information Sharing...............................................................................................1 Overview of Loan Syndication ......................................... iii List of Tables..............1 2.TABLE OF CONTENTS Page List of Figures……………………….......................................1 The Pre.....................3 Risk Exposure ..............................................................................2 Obligations of the Borrower (SPV) ...................................................................... .......................................Mandate Phase ....................................................... iii ABBREVIATIONS ........................................3 Administration of the loan ................................................0 MEASURES TO ENSURE SUCCESSFUL LOAN SYNDICATION...........10 6.... ...............................................................................4 3............................................................5 4...... ........6 Reduction in Marketing Costs.............................2 The Sharing Clause ....................................................................6 4............3 3............7 5........................... iv 1...0 INTRODUCTION ..........0 THE ROLE FOR LOAN SYNDICATION............................................................................................................................................1 Default and Remedy Clause ........4 3.................................................2 2.......2 Mobilisation of Funds .......................... ......................................11 ii ................................................4 3........................................................................ 5 4.........................................................0 THE PROCESS OF LOAN SYNDICATION .......................................................................................................10 6.........................................................................0 BACKGROUND ......................................................1 Obligations of Lenders ................................................................................................................................8 5..................1 Risk Diversification ...........................................................................2 Marketing of the Loan ...............................5 4..........................................................................................3 Obligations of the Agent ...................................................................6 5.......................................9 5.........................................8 5..................................................................................................................... ..................7 5.10 6..........................................5 Competitive Pricing..................................................

.....................................................................................11 6.............2 List of Tables Table 1: Financing Structures of Selected Projects.................................................3 iii .....................................................................................................................................3 Loan Syndication Democracy....0 CONCLUSION ...............................6........... ....................................................11 BIBLIOGRAPHY List of Figures Figure 1: Syndicated Loans Facilities 1992-2008 ..........................11 7........................................................................................4 Negotiation ......

ABBREVIATIONS ADB - Asian Development Bank BIS – Bank for International Settlement CA - Credit Agreement CB - Catalyst Bank COD - Commercial Completion Date CRB Credit Reference Bureau - EBRD - European Bank for Reconstruction and Development EoD - Event of Default FAC - Final Acceptance Certificate IFC - International Finance Cooperation MPS - Minimum Performance Standards PAC - Provisional Acceptance Certificate PB - Participating Bank PC - Project Completion SPV - Special Purpose Vehicle WB - World Bank iv .

The main objective of this paper is to examine the role of loan syndication in project financing. This is especially true for energy and infrastructure projects. The implementation of the planned project depends on the availability of funds to finance it from start to completion. 5 Power purchase or gas sales agreement. 2 Equity ranges from 20% to 40% and debt makes 60% to 80% in most projects (Sein. commitment by sponsors through various covenants and representations. therefore repayment of the loan is based on the isolated and assignable cash flow from the project4. et al (2006) show that banks extended syndicated loans equivalent to US $2 trillion in 2003. Loan syndication as a project financing mechanism has been increasing over the last decade (see graph 1). 1996). Therefore banks need assurance to the effect that the project will be able to generate revenue after its completion phase before committing funds to the project. Project Sponsors commit to providing contingent financial support above the upfront equity to give lenders extra comfort (Sein. the paper analysed the literature on the role of loan syndication to derive the conclusions. sponsors therefore must ensure that funds are available before the project starts. despite the transactions costs involved in securing the loan agreement of all the participating parties in the syndicate. The motivation for this research paper stems from the importance of credit in the project finance structure and the growing importance of syndicated loan structures in project financing. To achieve the objective. 4 Project financing is based on limited or non-recourse. 3 In practice.1. procurement and construction contract and government support undertakings. most projects are financed based on limited recourse. Loan syndication1 is the most common form used for funding project finance deals. especially when it involves large sums. 1996). 1 . The paper has investigated the benefits syndicated loans offer to both lenders and borrowers in order to maximise the returns on debt and equity respectively. This is done by ensuring that the project has an off-taker5.0 INTRODUCTION Loan syndication is a funding mechanism where two or more banks come together contribute a portion of the loan to finance the project. engineering. input supply contract (fuel or gas in case of power projects). The question is whether syndicated loan have benefited all the counterparties. Equity2 contribution is usually limited and the project is usually financed by debt for a large proportion of its finance structure. The project finance is based on limited or non-recourse3 to sponsors. Schure. 1 Loan syndication is one way of financing the project – where many banks come together and contribute portion of the loan requested by the borrower.

Figure 1: Syndicated Loans Facilities 1992-2008 Source: Bank for International Settlements (BIS). a total of US $194. syndicated loan facilities reduced by 37% in 2008 due to the financial crisis which especially affected credit facilities in the last quarter of 2008. 2009. it picked in 2004 with a growth rate of 38% (see appendix one).2. a large proportion of syndicated loan finance projects are in developed countries (on average 87%). which have since increased to $2. In 2008. In 2001 to 2003.0 BACKGROUND 2.666. 7% and 10% due to the September 11.1 billion were signed as loan syndicate credit facilities.1 Overview of Loan Syndication Loan syndicated facilities for project financing has been increasing since 1992. Quarterly Review March. Only 13% average (1992-2008) finance projects in developing 2 . From Figure 1. It is evident from the syndicated loan data that international developments affect credit facilities as they increase the risk of lending and reduce international financial flows. However. syndicated loans reduced by 9%. 2001 attack on the USA.62 billion in 2007 (see Graph 1). In 1992.

most project finance loans were huge and one bank could not manage financing the project without affecting other portfolios. banks started syndicating loans to share risks. Table 1: Project Name Financing Structures of Selected Projects. 3 . The data indicates the increasing importance of loan syndication in project financing.800 21% Project in Thailand (1992) Bridas Investments 141 60 40 201 67% in Argentina Algeria-Spain 146 829 222 975 27% Pipeline Project (Morocco section) Nigeria LNG Project 3. This paper explains why banks are interested in loan syndication by highlighting the benefits available to both parties and the mitigation measures in case of default. Government contribution. 2.295 275 1. In addition. Equity6 ($ Million) Total Debt ($ Million) 1.460 Syndicated Total Loan ($M) Financing ($M) Percent of Syndicate amount over Total Debt. pp 181-207. (1996) Financing Energy Projects in Emerging Economies. 48% The Hub Power 372 695 1. The issue that arises is that do banks arrange a syndicate? What is the role of each party to the syndicate? How is the credit risk shared? What is the process of involving all the participating banks? Who makes the decisions? What remedies are available in case of 6 Includes Equity.2 Financing Structures Selected Projects.240 360 260 3.countries.832 Project of Pakistan (1986) Power Transmission 112.5 262.600 72% 1995 Source: Sein R. In the 19th century.5 155 375 59% and distribution of Thailand The Shajao Power 56 484 131 540 27% Project in China (1984) Star Refinery 505 1. This may be due to the high risk and limited capacity to design international project finance deals. and support from Multilateral Agencies.

2002). the Project Company. The information memorandum includes an overview of the project. 4 . the banks appoint the lead manager. gathering and updating documentation) (Stefano. 2008).1 The Pre. It starts with a formal request by the prospective borrower (SPV8 ) to the bank9 to advise and manage the process. negotiating covenants and other pertinent issues related to the loan. that is the document with which the advisor contacts potential lenders and begins to negotiate the credit agreement and loan documentation with arrangers until the financial close is reached (Stefano. experience in handling 7 Ensure coherence. 11 Arranging means that sponsors are given an underwriting guarantee of the availability of funds. participatory. which identifies the interests of the SPV. However. efficient design of the loan facility and competitive negotiations of the term of the credit agreement 8 SPV and the borrower are used interchangeably. when the deal is sizeable and has an international scope it is more usual to create a team of arrangers.2 Marketing of the Loan To address the concerns of the prospective participating banks. 9 A bank that well knows the SPV and particularly has been dealing with the sponsors and by implication knows their credit rating. the lead bank. the common practice is to grant the mandate to a sole arranger. In order to grant an underwriting guarantee.Mandate Phase 7 To achieve the objectives . The SPV mandates the bank to be a lead manager. In this case. its general background. each of which has a specific role (contacts with lawyers. 13 The final information memorandum (FIM) used for syndication may be based on the preparatory information memorandum (PIM) originally prepared by the sponsors or their financial advisors to present the project to prospective lead managers (Yescombe. Alternatively the SPV can invite for competitive bidding10 where a number of banks with favourable terms of the loan are chosen to lead the syndicate and undertakes to underwrite11 the loan. prepares an information memorandum13. handling tax matters. its ownership. 3. term sheet. the loan syndication is designed to incorporate the concerns of all the counterparties to the loan. 3. effective monitoring. The PIM is the final outcome of the financial advisors’ work. 2008). develops a convincing credit proposal and obtains internal approval for marketing of the loan to prospective banks. organisation and management.0 THE PROCESS OF LOAN SYNDICATION 3. 12 When the deal is not very large. the arranger bank must have significant financial strengths. legal documentation and approaches selected banks to invite for participation. even if no lenders are interested in supporting the project are found. financial and other information on sponsors and other major parties.The lead manager is responsible for analysis of the credit quality.default? What is the process of a loan call-up? The paper would try to provide answers to these concerns. 10 In this case the underwriting banks select their lead manager.12 This results in the award of the mandate to the lead bank. designs an appropriate loan structure.

4. each participating bank (PB) agrees to contribute a proportion of the loan and signs the syndication agreement. 2002). At the request of the parties. project costs and financial plan. political. 5 . cash flow and the sensitivity analysis. Failure of one bank to fulfil its obligations to make advances to the SPV. the borrower is called on to participate in negotiations. the other banks are 14 Obligations relate to implementation and monitoring after a syndicate is formed. A full analysis of the project risks – completion risk. The agent receives drawdown from according to their quota for onward transmission to the borrower. In addition. the agent receives loan repayments from the SPV and remits them to the respective banks. ensure coordinated monitoring of the project performance. 3. After the construction phase. This confirms that funds would be available to the project based on the agreed financial plan. The agent acts as a conduit between the SPV and all the participating banks (Yescombe. 1998). loan drawdown and repayments are communicated through the agent to all counterparties. When agreement is reached. This is obligatory if the deal is to be syndicated. technology. market. and force majeure risks is done at this stage to ascertain whether the project is bankable. Lenders agree to make financial resources available up to a preset maximum amount and on request by the SPV. All issues that are related to project implementation. technical description of the construction and operation of the project are also availed. administration. The commitment of participating banks to a quota of the total amount of the loan precludes responsibility for the obligation to make payments for any other bank (Graham. banks select the agent to administer the loan. In case there are issues for clarification.1 Obligations of Lenders The provisions of the credit agreement detail and cover the obligations of both the SPV and the syndicate banks. All contracts pertaining to the sharing and allocation of the risk to parties competent to handle them are cross checked by prospective banks’ advisors to ensure the project meets financing criteria.3 Administration of the loan After signing the syndicate agreement.similar projects and their support for the current project.0 THE OBLIGATIONS14 OF PARTIES TO THE SYNDICATE. to ensure market risk is mitigated the commercial basis for the project (market situation) covering supply and demand particularly the off-taker of the output of the proposed project. 4.

Only the underwriting bank.3 Obligations of the Agent The loan is exclusively granted for a specific purpose specified in the credit agreement. They are also obligated to decide whether to continue lending during the subsistence in the event of a default15 (EoD). It is the responsibility of the agent to enforce this. The onus is on the SPV to resist any delaying tactics by the lead managers to avoid signing the loan agreement till the loan is syndicated to eliminate their underwriting risk (Yescombe. 4. representations and warranties. 1998) 6 . It receives draw downs from the agent as provided for in the credit agreement. The SPV does not take any direct risk as to whether the syndication is successful or not. It is the responsibility of the individual bank to ensure that their respective portion of the loan is paid according to the financial plan.2 Obligations of the Borrower (SPV) The SPV is responsible for all project activities starting from construction phase in liaison with the contractor and ensuring that the project is going on as planned. Banks have rights to get their portion of loan repayment in accordance with the provisions of the agreement. 4. the SPV makes payments to the agent as provided for under the repayment schedule. this should not amount to stifling the smooth implementation of the project. By the time a syndicate loan agreement is signed. In fact all the monies obtained from the borrower (SPV). In case the agent detects that the loan has 15 The event of default in a credit agreement includes non-payment. bankruptcy and insolvency. breach of representation. The SPV must ensure adherence to the cover ratios. the loan agreement should have been signed and thus underwritten by the lead managers. covenants. 2002). warranties and covenants. undertakings. It is the responsibility of the SPV to ensure that the project passes the completion test and performs as per the agreed performance levels. However. and cross-default (Graham. It cannot therefore be used for any other purpose without the approval of the syndicate banks. is shared equitably based on the proportions of their loan contributions. Failure to adhere would constitute an event of default which leads to termination of the loan.not held to make-up for the shortfall. acceleration or reducing the tenure of the loan. In the operation phase. when it complies with its obligations. takes this risk to find funds to compensate for the shortfall.

In case of detection of noncompliance behaviour. The agent is expected to act in the best interest of the syndicate and performs his duties with skill. the standard theory of why banks join a syndicate is risk diversification. Project finance deals are non-recourse and therefore depend on the isolated and assigned cash flow from the project. It is the duty of the agent to monitor and inform the participating banks the status of the performance of the loan. 5. In case of default. The agent ensures compliance with all the provisions of the credit agreement (CA) for both the SPV and the syndicate banks. Winston. 5. 2000 argue that diversification is important to enhance shareholder value by reducing monitoring cost and 16 Other remedies include acceleration of the loan – declaring the loan immediately due and payable and change of the loan into a demand loan (Graham. 1990 and Simons 1993. Important tests17 at each milestone of project completion (PC) are carried out in the presence in the presence of all the parties. 7 .1 Risk Diversification According to Hurn. this amounts to a default. 1998). the parties may agree to terminate the loan or allow the SPV to accelerate loan repayments.been diverted. 17 commercial completion date (COD) that checks whether the plant meets minimum performance standards (MPS) and provided with provisional acceptance certificate (PAC). Therefore banks can terminate the loan or may force the SPV to make early repayments16 if there is evidence to the effect that the borrower will not be able to repay the loan. organises impromptu meetings between the parties where strategies to revert the project to normality are agree upon and implemented accordingly. the bank that spread the risk by joining many syndicates faces a lower risk than one that finances projects individually. Depending on the gravity of the default. The agent however. the agent with agreement from syndicate banks takes enforcement action against the SPV. successive test are done till the syndicate is satisfied that the plant complied with all requirements and is provided with a final acceptance certificate (FAC) (Stefano. care and due diligence. 2008). During construction. 1997 and Ongena. has limited discretion to take minor decisions as spelt out in the credit agreement.0 THE ROLE FOR LOAN SYNDICATION. in case of default. With no recourse to project sponsors. Major decisions are taken with the approval of the syndicate. All payments from the project company are received by the agent and remit them to the individual syndicate banks. the agent organises site visits for the syndicate to keep breast of the progress of the project and obtain formal presentations from the SPV and sponsors.

Their argument is based on the assumptions that all the banks cannot renegotiate and internalise the agreement.transactions costs. the solution is to join effort with other banks and contribute a portion of the loan as per the bank regulations. these projects require high credit facility18 that may not be mobilised by one bank (Peter and Frank. railways and public services like hospitals. When the exposure limits are high. 8 . Although the risks19 in project finance structure are transferred to parties competent to bear them. 2000.2 Mobilisation of Funds Since mid 1980s. there is uncertainty that the project may not perform according to the financing plans and the credit agreement (Hurn 1990 and Simons 1993). and universities require several billions of dollars which may not be available in one bank. banks have to either adjust their exposure limits or join a syndicate (Christophe. banks employ advisors to ensure that all risks are allocated and the SPV has experience to implement the project in accordance with the provisions of the credit agreement. With many banks involved in the syndicate. 1996. infrastructural project – bridges.3 Risk Exposure Risk sharing and exposure. loan syndication has been at the centre stage of financing large projects. but to the SPV’s assets and cash flow. prisons. 19 Commercial banks that participate are usually experienced and can easily analyse complex project credit risks that may be present in financing the project (Peter and Frank . To participate in debt financing. Project sponsors can easily mobilise large sums using syndication mechanism (Sein. the risks are shared according the proportions of their contributions to the loan. and do effective monitoring henceforth limits their ability to default for strategic reasons. therefore have to ensure that the project will generate revenue to repay the loan. 5. pp 97). Financing of energy. tunnels. The main aspect of project finance is that lenders do not have recourse to the sponsor for loan repayment. In most cases. 2008). roads. As long as the project is bankable. banks with surplus funds are always happy to join the syndicate and enjoy its benefits. 2000) (see Table 1). 5. banks have lending exposure limits to specific sectors. Bolton and Scharfstein 1996 raised the issue of how many banks should be included in a syndicate. They developed a model of the optimal lenders and concluded that the borrower’s incentive to default is limited under multiple lending due to the uncoordinated monitoring by participating banks. This implies that in order to project finance deals with huge amounts. The residual risk is also borne by all the participating banks. In 18 Loan Syndication is more suitable for the debt financing of energy projects which require large sums of capital. 106). In addition.

This further reduces their risk exposure and enhances investment in projects with the highest returns on their equity (Peter and Frank. Information exchange is paramount for the success of a loan syndicate. banks that offer the best terms of the loan are awarded the tender (Christophe. information gaps between the members of the syndicate. 2008). To the SPV. They are best suited to handle risks related to those particular sectors and countries. Although Stefano (2008) argues that competition in the sector has been stiff and differences in prices are minimal. In cases where the process of loan syndication is through competitive bidding. In case of power projects where the tariff is a function of debt service among others. which is offset by returns from successful projects.4 Information Sharing Information sharing between many participating banks reduces risk exposure. 2000). a harmonised channel of communication reduces costs and time that would otherwise been spent communicating to individual participating banks. Banks are exposed to diverse information on borrowers. each bank bears a proportion of the risk. and lessens loan tenure. 5. can lead to agency problems (Christophe. 2008). Many participating banks generate competition and results in better implementation (Benjamin. A syndicate therefore acts as a reference credit bureau (RCB) on the borrowers and other sectors. As a consequence. 2004).5 Competitive Pricing20 Competitive pricing and more flexible funding structure benefits borrowers and the final consumers of the output or service produced by the project. it is important to note that stiffer competition results in normal prices and maximises consumer welfare. it increases the returns to equity and subordinated loans and leads to smooth implementation of the project. 20 In structuring the loan. there is a trade off. This eases the repayment schedule of the borrower in terms of reduction of interest rates. different sectors and different countries. reduces cover ratios. 9 . any reduction in interest rate benefits the power consumer. 5. Banks are therefore cautious about the future performance of the loan portfolios. However.case of default.

bankruptcy or Insolvency.6 Reduction in Marketing Costs To the participating banks. noncompliance with covenants. pp 96).1 Default and Remedy Clause The credit agreement clearly specifies the remedies in case of default. This provides comfort and additional security to commercial banks to participate in debt financing. Its success depends on a well designed credit agreement that provides for diverging interests of parties to the syndicate. Default arises from non-payment of the loan. 274). syndication provides them with lending opportunities that have low marketing costs and chances to participate in future group financing. lenders are entitled to take control of the project in order to remedy or make arrangements to remedy the causes of default situation as far as possible (Stefano. It is also responsible for the administration of the syndicated loan and all matters related to disbursement and repayment of the loan (Sein. all events of default must pass the materiality test in order to be considered as EoD. European Bank for Reconstruction and Development (EBRD). Asian Development Bank (ADB). pp 96) 22 The IFC handles all the technical and legal matters including risk mitigation measures and ensures that risks are allocated to counterparties properly. limitation of distributions to sponsors and step-in-rights23 (Stefano. downslide in financial ratios. they are normally assisted by catalyst banks (CB) or multilateral agencies21 to access the syndicated loan market (Sein. right to accelerate the loan.0 MEASURES TO ENSURE SUCCESSFUL LOAN SYNDICATION. 2008). pg. Many energy and infrastructure projects which require high capital have been supported through the assistance of International Finance Cooperation22 (IFC) as a lead arranger. 23 By means of the legal instruments provided in the finance documents. commercial banks may not be exposed and experienced to loan syndication. 10 . the transactions cost involved make loan syndication costly. The remedies include loan cancellation. however some credit agreements provide right of enforcement to some banks. In developing countries. warranties and non-payment by the sponsor of any other loan when due. All participating banks have the same rights to enforce these provisions. Because the default on the repayment of any of the participating banks is viewed as a default of the entire syndicated loan. 21 The World Bank (WB). 1996. thereby a default on repayment of the IFC loan. However. 2008. 1996. Despite its roles. 6. 6.5. and Inter-American Development Bank (IADB) provides partial risk guarantees to commercial banks for lending to energy projects in developing countries (Sein. 1996).

the syndicate democracy clause should be very instrumental in balancing the decision making interests of the parties to the credit agreement. 6.6. syndicate democracy prevails if the events of default pass the materiality test. otherwise it would 11 . participating banks appoint advisors from different disciplines to negotiate and ensure that the terms of the agreements are favourable. the voting clauses are included to ensure that the syndicate obtains majority consensus before making a decision. In this regard. and whichever the case. 7. If the bank feels that the terms are not in its favour. 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. This ensures fair distribution of benefits to all participating banks and leads to successful syndication. this must be expressly provided in the syndication agreement. All provisions of the credit agreement and other financing documents are subject to a comprehensive negotiation. but not to the detriment of the voter.4 Negotiation This should normally be at the centre stage if loan syndication is to succeed in performing its role. step-in-right enforcement. In case of major decisions like calling up a loan. it has the liberty to leave the syndicate. This power to exercise the syndicate voting rights must be exercised in the interest of the syndicate. If adequately addressed in the credit agreement. It is designed to share any proceeds from the SPV as a repayment of the loan or any other payment that results from default and all costs related to the syndicate in accordance with their proportional loan contributions. Most projects that require large sums of funds are easily financed through syndication mechanism. In this regard.0 CONCLUSION Loan syndication plays a significant role in financing projects. Appending the signature on the loan syndication agreement implies that all participating banks agree to the terms of the agreement and will comply accordingly.2 The Sharing Clause A sharing clause is intended to balance the interests of participating banks. 6.3 Loan Syndication Democracy The credit agreement contains provisions for decision making by the participating banks. The clause is aimed at protecting the minority banks from the majority participating ones.

Importantly. 12 . the credit agreement should be designed to clearly deal with the respective needs of the counterparties to the syndicate. However for loan syndication to succeed. risk sharing reduces risk exposure to individual lenders and this reduces the cost of debt.be difficult for a single bank to mobilise the funds.

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307–346. and Loan syndication. Journal of Financial Intermediation 6. 14 . G.. 2009). A.ssrn. Agency Costs.cfm?abstract_id=1126391. Competition among Financial Intermediaries when Diversification Matters. A Crosscountry analysis.. Banking Environment. (1997). 2008.com/sol3/papers.Winton. J. (Last visited on 12th April. http://papers. INTERNET SOURCES Christophe.