Professional Documents
Culture Documents
BF 430-LECTURE 4
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.
4.1 SYNDICATE STRUCTURE
There are multiple lenders to a single loan. It is fundamental to syndicated lending
that the terms and conditions of the loan are similar for each of the lenders. Though
there is a single loan contract, each syndicate member has a separate claim on the
debtor (several and joint liability).
The members of the syndicate fall into two distinct groups, namely, lead arrangers
(also known as senior syndicate members) and participant lenders (junior syndicate
members). These two distinct groups differ in two critical aspects.
Firstly, participant lenders rarely negotiate with the borrower, keeping an “arm’s
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.
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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.
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
necessarily 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 who 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 not all syndicated loans may 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.
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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 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.
The Agent has a number of important functions:
- Point of Contact: maintaining contact with the borrower and representing the views
of the syndicate.
- Monitor: monitoring the compliance of the borrower with certain terms of the
facility.
- 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.
If the syndicated loan is to be secured, a lender from the syndicate is usually
appointed to act as Security Trustee to hold the security on trust for the benefit of
all the lenders.
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The duties imposed upon the Security Trustee are typically more extensive than those
of an agent.
In large syndicates, it is sometimes decided that some decision making power should
be delegated to the majority from time to time (often referred to as the 'majority
lenders’ or 'instructing group').
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:
Benefits to the borrower
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).
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 - 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 bank 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
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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.
The lead bank/arranger is at liberty to appoint other participant lenders as co-
arrangers. These are usually appointed to perform specific tasks for the syndicate
such as book running and documentation. Syndicated loan agreements have an
agency section where the lead arranger is formally designated the duties and also
provides for the lead arrangers removal under special conditions.
The syndication process gives rise to the following sequence of events:
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.
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 contains commercial description of the borrower's business, management and
accounts, as wells the details of the proposed loan facilities being given.
It is not a public document and all potential lenders that wish to see it usually sign
confidentiality undertaking.
It is from the information memorandum that the syndicate establishes the
creditworthiness of the borrower.
D) Syndicated Loan Agreement:
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.
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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.
A typical fee structure would comprise of the following;
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.
Secondary Markets;
The secondary market is characterized by standardized loan documentation,
and high liquidity.
Loans can be transferred.
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.
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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 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. In case of major decision, like
calling up a loan or step-in-right enforcement, syndicate democracy prevails if the
events of default pass the materiality test.
Negotiation;-
CLASS EXERCISE
i) Identify examples of syndicated loan facilities on the Zambian market.
ii) Does the issue of information asymmetry exist in syndicated loans? If yes, elaborate.
iii) With regards to syndicated loans, explain what misrepresentation is, how it occurs and
identify the types of misrepresentations that occur.
iv) How are issues of conflict of interest in syndicated loan facilities handled?
v) What are exculpatory clauses?
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