8/9/2017 Arranging a syndicated loan | Treasury Today

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Arranging a syndicated loan

Oct 2004

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The growth of syndicated loans in Europe

over the last few years means that many The treasury of tomorrow,
companies now view them as alternatives to
a bond issuance programme. This article today
explains the process of arranging a New ways you can be supported
syndicated loan. It identifies the key across cash, liquidity and trade ➜
decisions a company needs to take when
structuring this sort of loan.
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Syndication as a financing
strategy
A syndicated loan is often part of a wider financing strategy. Unlike bilateral loans, they allow a
company direct access to both banks and institutional investors. Many companies use syndicated loans
alongside bilateral agreements and a bond issuance programme to maximise their ability to raise
funds effectively and cheaply. Some companies also use syndications as a key tool in managing bank
relationships. It is not uncommon, for example, for companies only to award other business to those
banks which participate in their syndication.

Understanding the role of the loan

Before approaching banks to arrange a syndicated loan, the
company will need to have a clear understanding of the role it will Index
play in its wider funding strategy. In last month’s issue of Treasury For more information on
Today, we identified a number of different reasons why a company the structure and uses of
might want to arrange one. Common reasons include: syndicated loans, see
September 2004
The provision of general working capital financing.
(http://treasurytoday.com.com/magazine/2004-
To fund an expected merger and acquisition programme. 09).

To fund a particular project, such as the building of a new

production facility.
To provide back stop facilities for other forms of financing, such as a commercial paper
programme.

In addition, the company needs to be able to demonstrate a coherent case to potential investors. This
will require them to identify how the funds will be used and where the loan fits within the company
financing strategy. Investors will also want to understand how the company plans to meet its
repayment obligations.

Appoint arranging bank(s)

Whatever the reason for a company wanting a syndicated loan, the first step in structuring one is to
appoint one or more arranging banks. It is increasingly common to hold a competition before

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appointing the arranging bank or banks. This appointment process can be difficult, especially when the
treasurer has limited experience of syndications. Two issues are important:

Bank relationship management

In practice, the treasurer needs to establish how many arrangers need to be appointed. The most
important factor is bank relationship management. The treasurer may want to reward a bank or banks
which already provide the company with credit. Some companies share the role of arranger for this
reason, although this has the effect of weakening the attraction of the position itself. Companies need
to be careful to understand what banks want from their role as the arranging bank. Because
syndications are often high profile, core banks will often want the opportunity to act as the arranger.
The treasurer will need to consider both which banks to ask to tender for the position and how many
to consider.

Club deal
In some cases, a company will arrange a ‘club deal’. This is essentially the same as a
syndicated loan, with the same terms and conditions applying to all banks. The main
difference is that an arranging bank is not appointed. Instead, the company will take the lead
in arranging the syndication. For this reason, club deals tend to involve a relatively small
number of banks.

Geographical spread
A second issue is to ensure the arranger(s) has (or have) coverage in all the appropriate markets,
particularly if the aim is to attract institutional investors. Multinational companies may want to invite
banks in all their countries of operation to come into a syndication. It is important that the arranging
bank(s) has a route into those countries and knowledge of the investors who are likely to be
interested. This is generally referred to as distribution capability.

Structure loan
Having appointed the arranging bank(s), the next step is to structure the loan itself. This will depend
on the purpose for which the company wants the loan, the creditworthiness of the borrower and the
size of the required loan.

Term and repayment

The first step is to decide the tenor of the loan. For how long is financing required? The decision will
vary according to the purpose of the loan and when the company expects to draw down the funds. For
example, if the funds are required to finance a particular project, the term should match the duration
of that project (perhaps with an extension option if there is any delay). However, if the company views
the syndication as contingency financing (to be used either when needed or when relatively cheap),
the term should be determined within the overall context of the company’s financing strategy. In
particular, it should not mature at the same time as other financing arrangements, as a refinancing
risk will still exist.

The company will also need to decide how repayment will be made. In effect, there are two
alternatives, although a loan can be structured with both elements within it. The elements are:

1. Repayment on maturity.
Some loans are drawn down in full and then repaid on the maturity at the end of the term. This
can be varied, by allowing companies either to draw down the funds in tranches or to repay in
instalments over the life of the loan.
2. Revolving loan.
Under the terms of a revolving loan, the company may be required to repay the loan in full at pre-
determined points throughout the term of the loan. Once repayment has been achieved, the terms
allow the company to draw down additional finance.

The key point is to ensure that an appropriate repayment profile is agreed. If the purpose of the loan
is to fund the building of a new factory, the company will probably want to delay making repayments

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until the factory starts production and generates cash. On the other hand, a company opting to repay
a loan taken out for working capital purposes (at a time in the business cycle when it tends to be cash
positive) will emphasise the short-term nature of the funding and impose discipline on the liquidity
management process.

Fees and pricing

There are essentially five elements to the fees payable on a syndicated loan. These are:

1. Margin
The lenders will charge a margin over an agreed market benchmark. In Europe, this will usually be
one of the interbank rates in the money market, either LIBOR or Euribor. The size of the margin
will depend on the creditworthiness of the borrower. These will range from less than 50 basis
points for the highest quality investment grade borrowers to 300 basis points for the riskier
leveraged buy-outs. The margin may change over the course of the loan, if the terms and
conditions allow, to represent, for example, a change in credit rating.

2. Commitment fee
Where a loan is not fully drawn, borrowers will be charged a commitment fee. This is charged on
the undrawn portion of the loan and is usually spread over the same benchmark rate as the
margin. It will usually be between a quarter and a half of the drawn margin.

3. Utilisation fee
In some cases, banks may be able to charge a small additional fee if a high proportion of the loan
is drawn. This applies to investment grade loans and reflects the fact that banks may have to set
aside additional capital to meet capital adequacy rules. For example, this may be an additional 10
basis points if over half of the loan is drawn.
4. Arrangement fee
The arranging bank or banks will normally receive a fee once the syndication has been successfully
completed. This will be determined by the size of the syndication and the associated credit risk. In
some cases, other lenders will receive an upfront fee (of only a few basis points) for participation
in the syndicate. Again, this will depend on their commitment and the risk of the credit. The
payment of these fees will depend on the nature of the relationship the bank has with the
borrower. In some cases, the arrangers or lenders will waive their fees as part of the overall
relationship.

5. Legal fees
Finally, companies will have to meet the costs of their legal advisors.

Underwriting
Both parties will have agreed whether the arranger will underwrite the loan or not.

If the loan is underwritten, the borrower will receive the full amount of the loan, irrespective of
whether the arranger has successfully syndicated the deal. If the arranger fails, then the underwriting
bank or institution has to advance the balance of the underwritten loan. If the loan is to be
underwritten, the arranger will usually try to involve other banks as underwriters as part of the
syndication process. Loans which are designed to raise a certain level of funds, perhaps to finance an
acquisition, are more likely to be underwritten. If a loan is not underwritten, it is said to be arranged
on a ‘best efforts’ basis. This means the arrangers do not have to meet any shortfall in any
unsuccessful syndication and the borrower will receive the reduced amount. ‘Best efforts’ deals are
more likely when they are arranged on behalf of investment grade companies looking for back-up
financing (where the total sum arranged is not vital).

Action by arranging bank

Once the arranger bank(s) has been appointed, it will start to sell the syndication to other banks. The
number of banks required will depend on the level of cash required to be raised and the individual
banks’ appetites for involvement.

First tier syndicate

The arranger will usually start by approaching the other members of the company’s core banking
group. Where a company does not have a core banking group (if it is company being spun off
another), this is more complex.
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Extends syndicate
Depending on the interest from the core banking group and the amount needed to be raised, the
arranger may look to extend the syndicate to a broader base of banks. By definition, these are not the
members of the core banking group. Banks joining the wider syndication may have a variety of
objectives. They may see participation as the first step towards joining the company’s core banking
group. Alternatively, they may be keen to diversify their portfolio of investments by lending to a
company new to them.

Close deal
Once a sufficient number of banks have joined the deal, the arranger will close the syndication. At this
stage, the banks will turn their attention to the documentation. It is important that all participants
agree to the same terms and conditions. This can take some time to negotiate. Once all parties are
comfortable, the deal will be signed.

Administration agent
The company will need to appoint a bank to act as administration agent. The administration agent has
two main roles:

1. It administers the collection of interest payments from the borrower and distributes them to the
lenders. This can be a complex issue as the amounts outstanding can vary over the term of the
loan as funds are drawn down and repaid.
2. It administers any interim draw-down notices. Under the terms of a revolving credit, the borrower
is entitled to call for a draw-down of funds at any time. In order to access these funds, all the
participants in the syndication need to provide funds. Ensuring all participants meet their
obligations is a key determinant of the success of the syndicated loan.

Secondary trading
Once the syndication has been closed, investors are able to trade part or all of their investment in the
secondary market. In most cases, there is a clause in the documentation which permits this. Most
transfers are made "by novation", in which case the new lender becomes a ‘lender of record’. In these
circumstances, the new lender simply replaces the original lender. The original terms and conditions
apply, with only the bank receiving the interest payments changing. In these circumstances, the
original investors will often simply be looking to make a fee on the trade of the loan. A small number
of loans do not permit secondary trading or transferability.

Documentation
The Loan Market Association was formed in 1996 with the
expressed aim of fostering a secondary market in European Next month
syndicated loans. Since then, the European secondary market has We will look at
developed relatively quickly. The LMA has now developed a documentation for
number of standard documents, at the heart of which is its syndicated loans
recommended form for primary documents. (http://treasurytoday.com.com/2004/11/syndicated-
loan-documentation) in the
Importance for lenders next issue of Treasury
The secondary market is an important factor for lenders. Lenders Today.
know that they can manage their exposure to a borrower by
selling on part or all of their participation in a syndicated deal.
There are three key aspects to this:

1. The prospective lender is not committed to the credit for the term of the loan. Under a revolving
credit, lenders often have the option of withdrawing from the loan after 364 days (depending on
the structure of the loan itself). However, under a term loan, the ability to trade participation in
the facility means the lender is not committed to the borrower until maturity.
2. The lender can manage its exposure to individual credits as part of its management of its
counterparty portfolio. To participate in the syndication, a potential lender may be asked to
advance a higher sum than it would like. Alternatively, a lender may want to extend credit to
another borrower in the same industry sector although it has reached its limit in that sector. The

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ability to trade part of the loan in the secondary market allows the lender to manage its own
portfolio of investments according to its overall credit policy. This credit policy is likely to change
over time, particularly over the course of the business cycle.
3. It offers investors the ability to recoup losses in the event that a loan becomes ‘distressed’. Banks
can sell such loans to other investors at a significant mark down from face value. The investors in
the ‘distressed’ loans are attracted by the additional returns offered in the event of full repayment.

The key factor in all cases is that the bank’s ability to sell loans in the secondary market reduces the
counterparty risk associated with the decision to participate in the syndication. As a result, the
secondary market enhances liquidity in the syndicated market.

Importance for borrowers

The transferability of loans is an important component in the growth of the European syndicated loans
market. The secondary loan market has been developed by the banks as a tool to benefit them.
Importantly though, from the corporate borrower’s perspective, the development of the secondary
market has also enhanced liquidity in the primary market and, arguably, has brought down margins
for all borrowers. This is because of the reduction in risk assumed by the original lenders.

Some corporate borrowers are still concerned about transferability of their loans. For the reasons
outlined above, companies need to accept that transferability has been an important factor in the
growth of the syndicated loan market. However, there are two valid areas of concern:

1. Relationship management.
Transferability makes it much more difficult for the corporate treasurer to evaluate a bank’s
commitment to the company. Although a core relationship bank may commit to a syndication, the
company may not know whether the bank has sold any of its loan in the secondary market. As a
result, it makes it more difficult to know the true level of commitment over time to the company.
Therefore it becomes very hard for the company to measure the level of ancillary business it
awards on the basis of the banks providing credit.

2. Renewing a facility.
Allied to this, any attempt to renew a syndicated facility on the basis of a commitment made in the
original syndication can be complicated. Treasurers, or their arranging banks, may be surprised
that some banks do not want to participate in a second syndication when the time comes to
renew. This may make the renewal process more complicated, although other factors such as the
market conditions and the nature of the credit will also be important.

Flexibility is important
One of the major reasons companies like syndicated loans is that they represent an alternative source
of funding, providing them with additional flexibility. However, to achieve that flexibility, the company
must take care to structure the loan appropriately. This requires careful thought about how the
syndication fits within the company’s financing structure. This then needs to be communicated to the
arranging bank(s) so that they understand the company’s objectives. Care needs to be taken to
ensure documentation is appropriate. We will examine this next month.

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