Funding & Investing

Stronger together: the power of syndicated lending

Published: Jan 2019

 

When a single lender is not strong enough to take on a large loan it can call a friend, or several if needed. By syndicating a loan, it enables huge sums to be lent and can mean the difference between a project funded and a project terminated. We go back to basics to see how and why this works.

When a corporate needs funding which cannot be met by a single provider, usually because that sum is deemed too large a risk, there may be an opportunity to share or ‘syndicate’ the loan.

Lenders are usually tier one banks and, particularly for leveraged transactions, institutional investors such as hedge funds, insurance companies and pension funds. Borrowers are usually large corporates (often seeking to refinance on improved terms, fund M&A or a major capital project), or major infrastructure projects (road or airport construction, for example).

Deals typically start at US$100m and are of at least one year. However, loans are bespoke and so price, size, tenor, structure and purpose are highly variable.

That said, for investment-grade borrowers, where more funding options are available, syndication is often seen as a strategic manoeuvre or an alternative funding source; the market in 2018 has seen a lot of US$1bn and US$2bn bridges to bonds, for example. (Source: Reuters)

Syndication can also be used as a borrowing strategy for a corporate with a lower credit rating, where it is unable to easily access the levels of funding required through the bond markets.

With a higher credit rating, the margin payable to lenders tends to be lower and few, if any, covenants restrict the way the company operates. The opposite is usually true for lower-rated borrowers, although strong due diligence will be in evidence in every case. In both cases, the existence of a syndicated facility may serve to reassure investors holding other instruments issued by the borrower, such as commercial paper, potentially facilitating a lower overall cost of future funding or a wider pool of liquidity.

Syndicated lending by numbers

In 2017, global syndicated lending totalled US$4.6trn from 9,887 transactions (up 12% on proceeds and 3% on completed loans). The US captured 58% of global lending (US$2.7trn, up 25% on 2016). Canada, for the first time ever, was the second largest loans market (US$235.2bn).

Regionally, the Americas took 65% of total proceeds (US$2.9trn/c.5,000 transactions). Europe saw 18% of the market (U$816.3bn, down 1% in proceeds and 14% in number of completed deals). Asia Pacific totalled US$493.3bn (down 3% in proceeds and 2% in number). (Source: HITC)

Bank of America Merrill Lynch ranked as the top global loans bookrunner for FY 2017, with 9.46% of credited market share. The bank acted as bookrunner in 1,412 deals over the period. J.P. Morgan and Citi ranked second and third, with 9.22% and 5.42% of credited market share, respectively. (Source: Bloomberg)

Global syndicated loans volume (as at 27th November 2018)

Rank Lead manager Amount US$m No. of issues Share %
1 J.P. Morgan 420,828.07 1194 10.93%
2 Bank of America Merrill Lynch 377,688.13 1213 9.81%
3 Citi 237,399.89 691 6.16%
4 Wells Fargo Securities 213,501.86 782 5.54%
5 MUFG 162,641.64 983 4.22%

Source: Dealogic

Loan types

Loans are typically offered as a fixed sum or a revolving credit line (the KKR/Flora deal included a US$799.5m equivalent 6.5-year revolving credit facility) but may also be a combination of these. Standby letters of credit may also be offered. Interest rates can be fixed or floating, the latter typically using a benchmark or reference rate such as libor or the US prime rate, plus a margin.

Apart from where collateral requirements may differ, most loan terms and conditions are uniform amongst all lenders and there will be one loan agreement for the whole syndicate. This commonly (but not mandatorily) uses Loan Market Association (LMA) documents.

  • Term. A term loan is a more traditional arrangement. The full amount is drawn either initially or in pre-determined instalments. The principal is either repaid over the term of the loan or at maturity.
  • Revolving. This will have a specified term limit but the borrower can draw down funds and repay them as necessary, as long as the terms and conditions of the loan (covenants) are met. This style of loan is more suited to companies which view the syndicated loan as a secondary source of finance or have a periodic need for funding.

Investment grade borrowers will often structure their loans into different revolving tranches, with short (one year) and longer maturities (typically three to five years). This provides a longer-term source of assured funding, particularly useful as a back-up to commercial paper or where it is beneficial to delay repayment (if it takes time to bring new equipment into service for example).

Loan syndicates: legal structure and red flags for corporates

Traditionally, lead arranger banks conduct lender due diligence, so the choice of which financial institution has that role has always been of decisive importance for corporates, says Julian Roche, Consultant at Redcliffe Training.

In conjunction with the corporate’s own lawyers, they will draft the key documents sent to potential syndicate members, the confidential information memorandum and associated corporate financial model in particular; and they will also draft the credit agreement itself. Borrowers must always assess potential syndicate members under a range of headings: any history or covenant impacts, knowledge and understanding of the business, balance sheet strength and stability, and track record.

Whilst the loans are collective, the obligations of lenders remain individual: a syndicate is not itself a bank. On the contrary, a syndicate is conventionally covered by partnership legislation, which imposes a range of reporting and tax obligations on partner financial institutions that corporates must study.

Legal issues remain varied and syndicate structures are sensitive to, and adapt to, regulatory regimes. Hence for example both the number and the volume of syndicated loan issuances in the UK dropped by an economically and statistically significant 15% after the Brexit referendum relative to the global market1.

Concern among lawyers therefore remains over important legal matters. For example, given the different definitions and practice of default between institutions, how individual syndicate members or the syndicate as a whole are permitted to respond to borrower default or the borrower or other party’s bankruptcy. Or whether unanimity or majority voting by syndicate members will suffice for decision-making – and if so whether by size of participation or not – how facility and security agent payments are treated.

Meanwhile bankers regret the slow development of the secondary loan market, with many markets still insisting on borrower consent before transfer of loan obligations. Problems of legal uncertainty for syndication are however gradually resolving across jurisdictions – Russia, for example, passed syndication legislation last year.

But there remain issues that corporates should, but often do not, recognise. The advantages of syndicated lending come at a cost because of the agency problems linked to differences in information between syndicate members2. These emerge in two principal forms.

First, as upcoming research3 will suggest, local lending by international financial institutions is far more sensitive to macro-economic data than transnational lending. Second, as long established by Harvard Business School’s Benjamin Esty, multiple lead arrangers can serve to curb the agency problem associated with individual banking relationships, control issues within corporates – which affect syndicate structure – and poor creditworthiness signalling in project finance.

But second, the range of permitted participants in syndicates is growing: from banks to non-bank financial institutions such as pension funds and even eventually loan crowd-funders, an evolution that poses significant financial risk for borrowers in future syndicated loan transactions as their borrower due diligence costs mount.

Recent research4 has indicated that syndicated loans with greater funding by non-banks experienced greater sales activity and downward pressure on secondary market prices during the global financial crisis.

These adverse effects were pronounced among loans funded by non-banks with relatively liquid liabilities: broker-dealers, hedge funds, and other investment funds. In a world where syndicated loans are frequently traded in secondary markets, quite contrary to the prevailing wisdom in academia5 and the business world alike, corporates could be sitting on enormous potential risks.

  1. Berg, T. et al. ‘Brexit’and the Contraction of Syndicated Lending’. 
  2. Godlewski. C. University of Strasbourg, ‘Banking Environment and Syndicate Structure: A Cross-Country Analysis’. 
  3. Avdjiev, S. et al, ‘What drives local lending by global banks? 
  4. Irani, R. M.et al. ‘The Rise of Shadow Banking: Evidence from Capital Regulation’. 
  5. eg Kamstra, M.J. et al ‘Does the Secondary Loan Market Reduce Borrowing Costs?’ 

Main roles

Within the corporate loan market, it’s worth knowing that the Loan Syndications and Trading Association (LSTA) is the main resource centre. It can bring together loan market participants, provide market research, and has the ear of the authorities in terms of influencing compliance procedures and industry regulations.

The main roles operating within a syndicate are (with much differing of opinion as to precise function):

Mandated lead arranger (MLA)

Usually takes a significant portion of the syndicated loan commitment, selling parts of the debt to build the syndicate.

Bookrunner/arranger

Advises the client, organises and arranges the loan, negotiates the broad terms, and often underwrites the loan (see below).

Agent

Day-to-day management of the transaction, liaising between banks and borrower. The task can be broken into facility agent (managing the day-to-day running of the loan itself and compliance with its terms) and the trustee who manages documentation and holds any securities required.

Deal types

A decision will be taken with the arranging bank as to whether the loan will be underwritten. In an M&A deal, for example, certainty of funding may be essential. If so, the borrower knows it will receive the full amount of the loan, irrespective of whether the arranger has successfully syndicated the deal. If the arranger fails to fully subscribe the loan, it must take on the difference (which it can later sell on to other investors). Underwriting is a competitive tool to win mandates and it generates more fees.

Without underwriting, a best effort arrangement means the borrower receives only as much as can be generated amongst participants. Undersubscription can mean the loan may not close or that it needs major changes to create market interest.

Fees

Fees associated with the loan can include the following:

  • Margin: lenders will charge a margin over an agreed market benchmark.
  • Commitment fee: where a loan is not fully drawn, borrowers will be charged a commitment fee to maintain it
  • Utilisation fee: banks may charge an additional fee if a high proportion of the loan is drawn in one.
  • Arrangement fee: the arranging bank normally receives a fee once the syndication has been successfully completed. This depends on the size of the syndication and the credit risk. Occasionally other lenders will receive an upfront fee of a few basis points for participation in the syndicate.
  • Legal fees: companies will have to meet the costs of their legal advisors.

Starting out

In practical terms, treasury must begin with a clear understanding of the role the loan will play in the company’s wider funding strategy. This provides a focal point when the company presents its case to potential investors.

Syndicated loans can be structured in many different ways. Treasurers will also need to pre-arm themselves with accurate forecasting data, especially covering future funding requirements; only this way can appropriate terms and conditions be agreed. A repayment strategy will also need to be outlined.

Of course, the arranging bank’s expertise and market influence are vital but so too is strength of the relationship, which can play a key part in making the decision as to which bank to mandate.

Finer points

Negotiations will be ongoing throughout the arrangement process and it is therefore important to understand what the other side wants. Treasurers must identify each potential lender’s approach to, and appetite for, syndicated loans. Points of discussion might include:

  • The type and size of banks involved and whether they will sell their participation right away or take a longer-term view.
  • The importance of the relationship to each party.
  • The proposed structure of the deal.
  • The fees.
  • Covenants or other restrictions that might conflict with policy.

Timing

Deal complexity will influence timing but the key driver on the corporate side for delivering a syndicated deal is the underlying transaction. For M&As, speed may be of the essence, less so a refinancing requirement. Typically, from initial meeting with the agent to signing the loan agreement it can take two to three months.

Secondary market

For primary lenders, an important factor is the secondary market, where exposure to the syndicated loan can be managed by selling on part or all of a bank’s participation in a syndicated deal. Secondary market deals represent work (and therefore fees) for the agent as each deal requires contract documentation to be drawn up and all the proportions for monetary calculations to be changed.

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 the only change relating to which bank receives the interest payments.

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.

What is sometimes less well understood is the importance of the secondary market for borrowers. For the corporate borrower, the development of the secondary market has also enhanced liquidity in the primary market, arguably bringing down margins for all borrowers.

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