A syndicate happens when a couple companies come together to share a large transaction. Have you ever wondered how large companies raise large amounts of money? Well, you’re not alone. This blog is about one important way in which large companies can raise these large sums and how they do it. Let’s say a car maker wants to build a new factory at the cost of 1,000,000,000 dollars. How do they do it? For starters, they could go to their bank. But, their bank might be reluctant to lend such an enormous sum. So, one solution is to persuade several banks, also known as a syndicate, to each lend part of the money.
What Does Being in a Syndicate Mean?
In a nutshell, a syndicate is a loan provided by a group of lenders.
It is then structured, arranged and administered by one or several commercial banks or investment banks.
Typically, the borrower requires a large sum of money and turns to multiple lenders to make it happen.
They need more than person, company, or bank to make it happen.
- A syndicate is essentially a leveraged loan.
- A leveraged loan is a commercial loan provided by a group of lenders.
- It’s structured, arranged, and administered by one or several commercial or investment banks, known as arrangers.
- It’s then sold (or syndicated) to other banks or institutional investors.
- No separate agreement between an individual bank and the borrower
- The length of the contract is generally between 3 to 15 years
- Each bank is not necessarily to contribute an equal amount.
The Changing Landscape Of Loans
The past few decades have seen a drastic change in trading, investing, and the art of corporate loan syndication. Not too long ago, there was a time when banks kept any loans to corporations on their books. The idea of letting those loans be traded by investors and kept in a portfolio was as foreign as living on Mars.
The Lure Of Corporate Loan Syndications
In time, however, investors came knocking, drawn in by the attractive features of loan syndications. Unlike bonds, these loans were senior secured debt obligations with a floating rate of return. Hence, a new institutional asset class emerged.
A Walk Down Memory Lane: Large Leveraged Buyout Syndicate Loan
Starting with the large leveraged buyout (LBO) loans of the mid-1980s, the leveraged/syndicated loan market has become the dominant way for corporate borrowers (issuers) to tap banks and other institutional capital providers for loans.
The reason is simple: Syndicated loans are less expensive and more efficient to administer than traditional bilateral – one company, one lender – credit lines.
KKR’s $25 billion acquisition of RJR Nabisco was the first – and remains the most (in)famous – of the high-flying LBOs. Struck during the loan market’s formative days, the RJR deal relied on some $16.7 billion in loan debt.
How Big Is The Syndicate Market?
Enormous. In the U.S. alone, total corporate lending was approximately $2.9 trillion in 2021. What is the length of a loan syndicate? The length of the agreement is between 3 to 15 years.
How Big Are Syndicate Loans?
Syndication loans or consortium loans are usually in huge amounts. Every bank limits the amount of credit exposure it can have to a person, a company, or a group of companies. Sometimes, a single bank may be unable to lend the whole finance requirement without breaching this criterion. So, a group of banks come together to finance the project.
How are Loans Syndicated?
Once the loan issuer (borrower) picks an arranging bank(s) and settles on the deal structure, the syndications process moves to the next phase.
The “retail” market for a syndicated loan consists of banks and, in the case of leveraged transactions, finance companies and institutional investors such as mutual funds, structured finance vehicles and hedge funds.
Who Is Involved In Loan Syndication?
The Arranging or “Lead” Bank
Participants of loan syndications include the arranging bank, known as the lead bank.
The arranger then does the bigger work of establishing the syndicate, bringing other lenders on board, and discussing the loan terms with them to determine how much credit each lender will contribute.
As a lead bank, they act as a syndicate manager and organize funding based on a specific term that the parties of the loan have agreed to.
Therefore, the arranging bank needs to find other banks willing to participate in the syndicate by lending money and assuming risk.
The arranging bank plays a role in negotiating the details of the arrangement, providing credit information and preparing loan documentation for the participating bank.
Then there’s the underwriting bank…
The Underwriting Bank
Their role is to supply the remanding funds or the unsubscribed portions of the desired loan. Based on the situation, the arranging bank plays the role of the underwriting bank. Usually, a different bank manager underwrites the loan portion.
Now we have the participating bank.
The Participating Bank
All banks that participate in loan syndication are known as participating banks. These banks also charge a fee like the lead bank for their participation.
The Agent Bank
The agent bank administers the term with profound accuracy. The Agent Bank is a link between the lender and the borrower and has a contractual obligation to both. The basic work of agent banks is to channel the funds from all participating banks to the borrower and channel back interest and principal amount from the borrower to participating banks.
Duration of a Syndicate Loan
The period of a corporate loan is generally between 1 to 5 years because it involves a huge amount of money to be lent to the borrower.
The Risk Of Syndicate Loans
The risk of default can be high with syndicated loans, particularly in the case of leveraged buyouts or sovereign entities. If a huge amount is lent to a party, and for whatever reason, the loan becomes non-performing, it will have a huge bearing on the lender’s financials.
Undoubtedly, this can impact their business. To share such business risks, two or more banks come together to lend to a company/project/group and share the risk and reward in mutually agreed ratios.
Types Of Syndicate Loans
- Underwritten Deal
- Best Efforts Syndication
- Club Des
Why Do Banks Syndicate Loans?
Because there is a lot of money in it. In fact, fees are the driving force behind banks doing more business.
Companies are willing to pay fees to access the investor clients of banks.
The business of corporate banking is to connect investors with corporate issuers of debt (and equities).
Often one loan is too large for any one investor to justify investing the whole loan amount.
Therefore syndication allows multiple investors to share the loan.
Additionally, syndicate loans allow banks to diversify by lending to borrowers, regions and industries to which they might otherwise have access.
It also helps them to diversify their portfolios.
Advantages of a Syndicate Loans
Loan syndication, where a group of banks makes a loan jointly to a single borrower, offers several benefits. Syndicate Loans offer an amalgamation of effort and the opportunity to create new banking contacts.
Lenders also prefer syndications, as Fidler and Neymeyer explained, that “…they permit the lenders to make more loans while limiting individual exposures and spreading their risk within portfolios more widely…” They further explained,“…Moreover, administration of the loan is extremely efficient, with the agent managing much of the process on behalf of the participants…”
Also, syndicated loans take less time. The borrower is not required to meet all the lenders in the syndicate to negotiate the loan terms. Rather, the borrower only needs to meet with the arranging bank to negotiate and agree on the loan terms.
Disadvantages of Syndicated Loans
Despite these benefits, loan syndication could pose additional risks for the banking system,
- Negotiating with a bank can be a time-consuming process.
- If problems arise, it may be difficult for borrowers to satisfy all banks simultaneously.
- Managing relationships can be hard. If profitability fails, the smallest banks may want to withdraw their capital.
Legal Issues Arising From Syndicate Loans
Which Legal System Applies?
Such deals raise many interesting legal issues as they typically involve players in different countries. The first of which is determining what legal system applies to the agreement.
Let’s take a Norwegian company that wants to drill for oil in Indonesia. The syndicate might comprise banks in the US, France, Britain, Germany and Japan while the contracts are negotiated and signed in London.
How does one determine which particular legal system applies to the syndicate? For fun, let’s choose English law. But how do we know if the Norwegian company has a contractual capacity to enter into the contract? Do we assess this by English law or by Norwegian Company law?
What Powers Do The Lenders Have?
Further to that, the loans secured on the Indonesian oil wells. What powers do the lenders have with those assets in question? Are the powers determined by Indonesian, Norwegian, or English law?
What Happens If One Lender Becomes Insolvent?
Another problem is the nature of the relationship between the various parties. Hypothetically, let’s assume each of the five banks promises to lend 100,000,000 dollars. What if one bank can’t comply because it’s become insolvent and looks to the other banks to make up the difference?
With Longer Time Frames Comes More Risk
Some other issues arise as syndicated loans often last for several years. The lenders need some reassurance about the continued financial health of the borrower. They need to know they can protect their investment if something goes wrong.
One way to do this is to take security over the borrower’s assets. This would give the lenders the right to sell them, but that’s a drastic solution. And further to that, the security may not be as valuable as initially thought.
It’s much better to prevent a crisis from happening as much as possible, but it’s not always straightforward in a syndicate. And surprisingly, for an area of law that involves trillions of dollars, there’s relatively little hard law and legislation surrounding syndicates.
Final Thoughts: What Is A Syndicate?
A syndicated loan is a loan provided by a group of lenders. Some lenders form a group and collectively give out the loan. Banks join syndication loans because this ensures that the loan amount and associated risks are distributed amongst all the lenders.