Updated July 10, 2023
What is Loan Syndication?
The term “loan syndication” refers to the lending process in which a group of lenders funds a loan for a single borrower. This arrangement often occurs when the loan amount is too large for a single lender or the risk associated with the loan exceeds the risk appetite of any single lender. Thus, multiple lenders join hands to form a syndicate and provide the requested capital to the borrower.
Key Takeaways
Some of the key takeaways of the article are:
- It refers to the arrangement in which a group of lenders joins hands to fund the loan requirement of a single borrower.
- It usually occurs when the loan amount is too large for a single bank or exceeds a bank’s risk appetite.
- In this arrangement, the lead bank takes on the role of the coordinating entity, while the remaining lenders, known as participating banks, collectively share the risk.
- There are three major types – underwritten deal, best-effort deal, and club deal.
Features of Loan Syndication
Some of the main features of loan syndication are as follows:
- The need for large loan amounts primarily drives the loan syndication arrangement, making it a key motivation behind such arrangements.
- The borrower and the group of lenders establish a single comprehensive agreement, eliminating the necessity for separate agreements between the individual banks and the borrower.
- The agreement explicitly outlines and pre-determines the loan amount allocated to each participating bank, ensuring transparency and avoiding confusion regarding their financing obligations.
- Loan syndication typically involves reputed corporate entities with strong creditworthiness, reflecting their ability to access substantial funds through this mechanism.
- The loan syndication tenure generally spans 3 to 15 years, depending on the loan’s nature and the agreement between the borrower and lenders.
- In loan syndication, all participating lenders actively share the credit risk. They ensure that in the case of borrower default, the losses are collectively distributed among them.
How Does Loan Syndication Work?
Now let us look at how loan syndication works in the real world:
- In the pre-mandate stage, the borrower approaches a lender or invites competitive bids from multiple lenders.
- Based on rounds of discussions, the borrower appoints the arranging bank or lead bank.
- The lead bank prepares the Information Memorandum for the loan, which typically includes the executive summary, terms & conditions, industry overview, detailed assessment, investment considerations, financial structure, and other key information about the loan.
- The lead bank then invites other banks to participate in the loan syndication.
- After finalizing the participating banks, the participants sign the confidentiality agreement.
- After completion of the loan documentation, the contract is prepared while the loan amount is disbursed.
- Finally, the loan must be monitored regularly through an escrow account in which the borrower must deposit the revenue. The escrow account serves the purpose of repaying the loans and fulfilling other statutory dues.
Example of Loan Syndication
Let us assume that ASD Inc. multinational organization is planning to acquire an entity in the African continent for which it requires $5 billion in debt funding. The company has a good relationship with one bank named GHJ Bank. Hence, the company approached the bank for a loan. However, the amount is too large for the bank. So, it can’t finance the loan and take that much risk alone.
GHJ Bank advises the company to syndicate the loan, to which the latter agrees. Next, GHJ Bank invites other banks to join the syndicate and decide how to distribute the loan amount among them. In this case, the role of the agent bank is assigned to GHJ Bank, while all other banks assume the role of participating banks. This is how loan syndication works in the real world.
Types of Loan Syndication
There are three major types. They are:
- Underwritten deal: In this type of loan syndication, the lead bank guarantees to arrange for the entire loan. The lead bank must finance the funding shortfall if the loan isn’t fully subscribed. Given the risk the lead bank assumes, it charges a higher service fee.
- Best-effort deal: In this type of loan syndication, the lead bank doesn’t commit to arranging the full loan amount and underwrites it on a best-effort basis. If the loan remains under-subscribed despite multiple attempts by the lead bank, the borrower is compelled to accept a lower loan amount.
- Club Deal: In this type, the loan amount is smaller (up to $150 million), and all the participants have an equal share.
Advantages of Loan Syndication
The following are some of the major advantages:
- Given that it lowers the lending risk, the alliance of lenders can provide the loan at competitive terms, such as prepayment facilities, without the standard penalty.
- Borrowers benefit in terms of flexible loan structure and reduced effort to disbursement.
- When a group of lenders agrees to fund a company’s business growth, it gives a facelift to the company’s reputation and boosts its market credibility.
Disadvantages of Loan Syndication
The following are some of the major disadvantages:
- First, forming a loan syndicate requires much time as the lenders must go through extensive documentation.
- The management of multiple lenders is an arduous task for a borrower. Even a small issue with a single bank can complicate things and impact the credit lines unfavorably.
Conclusion
Loan syndication benefits both lenders and borrowers. Lenders can share the risk, reducing their exposure, while borrowers benefit from a streamlined process that saves them time and effort.
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