Syndicated Loan

How Do Syndicated Loans Work?

Each lender in the syndicate contributes a portion towards the total loan – effectively sharing the lending risk and potential for capital loss.

Syndicated loans are a form of lending in which a group of lenders provides financing for a borrower under a single credit facility agreement.

Formally, the term “syndication” is defined as the process in which the contractual lending commitment is split up and transferred to lenders.

Leveraged loans are one of the most common financing instruments structured by a syndicate of lenders.

The major steps in the lending process are as follows:

1. The arranger(s), typically an investment bank, is the lead underwriter who negotiates the terms of the lending agreement with the intention of selling a portion (or most) of the debt to the market.
2. Before formally offering a loan and taking it to the market, arrangers often gauge the market to ensure sufficient demand.
3. If formalized, like a roadshow in M&A, the syndicated loan is proposed to other banks and institutional investors.
4. The term sheet is prepared, which is negotiated between the lead bank and the borrower, containing all the details of the loan agreement.
5. Once negotiations finalize and the signed contract materializes, the stated obligations in the contract occur (e.g. capital distributions).

Who are the Participants in the Loan Syndication Market?

The loan issuer – i.e. the borrower – negotiates the preliminary terms and eventually settles on the structure of the financing transaction with an appointed “arranging bank”.

The arranging bank (or lead arranger) taking the lead on structuring the loan is typically an:

• Investment Bank
• Corporate Bank
• Commercial Bank

The arranger is also responsible for facilitating the distribution process and drumming interest in the debt markets.

The proposed syndicated loan is presented to other participants, such as:

• Other Investment, Corporate, and Commercial Banks
• Direct Lenders and Other Specialty Lenders
• Hedge Funds and Institutional Debt Investors

Additionally, two other participants in the syndication process are the:

1. Agent: Serves as the point-of-contact for information and communications to flow among all parties
2. Trustee: Responsible for holding onto the securities associated with the “secured” debt (i.e. backed by collateral)

What is the Structure of Syndicated Loans?

The rationale for syndicated loans is to diversify the risk of lending capital via risk allocation across different lenders and institutional investors.

Typically, the context of the borrowing is financing for special purposes, such as:

• Complex Corporate Transactions
• Joint Venture (JV) Projects
• Multi-Year Infrastructure Projects

Given the sheer magnitude of capital, syndicated loans spread the risk among several financial institutions and institutional investors to mitigate the default risk, rather than full concentration on a single lender.

For the borrower, due to the reduced risk of capital loss (and maximum potential loss) for all participants, the lending terms contain more favorable terms – i.e. lower interest rates.

Considering the complexity and magnitude of the financing, syndicated loans are far more efficient than traditional loans with one borrower and one lender.

What is Flex Language in Syndicated Loan Contracts?

Syndicated loan contracts often include provisions that enable the lead arranger to alter the terms of the borrowing if certain contingencies are met.

For instance, if the demand for participation in the market is substantially lower than originally anticipated, there could be adjustments to the:

• Debt Pricing (i.e. Interest Rate)
• Changes in Debt Covenants
• Loan Maturity Date
• Principal Amortization

Underwritten Deal vs. “Best-Efforts” Financing: What is the Difference?

In an “underwritten” deal, the arranger guarantees the entire amount will be raised and backs that up with their own full commitment – i.e. the arranger assumes the risk (and plugs any “missing” capital) if demand falls short and investors do not fully subscribe to the loan.

By contrast, in “best-efforts” financing, the arranger only commits to providing its best effort – a subjective measure – to underwrite the entire loan.

The difference between the two is that an underwritten deal carries far more risk for the arranger (i.e. “skin in the game”), as the arranger in underwritten deals is not afforded the same type of protection.

The incentives for arrangers to underwrite loans are:

• Underwriting loans can be beneficial for not only their lending business (i.e. future revenue sources) but also other product groups within the bank, like M&A advisory.
• Given the time commitment (and risks), the arranger charges higher fees.