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.
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, there is a lead bank, and the remaining lenders are known as the participating banks, who 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:
- First, the loan amount is usually very large, which is one of the major reasons for a loan syndication arrangement.
- There is only one agreement between the borrower and the group of lenders. No other agreements are signed between the individual banks and the borrower.
- The loan amount to be disbursed by each bank is pre-decided and mentioned in the agreement. So, there is no confusion regarding the amount to be financed by the banks.
- Typically, the borrowers involved in a loan syndication arrangement are big corporate houses with high reputations and creditworthiness.
- The tenure under loan syndication usually falls in the range of 3 to 15 years, depending on the nature of the loan and the agreement between the borrower and the lenders.
- The risk of credit loss is distributed among the lenders, which means if the borrower defaults, then the loss is borne by all the lenders involved in the loan syndication.
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 has to be monitored regularly through an escrow account in which the borrower is required to deposit the revenue. The escrow account is used to repay the loans and 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, GHJ Bank is appointed as the agent bank, and all other banks are the 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 is obligated to finance the funding shortfall if the loan isn’t fully subscribed. Given the risk assumed by the lead bank, 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 amount of the loan and underwrites it on a best-effort basis. If the loan continues to be under-subscribed after several attempts by the lead bank, the borrower is forced 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.
- A company’s reputation gets a facelift, and its market credibility is boosted when a group of lenders agrees to fund its business growth.
Disadvantages of Loan Syndication
The following are some of the major disadvantages:
- First, forming a loan syndicate requires a lot of 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.
So, it can be seen that loan syndication benefits lenders and borrowers. The lenders can share the risk while the borrowers benefit in less time and effort.
This is a guide to Loan Syndication. Here we also discuss the definitions, features, working, examples, and types along with advantages and disadvantages. You may also have a look at the following articles to learn more –