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Meaning of the term Loan

A loan is a type of debt. All material things can be lent. Like all debt instruments, a loan

entails the redistribution of financial assets over time, between the lender and the

borrower. It is also defined as:-

Something lent for temporary use.

A sum of money lent at interest.

-Loan is an advance paid by the bank to the customer either with security or without

security is called as loan. If a loan is given without security it is called as an advance. It is

given for a fixed period of time and aggregate rate of interests. Repayments are spread

over from a period of 1-5 years. It is also known as demand loan and it is repayable on

demand.

-The loans are granted to meet long term working capital needs and for expansion and

modernization. Interest is charged on the actual amount sanctioned, whether withdrawn

or not. Loans may be short-term, medium-term or loan term. Long term loans are

generally for meeting the working capital requirements. Such loans are also called as

term loans. When a loan is meant for meeting both fixed and working capital

requirement of a borrower, it is called as a “Composite loan”.

Advantages of the loan system are as follows:-

Financial discipline on the borrower

Periodic review of local Account

Profitability

The system is quite simple

It is given for a fixed period and specific purpose.

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INTRODUCTION TO LOAN SYNDICATION

Loan syndication refers to services rendered by an organization in arranging and

procuring credit from financial institutions, banks, other lending and investment

companies for financing the project or meeting the working capital requirements.

The loan syndication work involves identification of sources where from funds

would be arranged, approaching these sources with requisite application and

supporting documents and complying with all the formalities involved in the

sanction and disbursal of loan.

Syndicated loans provide borrowers with a more complete menu of financing

options. In effect, the syndication market completes a continuum between

traditional private bilateral bank loans and publicly traded bond market.

Loan syndications are responsible for arranging co-financing with commercial

banks and other financial institutions directly or indirectly with export credit

agencies (ECA‟S).

Loan syndications have chosen a flexible and market oriented approach.

Loan syndication refers to assistance rendered by merchant banks to get mainly

term loans for projects. Such loans may be obtained from a single financial

institution or a syndicate or consortium.

Meaning of syndication

An association of individuals formed for the purpose of conducting a particular

business or a joint venture.

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Pooling of resources by financial institutions in a financing project to spread the

risk. Individual return from the investment is proportionate to the degree of risk or

amount of funds that each has put up or underwritten.

A syndicate is a general term describing any group that is formed to conduct some

type of business. For example, a syndicate may be formed by a group of

investment bankers who underwrite and distribute new issues of securities or

blocks of outstanding issues. Syndicates can be organized as corporations or

partnerships.

A Syndicated loan (or‟ syndicated bank facility‟) is a large loan in which a group

of banks work together to provide funds for a borrower. There is usually one lead

bank (the "Arranger" or "Agent") that takes a percentage of the loan and

syndicates the rest to other banks. A syndicated loan is the opposite of a bilateral

loan, which only involves one borrower and one lender (often a bank or financial

institution.

A syndicate only works together temporarily. They are commonly used for large

loans or underwritings to reduce the risk that each individual firm must take on.

It can also be termed as an association of people or firms formed to engage in an

enterprise or promote a common interest or an association of people or firms

authorized to undertake a duty or transact specific business.

The cost of a syndicated loan consists of interest and a number of fees-

management fees, participation fees, agency fees and underwriting fees when the

loan is underwritten by a bank or a group of banks. Spreads over LIBOR depend

upon borrower's credit worthiness, size and term of the loan, state of the market

(e.g. the level of LIBOR, supply of non-bank deposits to the EURO banks,) and

the degree of competition for the loan.

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Features of Syndicated Loans

The syndicated loan is a financing method evolved from bilateral loan. Under the

arrangement of syndicated loan, one bank or several banks (as the arrangers) organize

other banks to grant loans to the same borrower under one loan agreement according to

agreed terms.

Syndicated loans have the following features:

Huge amount and long term loans.

Less pressure on banks and diversified risk.

As for the borrower, syndicated loans provide large amounts of loans with

longer term and easy operation management (only need to contact with the

agent bank).

Fewer restriction on the use of proceeds (compared with government loans

and export credit)

Easier management (Compared with loans borrowed separately from

different banks)

Syndicated loans can be structured to incorporate various options. As in the

case of FRS, a drop lock feature converts the floating rate loan into a fixed

rate loan if the benchmark index hits a specified floor. A multi-currency

option allows the borrower to switch the currency of denomination on a

rollover date.

Security in the form of government guarantee or mortgage on assets is

required for borrowers in developing countries like India.

Syndicated loan is more suitable as compared to a simple loan from single or

multiple banks.

The borrower does not have to deal with a large number of lenders.

It has permitted the issuers to achieve more market-oriented and cost-

effective financing.

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Loan syndications are a cost-effective method for participating institutions to

diversify their banking books and to exploit any funding advantages relative

to agent banks.

Syndicated loans have increasingly become the corporate financing choice of

large- and mid-size firms. As a result, syndicated lending has become a major

component of today's financial landscape.

Syndicated lending also allows banks to compete more effectively with

public debt markets for corporate borrowers. To a large extent, the

development of the loan syndication market has stemmed, if not reversed, the

trend toward disintermediation of corporate debt by reducing the differences

between intermediated and public debt markets.

STAGES IN SYNDICATION

Broadly there are three stages in syndication, viz., Pre-mandate phase, Placing the loan

and disbursement and post-closure stage.

1. PRE-MANDATE STAGE: -

This is the initiated by the prospective borrower. It may liaise with a single bank or it

may invite competitor‟s bids from a number of banks. The borrower has to mandate the

lead bank, and the underwriting bank, if desired. Once the lead bank is selected and

PRE-MANDATE STAGE

PLACING THE LOAN AND

DISBURESEMENT

POST-CLOSURE STAGE

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mandated by the borrower, the lead bank has to undertake the appraisal process. The lead

banks needs to identify the needs of the borrower, design an appropriate loan structure,

and develop a persuasive credit proposal.

2. PLACING THE LOAN AND DISBURSEMENT: -

At this stage, the lead bank can start to sell the loan in the marketplace i.e. to prospective

participating banks. This means that the lead bank needs to prepare an information

memorandum, prepare a term sheet, prepare legal documentation, approach selected

banks and invite participation. A series of negotiations with the borrower are undertaken

if prospective participants raise concerns.

To conclude this stage the lead bank must achieve closing of the syndication, including

signing. If need be, underwriting bank has to sign the balance portion of the loan.

Loan is disbursed in phases as agreed in the loan contract. Loan is disbursed in „no-lien‟

account i.e. a bank account created exclusively to disburse loan. This account and its

withdrawals are monitored by banks. This is to ensure that the loan is used only for the

purpose defined in the loan agreement and that the funds are not diverted to any other

purpose.

3. POST-CLOSURE STAGE:-

This is monitoring and follow-up phase. It has many times done through an escrow

account. Escrow account is the account in which the borrower has to deposit its

revenues and the agent ensures that the loan repayment is given due priority before

payments to any other parties. Hence in this stage, the agent handles the day-to-day

running of the loan facility.

Purpose for syndicated lending

Like insurance, a loan is an assumption of risk. For a certain class of loan, with certain

rules, the bank might believe that it is likely that 5% of all borrowers may go bankrupt. If

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the bank's cost of funds is a hypothetical 5%, the bank needs to charge more than 10%

interest on the loan to make a profit. In general, banks and the financial markets use risk-

based pricing, charging an interest rate depending on the risk of the loan product in

general or the risk of the specific borrower.

The problem with larger businesses loans, however, is that there are fewer of them. So, if

the bank has the only large business loan and if that business happens to be one of that

defaults, then the bank loses all its money. For this reason, it is in the best interest of all

banks to split, or "syndicate" their large loans with each other, so each get a

representative sample in their loan portfolios.

A second, often criticized reason for syndicating loans is that it avoids large or surprising

losses and instead usually provides small and more predictable losses. Smaller and more

predictable losses are favored by many management teams because of the general

perception that companies with "smoother" or steadier earnings are awarded a higher

stock price relative to their earnings (benefiting management who is often paid primarily

by stock). Critics, such as Warren Buffett however, say that many times this practice is

irrational. If the bank could still get a representative sample by not syndicating, and if

syndication would reduce their profit margins, then over the long term a bank should

make more money by not syndicating. This same dynamic plays out in the investment

banking and insurance fields, where syndication also takes place.

To avoid that the borrower has to deal with all syndicate banks individually, one of the

syndicate banks usually acts as an Agent for all syndicate members and acts as the focal

point between them and the borrower.

Advantages/Benefits of Syndicated Loans

In addition, economists and syndicate executives contend that there are other, less

obvious advantages to going with a syndicated loan.

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These benefits include:-

Syndicated loan facilities can increase competition for your business, prompting

other banks to increase their efforts to put market information in front of you in

hopes of being recognized.

Flexibility in structure and pricing. Borrowers have a variety of options in shaping

their syndicated loan, including multicurrency options, risk management

techniques, and prepayment rights without penalty.

Syndicated facilities bring businesses the best prices in aggregate and spare

companies the time and effort of negotiating individually with each bank.

Syndicate banks sometimes are willing to share perspectives on business issues

with the agent that they would be reluctant to share with the borrowing business.

Syndicated loans bring the borrower greater visibility in the open market. Bunn

noted that "For commercial paper issuers, rating agencies view a multi-year

syndicated facility as stronger support than several bilateral one-year lines of

credit."

Benefits to the borrower

Raising a loan which would exceed the capacity of a single bank.

Cutting down on management capacity since the borrower communicates only

with the arranger/agent.

Broadening the financing base through the participation of other banks.

Typically less costly than numerous lines through multiple institutions.

It helps to enhance broader financial relationships.

Deals with a single bank.

Quicker and simpler than other ways of raising capital. E.g. Issue of equity or

bonds.

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Benefits to the investor

Establishing direct relationships with new customers.

Enables much broader risk diversification without significant additional

marketing efforts.

Due to uniform documentation there is a better chance for a subsequent

placement on the secondary market.

Contract documents and information provided at no expense.

Benefits to the lead banks

Fund arrangement and other fees can be earned without committing capital.

Enhancement of bank‟s reputation.

Enhancement of bank‟s relationship with the client.

Benefits to the participating banks

Access to lending opportunities with low marketing/ processing costs.

It triggers more opportunities to participate in future syndications as network of

the banks establishes a level of comfort with each other.

In case the borrower runs into difficulties, participant banks have equal treatment.

Parties and their roles within the syndication process

The lead bank and participating banks are the main parties involved in loan

syndication. In large loan amounts, sometimes there are four parties involved, other than

the borrower, in the syndication process. These are arranger {lead manager/ bank},

underwriting Bank, Participating Banks and the facility manager {agent. their roles are

defined as follows:-

1. Arranger/lead manager: - It is a bank which is mandated by the prospective

borrower and is responsible for placing the syndicated loan with other banks and

ensuring that the syndication is fully subscribed. This bank charges arrangement

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fees for undertaking the role of lead manager. Its reputation matters in the success

of syndication process as the participating banks would agree or disagree based on

the credibility and assessment expertise of this bank. In other words, since the

appraisal of the borrower and its proposed venture is primarily carried out by this

bank, onus of default is indirectly on this bank. Thus this bank carries „reputation

risk‟ in the syndication process.

2. Underwriting bank: - Syndication is a process of arranging loans, success of which

is not guaranteed. The arranger bank may underwrite to supply the entire

remainder (unsubscribed) portion of the desired loan and in such a case arranger

itself plays the role of “underwriting bank”. Alternatively a different bank may

underwrite (guarantee) the loan or portion (percentage of the loan). This bank

would be called the “underwriting bank”. It may be noted that all the syndicated

loans may not have this underwriting arrangement .Risk of underwriting is

obviously the “underwriting risk”. It means it will have to carry the credit risk of

the larger portion of the loan.

3. Participating banks: - These are the banks that participate in the syndication by

lending a portion of the total amount required. These banks charge participation

fees. These banks carry mostly the normal credit risk i.e. risk of default by the

borrower. As like any normal loan. These banks may also be led into passive

approval and complacency risk. It means that these banks may not carry rigorous

appraisal of the borrower and has proposed project as it is done by the lead

manager and many other participating banks. It is this banker‟s trust that so many

high profile banks cannot be wrong. This may be seen in the light of reputation

risk of the lead manager.

4. Facility manager/agent: - Facility manager takes care of the administrative

arrangements over the term of the loan (e.g. Disbursements, repayments and

compliance). It acts for and on behalf of the banks. In many cases the

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arranging/underwriting bank itself may undertake this role. In larger syndications

co-arranger and co-manager may be used.

The Syndicated Loan Market

The syndicated loan market, a hybrid of the commercial banking and investment

banking worlds, is globally one of the largest and most flexible sources of capital.

Syndicated loans have become an important corporate financing technique,

particularly for large firms and increasingly for midsized firms. The rapid

development of the syndicated corporate loan market took place in the 1990s

exploring the historical forces that led to the development of the contemporary

U.S. syndicated loan market, which is effectively a hybrid of the investment

banking and commercial banking worlds. Syndicated lending aims to increase the

risks and benefits involved in taking part in the syndicated loan market.

There has been a notable change in large corporate lending over the past decade,

as the old bilateral bank-client lending relationships have been replaced by a

world that is much more transaction-oriented and market-oriented. The Canadian

syndicated loan market has been strongly influenced by its U.S. counterpart, but it

is not yet at the same level of development. It also explores potential risk issues

for the new corporate loan market, including implications for the distribution of

credit risk in the system, risks in the underwriting process, the monitoring

function, and the potential for risk arising from asymmetric information.

The development of the market for syndicated loans, and has shown how this type

of lending, which started essentially as a sovereign business in the 1970s, evolved

over the 1990s to become one of the main sources of funding for corporate

borrowers. The syndicated loan market has advantages for junior and senior

lenders. It provides an opportunity to senior banks to earn fees from their

expertise in risk origination and manage their balance sheet exposures.

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Throughout history, innovation has driven the development of the financial

markets, and over the last 20 years, the syndicated loan market has provided

particularly fertile ground for financial innovation. From a relatively esoteric field

involving commercial banks syndicating lines of credit, financial innovations

have helped it develop into a broad, dynamic market encompassing both an

efficient primary market that originates syndicated credits and a liquid secondary

trading market where prices adjust to reflect credit quality and market conditions.

The development of an efficient and liquid syndicated loan market in the U.S. has

greatly impacted its capital markets. The syndicated loan market bridges the

private and public fixed-income markets and provides borrowers with an

alternative to high yield bonds and illiquid bilateral commercial bank loans. It

provides much-needed credit to lower-rated companies and has strengthened the

bankruptcy process in the U.S. through its facilitation of DIP (debtor-in-

possession) lending.

Today‟s syndicated loan market benefits banks also; in times of adversity, they

can sell portions of the syndicated credits into a relatively liquid secondary market

and actively manage the risk in their loan portfolios. This allows banks to avoid

unnecessary lending restrictions when the economy contracts and thus the impact

of an inefficient “credit crunch.”

The development of the secondary market for syndicated loans has led to the

creation of a new asset class with greater return per unit of risk than many other

fixed-income assets and low correlations with most other classes of assets. The

leveraged portion of the market, the part of the market where most innovation has

occurred, receives special attention. Syndicated loans are an integral part of

capital rising for these markets.

This analysis provides a primer to investors and other parties interested in a

market that has, without great fanfare, been one of the most rapidly growing and

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innovating sections of the U.S. capital market in the past 20 years. It explores

issues related to the main features of the primary market using the most recent

data available and details the characteristics of the secondary market. Investment

returns, as well as the risks of the asset class, particularly credit risk, receive

special attention.

The syndicated loans market has grown rapidly in recent years, driven primarily

by an increase in corporate takeovers, private equity transactions and

infrastructure deals. Strong liquidity means there is plenty of cash to invest, and

banks are willing lenders.

The leveraged loan market remains small compared with the investment-grade

market and bankers said the investors and their attitudes were markedly different.

The volumes in the Indian offshore syndicated loan market have grown enough in

the past few years.

How the market works

Major corporate clients will almost automatically consider a syndicated loan for

sums above a few hundred million euros. Syndication splits the lending risk

between large number of investors, at price (margin and fees) determined by the

market. It is an efficient way of raising funds quickly and on best terms. For

borrowers the advantage is that they can raise larger amounts and expand their

group of bankers whilst at the Same time only having to sign a single contract

For lenders, syndication allows a diversification of the lending portfolio from both

a geographical and sectorial point of view. In addition, lenders get the benefit of

the facility agent‟s expertise in management of drawdowns and of other events in

the lifetime of the loan after the facility agreement has been signed.

The syndicated loan market was originally developed in the USA in the 1970‟s

as a means of financing leveraged buy-outs (LBOs). It has since gone on to

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become the leading vector for all sorts of financing. In Europe the market

expanded rapidly in the UK and then on the continent, particularly in France.

The market‟s rapid growth can be seen from the fact that in 1993 the total volume

of the market worldwide was USD 1.4. trillion, whereas in 2005 it exceeded USD

3 trillion (dialogic)

The rapid growth in syndicated facilities is certainly due in part to the trend over

the past fifteen years, across all sectors of the economy, towards industry

consolidation. For a borrower, the choice between a syndicated loan and

negotiable debt instruments often comes down in favor of the first. Syndicated

loans are the only means of raising, rapidly and with few formalities, sums greater

than are available on other markets, like bonds and equities, or through private

placements.

By taking full advantage of the syndicated loan market, some banks have

managed to make headway in increasing their returns and still offering the

borrowers some of the finest terms and conditions ever seen. Features of the

syndicated loan market such as transaction size, availability, speed of reaction and

flexibility ensure that it continues to be one of the primary sources for issuers

looking to raise capital from the markets. It will examine the needs of both

borrowers and lenders involved in the origination, structuring, distribution and

management of syndicated loans and link the process of executing a successful

deal to the optimal design of a syndications unit. Banks have benefited from this

broadening of the syndicated loan market in several ways. They are a cost-

effective method for participating institutions to diversify and exploit any funding

advantages relative to agent banks.

To a large extent, the development of loan syndication market has stemmed, if not

reversed, the trend toward disintermediation of corporate debt by reducing the

differences between intermediated and public debt markets.