What is “Loan Syndication?”
Loan syndication refers to a group of lenders who collaborate together to provide a single (usually large) loan to a borrower. The collaboration is usually through an intermediary (or lead financial institution), which organizes and administers the syndicated loan on behalf of other lenders in the syndicate. In loan syndication, the credit risk vis-à-vis the loan is spread among the group of lenders and each lender contributes to part of the loan amount.
The lead financial institution usually puts together a syndicated loan offering and gets other lenders (i.e. multiple lenders) together. Loan syndication is required when a company may be wanting a loan that is too large (for example, US$2 billion) for any single lender, or in such cases when a project is unusually large or complex, for example, an infrastructure project. It may involve a group of lenders (or investors) who specialize in a certain part of the project and bring their own expertise.
Usually, there is only one loan agreement for the entire syndicate and the primary (or lead) lender conducts the due diligence and oversees the contract and subsequent loan monitoring (to keep costs down). Each lender’s risk is usually limited to its share of the loan amount. Loans such as these tend to incur initial fees to set up and ongoing fees (to be paid by the borrower) and the primary lender usually takes a large proportion (if not all) of the initial fees to cover the work involved.
Key Learning Points
- Loan syndication is when a group of leaders comes together to offer a single loan to a business or the corporation
- Loan syndication is typical when the loan amount is either too large or too risky for a single lending institution to undertake alone
- There are three types of loan syndication: underwritten deal, best-effort syndication, and club deal
- In loan syndication, the lead bank identifies potential lending partners to fulfill the borrowing requirements of this company
Loan Syndication – Types
There are three types of loan syndication.
The first type is an ‘underwritten deal’ in which the lead bank, agent, or underwriter assumes most of the risk and takes on the entire issuance (i.e. guarantees the entire loan) with the expectation that they will place the loans successfully with other lenders i.e. the syndication. In other words, the lead institution syndicates the entire loan.
The second type of loan syndication is a ‘best effort syndication’ which is typically used for complex loans or risky credits. In this case, the lead bank or agent will only commit to raising what it can from its own contribution plus other lenders. It does not commit to or guarantees the entire loan amount. In this type of loan syndication, the borrower may have to accept a lower loan amount if the offer does not attract any further lenders. In some cases, the loan can be canceled entirely too.
The third type of loan syndication is the ‘club deal’. This type of syndication typically involves a smaller loan amount and the lead bank or agent and other lenders of the syndicate share equally, or nearly equal portions of the fees earned from the loan.
Loan Syndication – An Example
Given below is an example of loan syndication, where a company is seeking a loan of US$250,000. The company wants the total syndicated loan principal of US$250,000 to be disbursed in two tranches of US$125,000 each with a total tenor (or term) of six months.
In both the tranches, the company wants to draw down the amount in three stages on the dates specified in the table. Further, in both the tranches, the company wants to draw down 40%, 30%, and 30% of each tranche in three stages (i.e. months).
The borrower has a contract under the syndication agreement with the lead or arranger bank. Under this contract, the loan is disbursed to the company as drawdowns under the tranches as per the syndication agreement.
For the first tranche, where US$125,000 has to be disbursed, the lead or arranger bank (Bank A) now identifies Bank B and Bank C as the possible funding partners or sources from which funding can be obtained to meet the loan requirements of this company. The ratio of participation or the funding load that is proposed to be shared between these banks vis-à-vis the first tranche is 20%, 40%, and 40% respectively of the first tranche of US$125,000.
Next, for the second tranche, where US$125,000 has to be disbursed, the lead or arranger bank (Bank A) now identifies Bank D and Bank E as the possible funding partners or sources from which funding can be obtained to meet the loan requirements of this company. The ratio of participation vis-à-vis the second tranche is 20%, 50%, and 30% respectively of the second tranche of US$125,000.
The approved loan contributions of each bank in this syndicated loan would be credited to a common syndication pool before each drawdown is due (on the dates specified in both the tables).