SYNDICATE LOANS: An Overview

A syndicated loan is one that is provided by a group of lenders and is structured, arranged, and administered by one or several commercial banks or investment banks known as arrangers.

The main goal of syndicated lending is to spread the risk of a borrower default across multiple lenders (such as banks) or institutional investors like pensions funds and hedge funds. Because syndicated loans tend to be much larger than standard bank loans, the risk of even one borrower defaulting could cripple a single lender. Syndicated loans are also used in the leveraged buyout community to fund large corporate takeovers with primarily debt funding.

Loan syndication - the sources of funds

Loan syndication in the case of domestic borrowings is undertaken with the institutional lenders and the banks. Amongst institutional lenders , the following institutions are the main suppliers of long and medium term funds with which the merchant bankers contact liaison and arrange loans , working for and on behalf of the clients.

A. Some of the All India Financial Institutions  include:

i)       Industrial Finance Corporation of India (IFCI)

ii)      Industrial Development Bank of India (IDBI)

iii)    Industrial Credit and Investment Corp. of India (ICICI)

iv)    Industrial Reconstruction Bank of India (IRBI)

B. State financial institutions like :

i)       state financial Corporations(SFCs)

ii)      State industrial development corporations(SIDCs)

iii)    State Industrial and Investment Corp. (SIICs)

are also approached by the merchant bankers

C. All India level investment institutions also help in the process . They include ;

i)       Life Insurance Corp. of India

ii)      Unit Trust of India

iii)    General Insurance Corp. of India an its subsidiaries.

D. Commercial Banks

Commercial banks join consortium financing with All India financial institutions to provide medium term loans to industrial projects , otherwise they cater to the needs of working capital requirements .

Loan Syndication - the process

Project details and estimated capital requirements

The service of loan syndication fixes up the responsibility upon the merchant bankers to help the company in availing the credit finance. Hence the merchant bankers should have correct assessment of the projects , products, promoters, project cost and profitability projections based on sales forecasts. In this direction the merchant baker has to take the following steps :

a)     Initial discussions with promoters

The initial discussion should be devoted to know the following aspects :-

·         background of the promoters in detail

·         promoters contribution to the project

·         details about the project report and

·         progress of the project.

b)     assessment of project

An estimate of the capital cost of the project should be worked out to find out its long term feasibility and whether the merchant bankers should actually go in for the project.

Locating sources of funds

The choice for sources of funds will depend upon the following :-

i)       nature of the project

ii)      quantum of the project costs

Sources of funds can be divide into three categories :

i) Short term finance where the funds are required upto a period of 1 year. Such finance is required to meet the working capital requirements or special seasonal needs. These are available from commercial banks , trade credit , public deposits , business finance companies and also from customers.

ii)   Medium term finance where the funds are needed for a period of 1-5 years. Such finance is needed to provide funds for permanent working capital , expansion or replacement of assets etc. These are available from SFCs , commercial banks and All India Financial Institutions through special schemes.

iii)   Long term finance where the funds are needed for a period of more than 5 years.  One term funds could be borrowed from international institutions where merchant bankers an play a constructive role through loan syndication services.

Loan Syndication - the instruments

There are several main groups of instruments on offer in the syndicated loan market :

•Term loan : This type of loan is fully drawn and is either repaid in full at maturity (bullet payment) or repayments may start before the final maturity (staged repayment). The borrower has a right to call all or part of the loan at any time without paying penalty, but it cannot redraw any part it has canceled.

•Revolving credit facility : A revolving credit facility gives the borrower more flexibility about how much principal can be outstanding during the loan’s life.

•Evergreen facility : A loan that can be extended after pre-set periods. For example, a five year evergreen loan could be extendible every year for another five years.

•Back-stop facility : A back-stop facility protects a company against liquidity crunch; it is a loan designed to be drawn only as the last resort. Many borrowers regard back-stop as an insurance policy in case they suffer temporary shortfalls in funds or a failure of one of their normal funding sources. Most back-stops also include a swingline facility, which gives the borrowers the "same day money".

Loan syndication - the advantages

•Cost of funds :

This mode of financing is cheaper than their average cost of funds raised through a series of bilateral loans. The cost saved increases as the amount required increases.

•Maturity Profile :

These facilities have a wide maturity range starting from an year to 20 years.

• Diversity of credit risk : Banks are also prepared to lend to non-investment grade companies, to borrowers not rated and to borrowers who are starting operations. Another advantage is that the banks will consider and price a range of credit enhancements, such as security over assets, off-balance sheet structures, security over property and using offshore vehicles to channel cash flows; which reduces funding costs for non-investment grade borrowers.

• Confidentiality : Confidentiality of the process can be ensured.

•Size : Funds larger than $1 billion have been raised by syndicated loan market. A case in point is the Hanbo Steel Company of S.Korea which raised close to $5.8 billion through syndicated loans to finance its expansion and modernisation.

•Speed and certainty : Once a borrower has mandated a group of banks to underwrite a loan it can be certain that it will have the funds it requires and on the terms it needs.

• Flexibility : Unlike highly standardised debt markets, banks are willing to price a wide range of transactions incorporating non-standard cash flow. A borrower can incorporate a variety of instruments like multi-currency options, risk management techniques and pre-payment of the loan in advance without paying a fee.

•Currency : Most bank lenders, provide freely convertible currencies while international bank markets change their positions regularly and are generally reluctant to buy bonds in a currency that is weakening.

•Renegotiation : Renegotiation may be possible under certain situation