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Introduction to syndicate loan arrangements


Basics of Syndicated loan

When a group of lenders collectively extend loan to a single borrower, using a similar terms and conditions, documentation etc administered by common agent, it is called a syndicated loan. The group of lenders is called the syndicate. It is contrasted with a bilateral loan, which is extended by a single lender to a single borrower.

Generally, this loan is provided to corporations and government bodies because the amount to be lent is huge. Syndicate loans are common for financing projects or meeting working capital requirements of a business. Syndicated loans are primarily given by the banks, but these days non-banking entities such as financial institutions, mutual funds, insurance companies, pension plans and hedge funds can also participate (i.e. lend a portion of the loan) in such transactions. 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 and legal requirements involved in the sanction and disbursal of loan. There is a lot of negotiation involved as well. The whole process of obtaining a syndicated loan is quite complex and involves multiple parties and execution of numerous agreements.
Why should a business opt for syndicated loan? What are the benefits of a syndicated loan?
  • Reduction of risk (for individual lenders) - As the size of the loan is huge and a single bank cannot bear the whole risk of lending, syndicated loan helps in getting the risk diversified.
  • Simplified process to find lenders (for borrower) - The process of syndication starts with an invitation for bids from the borrower. The borrower mentions the funds requirement, currency, tenor etc., thereafter the mandate is given to a particular bank or an institution that will take the responsibility of syndicating the loan by arranging for financing the banks, thus reducing the burden of the borrower to find multiple lender to meet its capital requirements.
  • Better chances and assurance of obtaining the loan (for a borrower) - Syndication is done on a best effort basis or on underwriting basis by a lead banker, which will either put its best effort to obtain the whole loan amount from other lenders, or will underwrite the rest of the amount which could not be raised from other lenders. The lead manager has a dual role i.e. formation of syndicate documentation and loan agreement.
  • Payment and repayment process is faster, certain and allows flexibility (for both borrower and lender) - The advantages of syndicated loans are the size of the loan, speed and certainty of funds, maturity profile of the loan, certain amount of flexibility in repayment, lower cost of funds, diversity of currency, simpler banking relationships and possibility of renegotiation. Even lenders have the option to sell or assign their portion of the loan to other interested lenders.

Different parties involved in a syndicated loan

Borrower- The person or institution which is in need of a loan and initiates the process is the borrower. 
Arranger/ Lead managers- Generally one of the lenders (mostly a bank) who forms a syndicate. He communicates, negotiate and lure financial institutions to join the syndicate. Also suggests the borrower which facility it requires and help it in negotiating the terms of the facility.  This bank charges arrangement 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.
Co-arranger – Sometimes, the arranger may not be enough and may appoint a co-arranger who will also jointly help it in syndicating the loan.
Agent- The agent is one of the lending banks, and typically looks after the day–to- day working and administration of the loan facility. It acts as an agent of the lenders not borrowers. The lending banks enforce the responsibility of monitoring compliance with the provisions of the loan agreement on the agent bank. Under certain circumstances the banks may be required to take decisions based on a majority – for example, declaration of an event of default (on a collective basis) may be based upon a collective decision of all the banks. In such cases the agent may be required to coordinate lender actions, communicate with the borrower and manage related administrative processes related to the operational aspects of the loan. The agent also collects payments from the borrower, on behalf of the individual lenders – it then transfers the amounts to the individual lenders.

Security Trustee – While the security trustee and agent may be different parties, often the agent is also accorded the responsibility of a ‘security trustee’. The role of the trustee is especially important in a secured loan – as the trustee is placed in charge of the security and is required to take necessary enforcement actions in the event of a default (depending on the decision of the lenders).  
Lending banks - The co-lenders would normally constitute a group of banks or other financial institutions who have contributed a percentage share towards the syndicated loan. Once these institutions have given their share of loan, and the syndicated loan agreement is signed; they usually take a more passive role in the project, relying on the competence of the Agent/Lead Manager to further their interests. These banks carry mostly the normal credit risk i.e. risk of default by the borrower. 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.
Process of syndication and the documentation to be made in each stage

There are three stages in a syndicated loan transaction, as explained below:

Stage 1 - Issuance of mandate letter to the arranger / lead bank - Once the need of credit has been realized by the borrower then it should approach a bank which is willing to take the lead in arranging the entire loan amount for the borrower. This is done through a ‘mandate letter’. The bank will use its networks to find other financial institutions which are willing to ‘participate’ in the loan. Once the lead bank is selected and mandated by the borrower, the lead bank has to undertake the appraisal process, design an appropriate loan structure, and develop a persuasive credit proposal.
The lead bank may assume the responsibility to take best efforts to find other banks who are willing to contribute to the loan, or ‘underwrite’ the loan (or a portion of it), which essentially means that in case of failure to convince other financial institutions to lend, the lead bank will lend the amount that it has underwritten (which can be the whole amount of the loan or a sizeable portion of it).
Important legal documentation needed in this stage
1) Mandate letter - To appoint an arranger the borrower sends a Mandate letter (also called as a commitment) letter to the arranger. The purpose of the mandate letter is to inform the arranging bank of the size of the loan required and the conditions that the borrower is tentatively looking at, so that the arranging bank can effectively channelize its network and resources to involve other financial institutions.
The content of a mandate letter is-

1)  An agreement with the arranging bank to underwrite or use best efforts to arrange.
2)  Titles of arrangers, commitment amounts required, exclusivity provisions.
3)  Broad duties and obligations of their lenders
4) Other terms relating to the syndication and relevant documents are also included. Typically, these could relate to can include preparation of an information memorandum, presentations for potential lenders and:
a) clear market provisions – borrowers have multiple strategies for raising finance. Once the borrower has instructed the arranger, the arranger will be adversely affected if the borrower subsequently adopts alternate routes (for example, if it attempts to issue bonds or debentures to the public). Clear market provisions give some protection to the arranger that the borrower will not use alternate mechanisms or sources to raise the finance that it needs.
b) Exclusivity provisions – The exclusivity clause states that the borrower will for a certain period of time negotiate exclusively with the lead bank for the syndicate finance facility (and not issue mandates to other banks for arranging the facility).
c) market flex provisions – post the financial crisis, arranging syndicated loans has become more difficult as availability of credit in the market (i.e. money available with banks and financial institutions for lending) has reduced. Therefore, arrangers may be required to put in more effort compared to what was originally contemplated to find willing lenders, and in some cases lenders may want a sweeter deal, even after they have agreed to the loan agreement. Market flex provisions allow certain provisions of the loan documentation to be amended subsequently (such as terms, pricing, or even amounts, in case the termsheet or the facility agreement permits) until the closing stage of the facility agreement. They may be triggered upon the decision of a predeterminate majority of the lenders.
Indian banks sometimes do not use these terms – these are more likely to be used by foreign banks which have Indian presence or in syndicate loan agreements which have offshore banks lending.
2) Information Memorandum - Generally prepared by both, the arranger and the borrower and is sent to the potential syndicate members containing necessary disclosures about the borrower. The arranger assists borrower in drafting this memorandum. They mention the important description about the borrower’s business (mentioned above) and details of proposed facilities. In case the syndicated loan is obtained for a project (such as construction of a port / road / dam or other infrastructural facility) , details of the project must also be included. Unlike a prospectus of a company that intends to listing, the information memorandum for a syndicated loan is not public but is confidential and all potential lenders who wish to see it usually sign a confidentiality agreement beforehand.   
3) Term Sheet The borrower and the lead bank agree to a tentative termsheet – the other lenders must create a termsheet which is aligned to this as far as possible, because incorporating major differences may involve extensive negotiation and transaction costs. When Indian banks disburse a syndicated loan (e.g. imagine a rupee loan to which several Indian banks have contributed) the loan approval document from the bank is referred to as the ‘sanction letter’ instead of the termsheet. The termsheet / sanction letter contain broad terms related to the financing - it is usually attached and signed with the Mandate Letter.
Stage 2 – Execution of final legal documentation and disbursement of loan
At this stage, the lead bank can start to sell the loan in the marketplace i.e. to prospective participating banks. Arranger should make sure that the client company has complied with all the necessary formalities.  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. The project will be appraised and sanctioned under ‘single window’ concept method of dispensing of credit. 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 for any other purpose.

Important documentation - Syndicated Loan / Facility Agreement: The loan agreement in which the detailed terms and conditions of the facility is made available to the borrower. The agents have to follow up the sanction of the loan amount by the lender. The Appraising Institute (who appraises the project) takes the matter to its board of directors or its office may put the proposal with full appraisal note before the sanctioning authority for according necessary sanction.  Then the financial institution informs the applicant borrower of such sanction along with the detailed terms and conditional and arrangements of other lenders. The sanction letter mainly covers amount of loan, interest, commitment, charge security for the loan conversion option, repayment of loan etc.
Stage 3 – Disbursement of loan on fulfilment of CPs
Although the facility agreement is signed, the loan may be disbursed only upon obtaining various shareholder and other approvals and satisfactory resolution of issues identified in the due diligence. Sometimes, regulatory approvals may also be necessary. These terms are typically added as ‘conditions precedent’ to the transaction – this implies that although the legal documentation is signed, the loan will not be disbursed until these conditions are fulfilled. The loan is disbursed only after these conditions are satisfied.
Stage 4: Post-closure stage
This is monitoring and follow-up phase. The ‘security trustee’ or the agent bank is responsible as a central point of communication, for administering the processes of the loan and taking any action in case of default in repayment to any participating bank.

Note on types of security

In case of large scale government projects, typically a separate entity (into which various entities have together contributed capital) undertakes the project – this is known as a Special Purpose Vehicle or SPV. As a precondition to project financing (such as financing a real estate or infrastructure project), apart from creation of security over land, plant and machinery, lenders may require control over the ‘receivables’ that is, all future income of the entity. In such cases the receivable are placed in an escrow account, where the money will be held and cannot be taken out without the lender’s permission. The 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 situation, the agent is involved in the day-to-day administration of the loan facility.

However, in a typical loan, the lenders do not take control of the receivables. In case of a term loan, they take a first charge on the fixed assets and a second charge on the movables (such as inventory, bank accounts and future receivables of the company) – this second charge is taken by way of hypothecation. In case of a working capital facility (extremely short term finance), lenders take a first charge on the movables (inventory, bank account and future receivables) and a second charge on the fixed assets. However, no ‘control’ or regulation is sought of the movables in either case, since these vary from day-to-day.
How do banks earn money on syndicated transactions? Understanding different kinds of fees for syndicated loans

While traditionally the cost of the loan is identified by the interest rate that is charged by a bank, a bank tends to levy several other ‘fees’ and charges for providing credit facilities, which are explained below. These add to the cost of the loan for a borrower. There are additional categories of charges in case of a syndicated loan.

Note that when the loan is taken from a foreign bank, it must adhere to certain requirements under the ECB regulations, which place a cap on the total cost of the loan. This cap is known as the ‘all-in-cost’ ceiling.

1)  Arrangement fee - Fee paid to the bank for arranging syndication, which includes structuring, syndicating and negotiating the documentation.

2)  Underwriting fee- Underwriting fee is money collected by underwriters for performing underwriting services (where underwriting is involved). 

3)  Participation fee- Fee paid to the bank for joining the syndicate process and is paid according to the commitment of the loan given by the bank.
Types of fees and bank charges
  • Commitment fee – Sometimes the borrower may not avail of the entire amount that is granted by a term loan or a revolving loan. For a bank, this can be a financial cost – it has to be release the money but in case the borrower does not take it, the bank stands to lose interest charges. Therefore, the commitment fee is a way to compensate the bank for this.  It is usually half of the margin. Sometimes, it may also be determined as a function of the level of utilization of the loan. 
  • Facility fee – It is charged on commercial paper, letters of credit or back-stop facilities (like underwriting or guarantee transactions). It is not like commitment fee and is payable in full amount regardless of the utilization. 
  • Management fee  The lead manager or arranger has certain duties to manage the overall loan transaction and the relationships amongst the various participants over the duration of the loan. Management fee is paid to the lead manager or arranger for this purpose. 
  • Agent fee- The fee paid to the agent for its services. Details of these fees are usually put in separate side letters to ensure confidentiality. The Loan Agreement should refer to the Fee Letters and when such fees are payable to ensure that any non-payment by the borrower carries the remedies of default set out in the Loan Agreement.

In case of a syndicated loan with foreign banks, the all-in-cost ceilings prescribed by RBI become relevant (see the chapter on external commercial borrowings for a detailed discussion of these – for an example, see the RBI Master Circular on External Commercial Borrowings, 2013, here). All-in-cost ceilings include, apart from the rate of interest, other fees and expenses in foreign currency. However, commitment fee, pre-payment fee, and fees payable in Indian Rupees are not included.

What is the interest rate charged by the banks on the syndicated loan dependent on?

The interest charged by banks on a syndicated loan facility is dependent on the following factors:
  • Amount of risk involved- whether the borrower is sovereign entity, public sector undertaking, ordinary public company, a joint venture or a private sector entity.
  • What is the industry or activity of the company? Is the turnover fairly consistent?
  • The credit rating of the country (in an international loan)
  • The credit rating of the borrower/ group
  • Average life span of the loan
  • Whether repayment is to be made in a ‘bullet’ down-payment, that is, where principal is repaid all at once, or whether it is amortised over a period of time.

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