Syndication of Loan: Meaning and How it works?
The syndication of loans can provide a means for your business to scale its operations. But what is loan syndication? It’s a structured loan arranged by a group of lenders or banks to cater to your large fund requirements. In this article, we are going to discuss – the meaning of ‘syndication of loan’, its features, need, and also how does it work.
Loan syndication – meaning
Loan syndication deals with securing a term loan agreement from financial institutions and banks to fund a company’s project. Loan syndication is done mostly when a borrower needs a loan amount that is too big for a single bank to provide.
For instance, a firm may seek corporate loans for a variety of reasons like mergers, acquisitions, buyouts, and other capital expenditure projects. The loan amount is beyond the scope of a single lender’s risk exposure levels and, therefore, a bunch of banks/lenders fund various segments of a loan of an individual borrower.
Multiple lenders form a loan syndicate to provide the requested capital to the borrower. There is always a syndicate agent (often known as a lead bank) that organizes the loan, its terms and conditions, and other relevant information.
Thus, loan syndication is, in essence, a tie-up of long-term loans from different financial institutions.
How does loan syndication work?
Syndication of loan can be done in either of the following two ways:
First (Borrower himself): The borrower directly submits the request for a loan to the lead bank for a specific industry. The loan syndication shall be arranged automatically through the lead institution which, on its own, would like the other financial institutions to engage in offering financial assistance to the borrower.
Second (Taking recourse of a merchant banker): The borrower hires a merchant banker to organize loan syndication. It is the responsibility of the merchant banker to approach financial institutions to determine the likelihood of securing a loan from such financial institutions for a specific industry. Upon obtaining a positive response, the merchant banker shall submit the formal details or application form to the lead bank on behalf of the borrower. In this situation, the borrower does not need to contact multiple financial institutions, on its own.
What are the features of ‘syndication of loan’?
A syndicated loan is characterized by the following features:
- ‘Syndication of loan’ is an essential source of debt financing for corporates.
- The key purpose of syndicated lending is to distribute the risk of default by borrowers among many lenders or banks or institutional investors.
- The rate of interest on a syndicated loan may be fixed or variable, based on a benchmark rate such as the Marginal Cost of Funds based Lending Rate (MCLR) implemented by RBI.
- The lead bank may have a proportionally greater share of the loan and may undertake duties such as dispersing cash flows among the other parties of the syndicate and administrative tasks.
- There is one uniform loan agreement for the entire loan syndicate. Also, barring collateral requirements, most of the terms are uniform among all lending participants. For each lender, collateral securities are usually assigned to different assets of the borrower.
Who are the various participants in loan syndication?
Borrower: The borrower could be a corporate, a large project, or a government undertaking.
Merchant banker: A merchant banker functions as a facilitator in the transaction. Merchant bankers get a fee as is equivalent to a specific % of the amount of loan arranged.
Syndicate agent/Lead bank: The syndicate agent is often responsible for the initial transaction, fees, entire structuring of loan, coordination between all the lending parties and the borrower, compliance reports, monitoring of the loan, and overall reporting for all lending participants. (Source)
Participating banks: All the lending parties who lend a certain earmarked proportion of the total loan amount.
Why loan syndication?
Some of the advantages of syndication of loan can be:
- Any corporation or a large infrastructure project may avail of a syndicated loan.
- Syndication of loans aids in minimizing the risk any lender or financial institution might have to take.
- Lenders would prefer to be distributed than take the whole big risk themselves.
- Banks in a loan syndicate share the risk and are only exposed to their portion of the loan. It means each lending institution’s liability is restricted to their respective share in the loan interest.
- ‘Syndication of loan’ ensures great visibility of borrowers in the open market.
- Syndicate banks also share feedback on business issues.
Loan syndication process
The following is the checklist of formalities involved in the process of loan syndication:
1. Preparation of project details
2. Selection of financial institutions for loan syndication
3. Preparation of loan application
4. Issue of sanction letter of intent from the financial institutions
5. Compliance of terms and conditions for the availing of the loan
6. Documentation of the loan
7. Disbursement of the loan
- The borrower (himself or through the help of a merchant banker) prepares a detailed project report and submits a credit request to the financial institutions.
- This stage entails the borrower either linking to a single lender or inviting tenders from multiple lenders.
- The lead bank gets selected and mandated by the borrower.
- The lead bank analyses the needs of the borrower and designs an appropriate loan structure.
- The lead bank approaches some selected banks and invites participation.
- The lead bank requires the borrower to submit requisite information for the loan in a prescribed application form which is thoroughly scrutinized by all participants at individual levels and discussed in inter-institutional meetings.
- After the officers of all financial institutions satisfy themselves of the project’s viability, the loan proposal is submitted to the sanctioning authority and it is after this sanction that the formal letter of intent is issued to the borrower.
- A corporate borrower may also need to rely on the services of a legal counsel or risk manager to enforce loan covenants, pen down contractual obligations, conduct due diligence, and reduce misunderstandings between the lending parties and loan recipients.
- The arranging bank/syndicate agent also prepares a term sheet, information memorandum, and legal documentation to specify the financial terms negotiated with the borrower.
- On complying with the terms and conditions of the loan, the borrower avails of the loan amount in suitable installments as per the project details agreed to by the participants.
- Loans are then disbursed.
- The borrower also can avail of a bridge loan against the sanctioned amount of the loan.
Post- closure stage:
- The syndicate agent manages the operation and running of the loan facility.
- It monitors the escrow account of the borrower.
- An escrow account is an account in which the borrower deposits his/her revenue and the agent ensures that the loan repayment is given due priority over the payments to any other parties.
The table below shows how ABC company’s fund requirement is met by a lead bank (Bank A) and four other lending participants:
|Amount of loan required||Mode||Conglomerate of banks|
|Company ABC = Loan requirement = $1 billion||Loan syndicate||Bank A (lead bank) = finances $300 million |
Bank B = finances $200 million
Bank C = finances $100 million
Bank D = finances $250 million
Bank E = finances $150 million
Many big corporations opt for syndication of their loans worldwide. In November 2017, Yes Bank had obtained debt finance through a 5-year syndicated loan led by CTBC Bank, Bank of Taiwan, Mega International Commercial Bank, and Land Bank of Taiwan (four lead banks) along with other lending participants. The aggregate amount of the loan raised from these Taiwanese banks was $400 million. Further, Yes Bank had also raised $150 million from a 1-year syndicated loan led solely by Bank of Tokyo, Mitsubishi (along with 8 banks).
A few top Indian banks that arrange for syndicated loans are State Bank of India, IDBI Bank, Axis Bank, and ICICI Bank.
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