Definition of Loan Syndication

Syndicated Loans and Other Banking Products

The most common form of international lending by commercial banks is the Syndicated Floating Rate Loan. This can be defined as a medium-to long-term financing provided by several banks with common loan documentation with a variable interest rate.

The most common pricing benchmark is the LIBOR (London Inter-Bank Offered Rate) in the relevant currency and the loan document states interest rate as LIBOR plus a margin or spread e.g. LIBOR + 1.5%.

A traditional syndicated loan is usually a floating rate loan with fixed maturity, a fixed draw-down period and a specified repayment schedule. A typical eurocredit would have maturity between five and 10 years, amortization in semiannual installments, and interest rate reset every three or six months with reference to LIBOR + 1.5%

A traditional syndicated loan is usually a floating rate loan with fixed maturity, a fixed draw-down period and a specified repayment schedule. A typical eurocredit would have maturity between five and 10 years, amortization in semi annual instalments, and interest rate reset every three or six months with reference to LIBOR.

In a standby facility, the borrower is not required to draw down the loan during a fixed, pre-specified period; instead, he pays a contingency fee till he decides to draw the loan at which time interest begins to accrue. Syndicated credits can be structured to incorporate various options. As in the case of FRNs, a drop-lock feature converts the floating rate loan into a fixed rate loan if the benchmark index hits a specified floor.

There are usually three categories of bank in a loan syndicate. There are lead banks, managing banks and participating banks. In large credits, there is a separate group called co-managers. This group comprises participating banks providing more than a specified amount of funds. Most loans are led by one or two major banks which negotiate to obtain a mandate from the borrower to raise funds. After the preliminary stages of negotiation with a borrower, the lead bank begins to assemble the management group, which commits itself to provide the entire amount of the loan, if necessary. Portions of the loan are then marketed to participating banks.

The lead bank assembles a management group to assure the borrower that the entire amount of the loan will be taken up. During this phase, the lead bank may renegotiate the terms and conditions of the loan if it cannot assemble a managing group on the initial terms. Many lead banks are willing to take more of the credit into their own portfolio than they had originally planned. The lead bank is normally expected to provide a share at least as large as any other bank. Once the lead bank has established the group of managing banks, it then commits the group to raise funds for the borrower on specified terms and conditions.

When the management group is established and the lead bank has received a mandate from the borrower, a placement memorandum is prepared by the lead bank and the loan is marketed to other banks which may be interested in taking up shares. Such lenders are termed the participating banks. The placement memorandum describes the transaction and gives information regarding the financial health of the borrower.

The lead bank bears the chief responsibility for marketing the loan. There are three main methods used to find participants for syndicated credits. Often banks contact the borrower expressing an interest in participating in a given credit. But the bulk of participants are banks invited by the lead bank to join the syndication. Each major bank maintains files on the syndicated lending activities of other banks. The files contain lists of banks that have joined various syndications. This information enables the loan syndication officers at the lead bank to estimate which banks might be interested in which borrowers.

When a bank is invited to participate in syndication, the amount and the terms and conditions it is being asked to accept are set out in a telex sent by the lead bank. These shortcuts the negotiation process and expedites the credit.

The lead bank usually offers to sell off more of the credit than it really wishes. An experienced lead bank can usually gauge the appropriate number of participation invitations to be extended. If the credit is attractive, fewer banks will be contacted. If the credit appears hard to place, a greater number of invitations will be sent out. If the loan is oversubscribed, the borrower is usually given the opportunity to borrow more money than initially negotiated on the same terms. If the borrower does not choose to take advantage of this, the amounts assigned to each bank are scaled down pro rata.

In a successful loan syndication, once the marketing to participants is completed, the lead and managing banks usually keep 50 to 75 per cent of their initial underwritten share. The lead bank is generally expected to take into its portfolio about 10 per cent of the total credit.

The most common type of syndicated loan is a term loan, where funds can be drawn down by the borrower within a specified time of the loan being signed – this is called the ‘drawdown period’. Repayments are subsequently made in accordance with an amortization schedule. For other loans, amortization may not commence until five or six years after drawing down the loan.

This kind of loan is termed a ‘bullet loan’. Loans which require repayment according to an amortization schedule and include a larger final payment on maturity are termed ‘balloon repayment loans’. The period prior to the commencement of repayment is termed the ‘grace period’. The extent of the grace period is usually a major negotiating point between borrower and lead bank. Borrowers are usually willing to pay a wider spread in order to obtain a longer grace period.

Syndicated loans of the revolving credit type are occasionally encountered. In these, the borrower is given a line of credit which it may draw down and repay with greater flexibility than under a term loan. Borrowers pay a fee on the undrawn amount of the credit line.

Additional to interest costs on a loan, there are also front-end fees, commitment fees and occasionally an annual agent’s fee. Front-end management fees are one-off charges negotiated in advance and imposed when the loan agreement is signed. These fees are usually in the range of 0.5 to 1 per cent of the value of the loan. The fees may be higher if a particular borrower insists upon obtaining funds at a lower spread than is warranted by market conditions and credit worthiness.

The relationship between spreads and fees is hard to quantify, as data on all fees are usually unobtainable. Lower spreads if compensated by higher fees, since they are interested in the total return on the loan. Some borrowers prefer to pay a higher fee, which is not published, while going on record as paying a low spread. Over time, demand and supply conditions determine both spreads and fees. During periods of easy market conditions, borrowers can command low fees and low spreads. During periods when banks are reluctant to extend credit, high spreads and high fees are the norm.

Front-end fees consist of participation fees and management fees. Each of these typically amount to between 0.25 and 0.5 per cent of the entire amount of the loan.

In addition to front-end fees, borrowers may pay commitment fees. These fess are charged to the borrower as a percentage of the undrawn portion of the credit in return for the bank typing up part of its credit capacity on behalf of the borrower. Commitment fees of 0.375 to 0.5 per cent per annum are typically imposed on both term loans and revolving credits. The agent’s fee, if applicable, is usually a yearly charge.

In order to protect their margins, basis usually require all payments of principal an interest to be made after taxes imposed have been paid. If those taxes are not creditable against the banks’ home country taxes, the borrower must adjust payments so that the banks receive the same net repayment. The decision as to whether the borrower or lender absorbs any additional taxes imposed by the country in which the loan is booked is negotiated between the parties. Additionally, a reserve requirement clause is inserted, stipulating that an adjustment will be made if the cost of funds increases because reserve requirements are imposed or increased.

There is generally no prepayment penalty on Eurocredits. The charges on syndicated loans may be summarized as follows:

Annual payments = (LIBOR + spread)

X amount of loan drawn down and outstanding

+ commission fee X amount of loan undrawn

+ annual agent’s fee (if any)

+ tax adjustment (if any)

+ reserve requirement adjustment (if any)

Front-end charges = lead bank praecipium X total amount of loan

+ participation fee X face amount of loan

+ management fee X face amount of loan

+ initial agent’s fee (if any)

Exchange Markets vs. Currency Markets

In the foreign exchange market, one currency is exchanged for another currency at a rate of exchange which is the price in terms of the number of units of the currency exchanged for one unit of the latter. On the other hand, the price paid for borrowing or lending a currency in the international currency market is the rate of interest. The purpose for which currencies are exchanged in the foreign exchange market or borrowed in the international currency market may be the same.

Dealers in the Market

International banks or multi-national banks and foreign branches of domestic banks, private banks, merchant banks and other banks are the main dealers in this market. In fact, most of the US banks deal in this market. The market is of a wholesale nature, highly flexible and competitive and well-connected in the world over by a wide network of brokers and dealers. London is the focal centre for the Euro-dollars as Singapore is the focal centre for Asian-dollars. There are a number of centres in both West and East, namely, Zurich, Luxembourg, Paris, Tokyo, Hongkong, Manila, etc.

The International Bond Market

Money may be raised internationally by bond issues and by bank loans. This is done in domestic as well as international markets. The difference is that in international markets the money may come in a currency which is different from that normally used by the borrower. The characteristic feature of the international bond market is that bonds are always sold outside the country of the borrower. There are three types of bond, of which two are international bonds. A domestic bond is a bond issued in a country by a resident of that country. A foreign bond is a bond issued in a particular country by a foreign borrower. Eurobonds are bonds underwritten and sold in more than one country.

A foreign bond may be defined as an international bond sold by a foreign borrower but denominated in the currency of the country in which it is placed. It is underwritten and sold by a national underwriting syndicate in the lending country. Thus, a US company might float a bond issue in the London capital market, underwritten by a British syndicate and denominated in sterling. The bond issue would be sold to investors in the UK capital market, where it would be quoted and traded. Foreign bonds issued outside the USA are called Yankee bonds, while foreign bonds issued in Japan are called Samuri bonds. Canadian entities are the major floaters of foreign bonds in the USA.

A Eurobond may be defined as an international bond underwritten by an international syndicate and sold in countries other than the country of the currency in which the issue is denominated.

In the Eurobond market, the investor holds a claim directly on the borrower rather than on a financial institution. Eurobonds are generally issued by corporation and governments needing secure, long-term funds and are sold through a geographically diverse group of banks to investors around the world.

Eurobonds are similar to domestic bonds in that they may be issued with fixed or floating interest rates.

Characteristics

The issuing technique takes the form of a placing rather than formal issuing, this avoids national regulations on new issues.

Eurobonds are placed simultaneously in many countries through syndicates of underwriting banks which sell them to their investment clientele throughout the world.

Unlike foreign bonds, Eurobonds are sold in countries other than that of the currency of denomination; thus dollar – denominated Eurobonds are sold outside the U.S.A.

The interest on Eurobonds is not subject to withholding tax.

There are a number of different types of Eurobond. A straight bond is one having a specified interest coupon and a specified maturity date. Straight bonds may be issued with a floating rate of interest.

Such bonds may have their interest rate fixed at six-month intervals of a stated margin over the LIBOR for deposits in the currency of the bond. So, in the case of a Eurodollar bond, the interest rate may be based upon LIBOR for Eurodollar deposits.

A convertible Eurobond is a bond having a specified interest coupon and maturity date, but it includes an option for the hold to convert its bonds into an equity share of the company at a conversion price set at the time of issue.

Medium-term Euronotes are shorter-term Eurobonds with maturities ranging from three to eight years. Their issuing procedure is less formal than for large bonds. Interest rates on Euronotes can be fixed or variable. Medium-term Euro-notes are similar to medium- term roll-over Eurodollar credits. The difference is that in the Eurodollar market lenders hold a claim on a bank and not directly on the borrower.

The issue of Eurobonds is normally undertaken by a consortium of international banks. A record of the transaction called a ‘tombstone’ is subsequently published in the financial press. Those banks whose names appear at the top of the tombstone have agreed to subscribe to the issue. At a second level, a much larger underwriting syndicate is mentioned.

The banks in the managing syndicate will have made arrangements with a worldwide group of underwriters, mainly banks and security dealers. After arranging the participation of a number of underwriters, the managing syndicate will have made a firm offer to the borrower, which obtains the funds from the loan immediately. At a third level, the underwriting group usually arranges for the sale of the issue through an even larger selling group of banks, brokers and dealers.

The Advantages of the Eurobond Market to Borrowers

The Eurobond market possess a number of advantages for borrowers

The size and depth of the market are such that it has the capacity to absorb large and frequent issues.

The Eurobond market has a freedom and flexibility not found in domestic markets.

The cost of issue of Eurobonds, around 2.5 per cent of the face value of the issue.

Interest costs on dollar Eurobonds are competitive with those in New York.

Maturities in the Eurobond market are suited to long-term funding requirements.

A key feature of the Eurobond market is the development of a sound institutional framework for underwriting, distribution and placing of securities.

The Advantages of Eurobonds to investors

Eurobonds are issued in such a form that interest can be paid free of income or withholding taxes of the borrowing countries. Also, the bonds are issued in bearer form and are held outside the country of the investor, enabling the investor to evade domestic income tax.

Issuers of Eurobonds have well reputation for credit worthiness.

A special advantage to borrowers as well as lenders is provided by convertible Eurobonds. Holders of convertible debentures are given an option to exchange their bonds at a fixed price.

The Eurobond market is active both as a primary and as a secondary market.

Some Terminology used in International Finance Market

American depository receipt (ADR): Certificate of ownership issued by a US bank to investors in place of the underlying corporate shares, which are held in custody.

Bond: A promise under seal to pay money. The term is generally used to designate the promise made by a corporation, either public or private, to pay money, and it generally applies to instruments with an initial maturity of five years or more.

Eurobond: A bond underwritten by an international syndicate of banks and marketed internationally in countries other than the country of the currency in which it is denominated.

Eurocommercial paper: A generic term used to describe Euronotes that are issued without being underwritten.

Eurocredit: The Eurocredit market is where highly rated borrowers can gain access to medium-term bank lending. The loan can be denominated in one or several Eurocurrencies as can the interest and the principal. The interest rate is normally fixed as a margin over LIBOR.

Eurocurrency: A time deposit in a bank account located outside the banking regulations of the country which issues the currency.

Eurodollars: Dollars held in time deposits in banks outside the United States. These banks may be foreign owned or overseas branches of US banks.

Euromarkets: A collective term used to describe a series of offshore money and capital markets operated by international banks. They comprise Eurocurrency, Eurocredit and Eurobonds markets. The centre of these markets is London, except for Euro-sterling market which is centred in Paris.

Euronote: The Euronote market is one in which borrowers raise money by the issue of short-term notes, generally with maturities of three and six months, that are negotiable like certificates of deposit. As one issue of notes matures, the borrower issues some more so that, while the holders of the debt change over time, the total amount outstanding can be maintained in the medium term. A group of commercial banks may ensure that the borrower in a particular issue will be able to place such notes by standing by ready to purchase the paper should the appecite of short-term investors wane.

Euro-note facility: This allows borrowers to issue short-term notes through a variety of note distribution mechanisms, under the umbrella of a medium-term commitment from banks.

European Monetary System (EMS):A structure of agreements governing the exchange market activities of participating members of the European Union. Agreements require members closely to manage the exchange values of their currencies relative to those of other members.

Floating exchange rate system: A system in which the value of a currency relative to others is established by the forces of supply and demand in the foreign exchange markets.

Floating or variable rate interest: Interest on an issue of securities which is not fixed for the life of the issue, but is periodically set according to a predetermined formula. The rate is usually set at a margin or spread in relation to a specified money-market rate, such as LIBOR.

Floating rate note (FRN): A short-term floating interest rate security. The interest rate is pegged to LIBOR, and is adjusted semi-annually. These securities are attractive to investors during periods of rising interest when fixed rate bonds are subject to depreciation.

Floating rate payer: A party that makes swaps payments calculated on the basis of a floating rate.

London inter-bank offered rate (LIBOR): The interest rate at which prime banks offer deposits to other prime banks in London. This rate is often used as the basis for pricing Eurodollar and other Eurocurrency loans. The lender and the borrower agree to a mark- up over LIBOR: the total of LIBOR plus the mark-up is the effective interest rate for the loan.