LOAN SYNDICATION

Meaning of the term Loan

A loan is a type of debt. All material things can be lent. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower. It is also defined as: Something lent for temporary use. A sum of money lent at interest.

-Loan is an advance paid by the bank to the customer either with security or without security is called as loan. If a loan is given without security it is called as an advance. It is given for a fixed period of time and aggregate rate of interests. Repayments are spread over from a period of 1-5 years. It is also known as demand loan and it is repayable on demand.

-The loans are granted to meet long term working capital needs and for expansion and modernization. Interest is charged on the actual amount sanctioned, whether withdrawn or not. Loans may be short-term, medium-term or loan term. Long term loans are generally for meeting the working capital requirements. Such loans are also called as term loans. When a loan is meant for meeting both fixed and working capital requirement of a borrower, it is called as a Composite loan.

Advantages of the loan system are as follows: Financial discipline on the borrower Periodic review of local Account Profitability The system is quite simple It is given for a fixed period and specific purpose.

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INTRODUCTION TO LOAN SYNDICATION
Loan syndication refers to services rendered by an organization in arranging and procuring credit from financial institutions, banks, other lending and investment companies for financing the project or meeting the working capital requirements. 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 involved in the sanction and disbursal of loan. Syndicated loans provide borrowers with a more complete menu of financing options. In effect, the syndication market completes a continuum between traditional private bilateral bank loans and publicly traded bond market. Loan syndications are responsible for arranging co-financing with commercial banks and other financial institutions directly or indirectly with export credit agencies (ECAS). Loan syndications have chosen a flexible and market oriented approach. Loan syndication refers to assistance rendered by merchant banks to get mainly term loans for projects. Such loans may be obtained from a single financial institution or a syndicate or consortium.

Meaning of syndication
An association of individuals formed for the purpose of conducting a particular business or a joint venture.

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Pooling of resources by financial institutions in a financing project to spread the risk. Individual return from the investment is proportionate to the degree of risk or amount of funds that each has put up or underwritten. A syndicate is a general term describing any group that is formed to conduct some type of business. For example, a syndicate may be formed by a group of investment bankers who underwrite and distribute new issues of securities or blocks of outstanding issues. Syndicates can be organized as corporations or partnerships. A Syndicated loan (or syndicated bank facility) is a large loan in which a group of banks work together to provide funds for a borrower. There is usually one lead bank (the "Arranger" or "Agent") that takes a percentage of the loan and syndicates the rest to other banks. A syndicated loan is the opposite of a bilateral loan, which only involves one borrower and one lender (often a bank or financial institution. A syndicate only works together temporarily. They are commonly used for large loans or underwritings to reduce the risk that each individual firm must take on. It can also be termed as an association of people or firms formed to engage in an enterprise or promote a common interest or an association of people or firms authorized to undertake a duty or transact specific business. The cost of a syndicated loan consists of interest and a number of feesmanagement fees, participation fees, agency fees and underwriting fees when the loan is underwritten by a bank or a group of banks. Spreads over LIBOR depend upon borrower's credit worthiness, size and term of the loan, state of the market (e.g. the level of LIBOR, supply of non-bank deposits to the EURO banks,) and the degree of competition for the loan.

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Features of Syndicated Loans
The syndicated loan is a financing method evolved from bilateral loan. Under the arrangement of syndicated loan, one bank or several banks (as the arrangers) organize other banks to grant loans to the same borrower under one loan agreement according to agreed terms.

Syndicated loans have the following features:

Huge amount and long term loans. Less pressure on banks and diversified risk. As for the borrower, syndicated loans provide large amounts of loans with longer term and easy operation management (only need to contact with the agent bank). Fewer restriction on the use of proceeds (compared with government loans and export credit) Easier management (Compared with loans borrowed separately from different banks) Syndicated loans can be structured to incorporate various options. As in the case of FRS, a drop lock feature converts the floating rate loan into a fixed rate loan if the benchmark index hits a specified floor. A multi-currency option allows the borrower to switch the currency of denomination on a rollover date. Security in the form of government guarantee or mortgage on assets is required for borrowers in developing countries like India. Syndicated loan is more suitable as compared to a simple loan from single or multiple banks. The borrower does not have to deal with a large number of lenders. It has permitted the issuers to achieve more market-oriented and effective financing. cost-

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Loan syndications are a cost-effective method for participating institutions to diversify their banking books and to exploit any funding advantages relative to agent banks. Syndicated loans have increasingly become the corporate financing choice of large- and mid-size firms. As a result, syndicated lending has become a major component of today's financial landscape. Syndicated lending also allows banks to compete more effectively with public debt markets for corporate borrowers. To a large extent, the development of the loan syndication market has stemmed, if not reversed, the trend toward disintermediation of corporate debt by reducing the differences between intermediated and public debt markets.

STAGES IN SYNDICATION
PRE-MANDATE STAGE

PLACING THE LOAN AND DISBURESEMENT

POST-CLOSURE STAGE
Broadly there are three stages in syndication, viz., Pre-mandate phase, Placing the loan and disbursement and post-closure stage. 1. PRE-MANDATE STAGE: This is the initiated by the prospective borrower. It may liaise with a single bank or it may invite competitors bids from a number of banks. The borrower has to mandate the lead bank, and the underwriting bank, if desired. Once the lead bank is selected and
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mandated by the borrower, the lead bank has to undertake the appraisal process. The lead banks needs to identify the needs of the borrower, design an appropriate loan structure, and develop a persuasive credit proposal.

2. PLACING THE LOAN AND DISBURSEMENT: At this stage, the lead bank can start to sell the loan in the marketplace i.e. to prospective participating banks. 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. 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 to any other purpose.

3. POST-CLOSURE STAGE:This is monitoring and follow-up phase. It has many times done through an escrow account. 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 stage, the agent handles the day-to-day running of the loan facility.

Purpose for syndicated lending

Like insurance, a loan is an assumption of risk. For a certain class of loan, with certain rules, the bank might believe that it is likely that 5% of all borrowers may go bankrupt. If
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the bank's cost of funds is a hypothetical 5%, the bank needs to charge more than 10% interest on the loan to make a profit. In general, banks and the financial markets use riskbased pricing, charging an interest rate depending on the risk of the loan product in general or the risk of the specific borrower.

The problem with larger businesses loans, however, is that there are fewer of them. So, if the bank has the only large business loan and if that business happens to be one of that defaults, then the bank loses all its money. For this reason, it is in the best interest of all banks to split, or "syndicate" their large loans with each other, so each get a representative sample in their loan portfolios.

A second, often criticized reason for syndicating loans is that it avoids large or surprising losses and instead usually provides small and more predictable losses. Smaller and more predictable losses are favored by many management teams because of the general perception that companies with "smoother" or steadier earnings are awarded a higher stock price relative to their earnings (benefiting management who is often paid primarily by stock). Critics, such as Warren Buffett however, say that many times this practice is irrational. If the bank could still get a representative sample by not syndicating, and if syndication would reduce their profit margins, then over the long term a bank should make more money by not syndicating. This same dynamic plays out in the investment banking and insurance fields, where syndication also takes place.

To avoid that the borrower has to deal with all syndicate banks individually, one of the syndicate banks usually acts as an Agent for all syndicate members and acts as the focal point between them and the borrower.

Advantages/Benefits of Syndicated Loans

In addition, economists and syndicate executives contend that there are other, less obvious advantages to going with a syndicated loan.

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These benefits include: Syndicated loan facilities can increase competition for your business, prompting other banks to increase their efforts to put market information in front of you in hopes of being recognized. Flexibility in structure and pricing. Borrowers have a variety of options in shaping their syndicated loan, including multicurrency options, risk management techniques, and prepayment rights without penalty. Syndicated facilities bring businesses the best prices in aggregate and spare companies the time and effort of negotiating individually with each bank. Syndicate banks sometimes are willing to share perspectives on business issues with the agent that they would be reluctant to share with the borrowing business. Syndicated loans bring the borrower greater visibility in the open market. Bunn noted that "For commercial paper issuers, rating agencies view a multi-year syndicated facility as stronger support than several bilateral one-year lines of credit."

Benefits to the borrower

Raising a loan which would exceed the capacity of a single bank. Cutting down on management capacity since the borrower communicates only with the arranger/agent. Broadening the financing base through the participation of other banks. Typically less costly than numerous lines through multiple institutions. It helps to enhance broader financial relationships. Deals with a single bank. Quicker and simpler than other ways of raising capital. E.g. Issue of equity or bonds.
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Benefits to the investor
Establishing direct relationships with new customers. Enables much broader risk diversification without significant additional marketing efforts. Due to uniform documentation there is a better chance for a subsequent placement on the secondary market. Contract documents and information provided at no expense.

Benefits to the lead banks

Fund arrangement and other fees can be earned without committing capital. Enhancement of banks reputation. Enhancement of banks relationship with the client.

Benefits to the participating banks

Access to lending opportunities with low marketing/ processing costs. It triggers more opportunities to participate in future syndications as network of the banks establishes a level of comfort with each other. In case the borrower runs into difficulties, participant banks have equal treatment.

Parties and their roles within the syndication process

The lead bank and participating banks are the main parties involved in loan syndication. In large loan amounts, sometimes there are four parties involved, other than the borrower, in the syndication process. These are arranger {lead manager/ bank}, underwriting Bank, Participating Banks and the facility manager {agent. their roles are defined as follows:-

1. Arranger/lead manager: - It is a bank which is mandated by the prospective borrower and is responsible for placing the syndicated loan with other banks and ensuring that the syndication is fully subscribed. This bank charges arrangement
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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. In other words, since the appraisal of the borrower and its proposed venture is primarily carried out by this bank, onus of default is indirectly on this bank. Thus this bank carries reputation risk in the syndication process.

2. Underwriting bank: - Syndication is a process of arranging loans, success of which is not guaranteed. The arranger bank may underwrite to supply the entire remainder (unsubscribed) portion of the desired loan and in such a case arranger itself plays the role of underwriting bank. Alternatively a different bank may underwrite (guarantee) the loan or portion (percentage of the loan). This bank would be called the underwriting bank. It may be noted that all the syndicated loans may not have this underwriting arrangement .Risk of underwriting is obviously the underwriting risk. It means it will have to carry the credit risk of the larger portion of the loan.

3. Participating banks: - These are the banks that participate in the syndication by lending a portion of the total amount required. These banks charge participation fees. These banks carry mostly the normal credit risk i.e. risk of default by the borrower. As 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. It is this bankers trust that so many high profile banks cannot be wrong. This may be seen in the light of reputation risk of the lead manager.

4. Facility manager/agent: - Facility manager takes care of the administrative arrangements over the term of the loan (e.g. Disbursements, repayments and compliance). It acts for and on behalf of the banks. In many cases the

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arranging/underwriting bank itself may undertake this role. In larger syndications co-arranger and co-manager may be used.

The Syndicated Loan Market

The syndicated loan market, a hybrid of the commercial banking and investment banking worlds, is globally one of the largest and most flexible sources of capital. Syndicated loans have become an important corporate financing technique, particularly for large firms and increasingly for midsized firms. The rapid development of the syndicated corporate loan market took place in the 1990s exploring the historical forces that led to the development of the contemporary U.S. syndicated loan market, which is effectively a hybrid of the investment banking and commercial banking worlds. Syndicated lending aims to increase the risks and benefits involved in taking part in the syndicated loan market. There has been a notable change in large corporate lending over the past decade, as the old bilateral bank-client lending relationships have been replaced by a world that is much more transaction-oriented and market-oriented. The Canadian syndicated loan market has been strongly influenced by its U.S. counterpart, but it is not yet at the same level of development. It also explores potential risk issues for the new corporate loan market, including implications for the distribution of credit risk in the system, risks in the underwriting process, the monitoring function, and the potential for risk arising from asymmetric information. The development of the market for syndicated loans, and has shown how this type of lending, which started essentially as a sovereign business in the 1970s, evolved over the 1990s to become one of the main sources of funding for corporate borrowers. The syndicated loan market has advantages for junior and senior lenders. It provides an opportunity to senior banks to earn fees from their expertise in risk origination and manage their balance sheet exposures.

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Throughout history, innovation has driven the development of the financial markets, and over the last 20 years, the syndicated loan market has provided particularly fertile ground for financial innovation. From a relatively esoteric field involving commercial banks syndicating lines of credit, financial innovations have helped it develop into a broad, dynamic market encompassing both an efficient primary market that originates syndicated credits and a liquid secondary trading market where prices adjust to reflect credit quality and market conditions. The development of an efficient and liquid syndicated loan market in the U.S. has greatly impacted its capital markets. The syndicated loan market bridges the private and public fixed-income markets and provides borrowers with an alternative to high yield bonds and illiquid bilateral commercial bank loans. It provides much-needed credit to lower-rated companies and has strengthened the bankruptcy process in the U.S. through its facilitation of DIP (debtor-inpossession) lending. Todays syndicated loan market benefits banks also; in times of adversity, they can sell portions of the syndicated credits into a relatively liquid secondary market and actively manage the risk in their loan portfolios. This allows banks to avoid unnecessary lending restrictions when the economy contracts and thus the impact of an inefficient credit crunch. The development of the secondary market for syndicated loans has led to the creation of a new asset class with greater return per unit of risk than many other fixed-income assets and low correlations with most other classes of assets. The leveraged portion of the market, the part of the market where most innovation has occurred, receives special attention. Syndicated loans are an integral part of capital rising for these markets. This analysis provides a primer to investors and other parties interested in a market that has, without great fanfare, been one of the most rapidly growing and
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innovating sections of the U.S. capital market in the past 20 years. It explores issues related to the main features of the primary market using the most recent data available and details the characteristics of the secondary market. Investment returns, as well as the risks of the asset class, particularly credit risk, receive special attention. The syndicated loans market has grown rapidly in recent years, driven primarily by an increase in corporate takeovers, private equity transactions and infrastructure deals. Strong liquidity means there is plenty of cash to invest, and banks are willing lenders. The leveraged loan market remains small compared with the investment-grade market and bankers said the investors and their attitudes were markedly different. The volumes in the Indian offshore syndicated loan market have grown enough in the past few years.

How the market works

Major corporate clients will almost automatically consider a syndicated loan for sums above a few hundred million euros. Syndication splits the lending risk between large number of investors, at price (margin and fees) determined by the market. It is an efficient way of raising funds quickly and on best terms. For borrowers the advantage is that they can raise larger amounts and expand their group of bankers whilst at the Same time only having to sign a single contract For lenders, syndication allows a diversification of the lending portfolio from both a geographical and sectorial point of view. In addition, lenders get the benefit of the facility agents expertise in management of drawdowns and of other events in the lifetime of the loan after the facility agreement has been signed. The syndicated loan market was originally developed in the USA in the 1970s as a means of financing leveraged buy-outs (LBOs). It has since gone on to
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become the leading vector for all sorts of financing. In Europe the market expanded rapidly in the UK and then on the continent, particularly in France. The markets rapid growth can be seen from the fact that in 1993 the total volume of the market worldwide was USD 1.4. trillion, whereas in 2005 it exceeded USD 3 trillion (dialogic)

The rapid growth in syndicated facilities is certainly due in part to the trend over the past fifteen years, across all sectors of the economy, towards industry consolidation. For a borrower, the choice between a syndicated loan and negotiable debt instruments often comes down in favor of the first. Syndicated loans are the only means of raising, rapidly and with few formalities, sums greater than are available on other markets, like bonds and equities, or through private placements.

By taking full advantage of the syndicated loan market, some banks have managed to make headway in increasing their returns and still offering the borrowers some of the finest terms and conditions ever seen. Features of the syndicated loan market such as transaction size, availability, speed of reaction and flexibility ensure that it continues to be one of the primary sources for issuers looking to raise capital from the markets. It will examine the needs of both borrowers and lenders involved in the origination, structuring, distribution and management of syndicated loans and link the process of executing a successful deal to the optimal design of a syndications unit. Banks have benefited from this broadening of the syndicated loan market in several ways. They are a costeffective method for participating institutions to diversify and exploit any funding advantages relative to agent banks.

To a large extent, the development of loan syndication market has stemmed, if not reversed, the trend toward disintermediation of corporate debt by reducing the differences between intermediated and public debt markets.

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