Several parties coming together to provide sizable capital to a single borrower.
A syndicated loan refers to a situation where several parties, usually large financial institutions, come together to provide sizable capital to a single borrower, satisfying their capital requirements through several lenders.
Usually, a syndicated loan is offered in a particular scenario where a borrower requires an enormous pool of capital for a project or investment. Commonly, interested financial organizations would create an agreement where they act together as one lender.
Given the nature of such loans, they are less common. In addition, the criteria to receive a syndicated loan are not set conventionally because every deal structure in this space differs.
For example, loan syndications may be used in large acquisition cases where significant financing is required to fund a deal.
Therefore, the structure of such loans varies based on the lenders and how they view the borrower's creditworthiness. As a result, deal structures of this type of debt are complicated and can go heavily.
You might wonder why financial institutions have the incentive to come together to provide the capital required for a single borrower.
This type of loan is applicable when a borrower requires a large amount of capital that no single lender would be willing to fund on its own.
Furthermore, it should also be reasonable to assume that the lenders are already aware and confident of the borrower's ability to pay back the debt. Only then would they consider cooperating to make the deal.
Moreover, lenders can set terms and conditions that would generate higher than market returns for the risk they are involved in.
Of course, the lenders would all need to cooperate throughout the process. For instance, each lender must conduct their due diligence on the borrower. After that, the lenders would all need to agree on a set of terms and conditions that satisfies all parties involved.
Usually, the group of lenders appoints a lead agent that becomes the first point of contact for the borrower's queries. The lead lender is typically the firm with the most significant stake in the transaction. Therefore, the lenders trust that the lead agent will work to set fair terms for all parties involved.
The lead lender may have a strong incentive to set terms benefiting itself. However, it is extremely rare since the lead lender would incur a high reputational cost if they go in that direction.
Hence, the lead lender sets terms and negotiates for the interest of the group of lenders transparently. They are responsible for the covenants, terms, and other loan details.
From the individual lender's perspective, a syndicated loan allows participation in high-profile deals while staying diversified. These financial institutions can take riskier deals in areas they would not otherwise consider.
Each lender must only deploy an amount of capital that meets its risk tolerance. Additionally, the loan amount can be secured by collateral, such as real estate or other assets. This allows the risk of default to be mitigated.
Since syndicated loans provide funding for high-value transactions, they may be used for significant acquisitions, i.e., when one firm acquires another.
They are, however, not limited to this use. They can be used for many other purchases, such as when a country requires significant funds to escape financial trouble.
Loan syndication can be one of the only practical options when an entity plans out a new project, such as opening a manufacturing facility or other capital-intensive facility.
From the borrower's perspective, they are trying to fill in a capital requirement that is difficult for any one lender to meet comfortably. Further, as they are a single party, they need to convince a group of lenders to work together to meet their needs.
As you can imagine, the borrower must have many connections with the right people to make such a deal happen.
Moreover, the borrower's creditworthiness is not enough for a syndicated loan, as they must convince all lenders that their project or investment will be successful.
Furthermore, after filling the lenders' criteria, the borrower needs to set terms and conditions to work with the lenders and satisfy them. Hence, the borrower takes on a lot of responsibility during such a deal.
Syndicated loans make it much easier for an entity to borrow a substantial amount if no single lender is willing to provide all the capital.
Additionally, it allows the borrower to sign one agreement with multiple parties coming together instead of trying to secure funding through separate agreements with different lenders. This allows the borrower to find a more straightforward financing option that works.
Borrowers have many requirements to secure financing through a syndicated loan, meaning financing requires expertise and a trustworthy network.
Due to these reasons, most borrowers with syndicated loans are large firms making significant investments like acquiring a facility or another company.
Loan Syndications in Real Life
Loan syndications have been used in various ways to fund capital-intensive projects. Below are some interesting examples that showcase how syndicated debt has been used:
HDFC Bank Limited (NYSE: HDB), an Indian financial banking and services company, recently secured a $1.1 billion syndicated social loan for affordable housing purposes in India. This transaction is said to be one of the largest social loans globally.
Linas Agro Group AB (VSE: LNA1L), a firm involved in the agricultural business, received a syndicated loan amounting to EUR 170 million to finance operations in Lithuania. The loan came from Credit Suisse Group AG (SWX: CSGN), Swedbank (STO: SWED-A), and Skandinaviska Enskilda Banken AB (STO: SEB-A).
Verizon Communications Inc (NYSE, Nasdaq: VZ) acquired Vodafone Group Plc's (NASDAQ: VOD) 45 percent indirect interest in Verizon Wireless in a transaction valued at approximately $130 billion in 2014. This required a syndicated loan.
In 2018, Broadcom Inc (NASDAQ: AVGO) attempted to acquire QUALCOMM Inc (NASDAQ: QCOM) through a $100 billion syndicated loan. This covered the cost of the acquisition and merger. However, President Trump did not approve this deal due to national security concerns.
The examples above are just a few syndicated loans allowing firms to embark on large projects which would otherwise be impossible.
Types of Syndicated Loans
Loan syndicates may be structured in several ways. This means that the type of debt can differ. Such flexibility allows deals to happen more simply, as parties can negotiate on terms to reach a group consensus.
Here are the different terms that may be included in loan syndication:
1. Revolving Debt
Such debt allows the borrower to access a Line of Credit (LOC). This means the borrower may access the funds if and when needed. Further, there is flexibility on when the borrower must withdraw funds. Finally, lenders set a credit limit for revolting debt, allowing entities to borrow and repay repeatedly.
2. Term Loans
A term loan is a one-time financing option usually paid back through pre-negotiated fixed monthly payments. Note that some term loans may include a large balloon payment at maturity instead of payments throughout a period.
3. Letters of Credit (LOCs)
A letter of credit is a bank guarantee that protects a party working with the borrower. For instance, a credit letter can be provided to a municipality that invests in a large infrastructure project with a contractor. If the contractor does not finish the project, the LOC will provide the municipality with the funds to continue the project with a different party.
4. Delayed-Draw Lines
Delayed-draw lines are approved credit lines that have credit limits based on the borrower's planned expenditures. Withdrawal periods are also determined in advance
5. Other Arrangements
Loan syndication is structured through a combination of unique terms that satisfies all parties. Therefore, given that these deals are large, borrowers can create special terms to push lenders to provide the capital they need.
Let's run an example that may help you understand how loan syndication works. For this example, assume that you are a creditworthy individual with connections to many major lending institutions.
Assume that you are the head of a large institution that provides a range of services to customers and businesses in the real estate space, and you are looking to acquire a rising competitor.
Your estimated acquisition cost sits at $900 million; therefore, you approach a lender in the space. This lender approves your loan but insists that it will only provide the funding through loan syndication.
The lender can then act as a lead agent to create a collaboration between multiple firms that will each provide a share of the loan amount. For example, five different lenders can split the loan amount, with the lead agent usually having the largest stake.
As you can see, the result is that you can receive funding through loan syndication, and the lenders can participate in a deal that otherwise may not be practical.
Advantages and Disadvantages
Potential borrowers looking at loan syndication as an option to fund capital need to be aware of such a transaction's various drawbacks and benefits.
The table below highlights the advantages and disadvantages of loan syndication:
|Saves time and money that would have been spent individually approaching many lenders.||Unconventional funding option, meaning there's a lack of public information on how such deals work or are initiated.|
|Simplicity due to the single-credit agreement.||Long approval process as it requires the collaboration of many parties.|
|Funds large capital needs.||Requires constant relationship management between the lenders and the borrower.|
Perhaps the most crucial drawback of loan syndication is the time it takes to process such a deal. Since so many parties are involved, there is a lot of negotiation and back and forth regarding the transaction.
However, the borrower in loan syndication usually has no other financing options given the loan amount. Hence, the primary advantage of loan syndication is that it can cover the borrower's needs.
Moreover, the transaction itself requires a lot of experience from the borrower. Usually, only large, well-established firms act as single borrowers in loan syndications, as they have the clientele and information to strike such an enormous deal.