Syndicated loan

A syndicated loan is one that is provided by a group of lenders and is structured, arranged, and administered by one or several commercial or investment banks known as arrangers.

Starting with the large leveraged buyout loans of the mid-1980s, the syndicated loan market has become the dominant way for issuers to tap banks and other institutional capital providers for loans.

At the most basic level, arrangers serve the investment-banking role of raising investor funding for an issuer in need of capital. The issuer pays the arranger a fee for this service, and this fee increases with the complexity and risk factors of the loan. As a result, the most profitable loans are those to leveraged borrowers—issuers whose credit ratings are speculative grade and who are paying spreads (premiums above LIBOR or another base rate) sufficient to attract the interest of non-bank term loan investors. Though, this threshold moves up and down depending on market conditions.

Loan Market Overview

The “retail” market for a syndicated loan consists of banks and, in the case of leveraged transactions, finance companies and institutional investors. Before formally launching a loan to these retail accounts, arrangers will often get a market read by informally polling select investors to gauge their appetite for the credit. After this market read, the arrangers will launch the deal at a spread and fee that it thinks will clear the market. Until 1998, this would have been it. Once the pricing was set, it was set, except in the most extreme cases. If the loans were undersubscribed, the arrangers could very well be left above their desired hold level. Since the Russian debt crisis roiled the market in 1998, however, arrangers have adopted market-flex language, which allows them to change the pricing of the loan based on investor demand—in some cases within a predetermined range—as well as shift amounts between various tranches of a loan, as a standard feature of loan commitment letters.

As a result of market flex, loan syndication functions as a “book-building” exercise, in bond-market parlance. A loan is originally launched to market at a target spread or, as was increasingly common by 2008 with a range of spreads referred to as price talk (i.e., a target spread of, say, LIBOR+250 to LIBOR+275). Investors then will make commitments that in many cases are tiered by the spread. For example, an account may put in for $25 million at LIBOR+275 or $15 million at LIBOR+250. At the end of the process, the arranger will total up the commitments and then make a call on where to price the paper. Following the example above, if the paper is vastly oversubscribed at LIBOR+250, the arranger may slice the spread further. Conversely, if it is undersubscribed even at LIBOR+275, then the arranger will be forced to raise the spread to bring more money to the table.

Types of Syndications

There are three types of syndications: an underwritten deal, “best-efforts” syndication, and a “club deal.”

Underwritten deal

An underwritten deal is one for which the arrangers guarantee the entire commitment, then syndicate the loan. If the arrangers cannot fully subscribe the loan, they are forced to absorb the difference, which they may later try to sell to investors. This is easy, of course, if market conditions, or the credit’s fundamentals, improve. If not, the arranger may be forced to sell at a discount and, potentially, even take a loss on the paper. Or the arranger may just be left above its desired hold level of the credit.

Arrangers underwrite loans for several reasons. First, offering an underwritten loan can be a competitive tool to win mandates. Second, underwritten loans usually require more lucrative fees because the agent is on the hook if potential lenders balk. Of course, with flex-language now common, underwriting a deal does not carry the same risk it once did when the pricing was set in stone prior to syndication.

Best-efforts syndication

A best-efforts syndication is one for which the arranger group commits to underwrite less than the entire amount of the loan, leaving the credit to the vicissitudes of the market. If the loan is undersubscribed, the credit may not close—or may need major surgery to clear the market. Traditionally, best-efforts syndications were used for risky borrowers or for complex transactions. Since the late 1990s, however, the rapid acceptance of market-flex language has made best-efforts loans the rule even for investment-grade transactions.

Club deal

A club deal is a smaller loan—usually $25 million to $100 million, but as high as $150 million—that is premarketed to a group of relationship lenders. The arranger is generally a first among equals, and each lender gets a full cut, or nearly a full cut, of the fees.

The Syndication Process

Before awarding a mandate, an issuer might solicit bids from arrangers. The banks will outline their syndication strategy and qualifications, as well as their view on the way the loan will price in market. Once the mandate is awarded, the syndication process starts. The arranger will prepare an information memo (IM) describing the terms of the transactions. The IM typically will include an executive summary, investment considerations, a list of terms and conditions, an industry overview, and a financial model. Because loans are unregistered securities, this will be a confidential offering made only to qualified banks and accredited investors. If the issuer is speculative grade and seeking capital from nonbank investors, the arranger will often prepare a “public” version of the IM. This version will be stripped of all confidential material such as management financial projections so that it can be viewed by accounts that operate on the public side of the wall or that want to preserve their ability to buy bonds or stock or other public securities of the particular issuer (see the Public Versus Private section below). Naturally, investors that view materially nonpublic information of a company are disqualified from buying the company’s public securities for some period of time. As the IM (or “bank book,” in traditional market lingo) is being prepared, the syndicate desk will solicit informal feedback from potential investors on what their appetite for the deal will be and at what price they are willing to invest. Once this intelligence has been gathered, the agent will formally market the deal to potential investors.

The executive summary will include a description of the issuer, an overview of the transaction and rationale, sources and uses, and key statistics on the financials. Investment considerations will be, basically, management’s sales “pitch” for the deal. The list of terms and conditions will be a preliminary term sheet describing the pricing, structure, collateral, covenants, and other terms of the credit (covenants are usually negotiated in detail after the arranger receives investor feedback).

The industry overview will be a description of the company’s industry and competitive position relative to its industry peers.

The financial model will be a detailed model of the issuer’s historical, pro forma, and projected financials including management’s high, low, and base case for the issuer.

Most new acquisition-related loans are kicked off at a bank meeting at which potential lenders hear management and the sponsor group (if there is one) describe what the terms of the loan are and what transaction it backs. Management will provide its vision for the transaction and, most important, tell why and how the lenders will be repaid on or ahead of schedule. In addition, investors will be briefed regarding the multiple exit strategies, including second ways out via asset sales. (If it is a small deal or a refinancing instead of a formal meeting, there may be a series of calls or one-on-one meetings with potential investors.) Once the loan is closed, the final terms are then documented in detailed credit and security agreements. Subsequently, liens are perfected and collateral is attached.

Loans, by their nature, are flexible documents that can be revised and amended from time to time. These amendments require different levels of approval. Amendments can range from something as simple as a covenant waiver to something as complex as a change in the collateral package or allowing the issuer to stretch out its payments or make an acquisition.

Loan Market Participants

There are three primary-investor consistencies: banks, finance companies, and institutional investors. Banks, in this case, can be either a commercial bank, a savings and loan institution, or a securities firm that usually provides investment-grade loans. These are typically large revolving credits that back commercial paper or are used for general corporate purposes or, in some cases, acquisitions. For leveraged loans, banks typically provide unfunded revolving credits, LOCs, and—although they are becoming increasingly less common—amortizing term loans, under a syndicated loan agreement. Finance companies have consistently represented less than 10% of the leveraged loan market, and tend to play in smaller deals—$25 million to $200 million. These investors often seek asset-based loans that carry wide spreads and that often feature time-intensive collateral monitoring.

Institutional investors in the loan market are principally structured vehicles known as collateralized loan obligations (CLO) and loan participation mutual funds (known as “prime funds” because they were originally pitched to investors as a money-market-like fund that would approximate the prime rate). In addition, hedge funds, high-yield bond funds, pension funds, insurance companies, and other proprietary investors do participate opportunistically in loans. Typically, however, they invest principally in wide-margin loans (referred to by some players as “high-octane” loans), with spreads of LIBOR+500 or higher. During the first half of 2008, these players accounted for roughly a quarter of overall investment.

CLOs are special-purpose vehicles set up to hold and manage pools of leveraged loans. The special-purpose vehicle is financed with several tranches of debt (typically a ‘AAA’ rated tranche, a ‘AA’ tranche, a ‘BBB’ tranche, and a mezzanine tranche) that have rights to the collateral and payment stream in descending order. In addition, there is an equity tranche, but the equity tranche is usually not rated. CLOs are created as arbitrage vehicles that generate equity returns through leverage, by issuing debt 10 to 11 times their equity contribution. There are also market-value CLOs that are less leveraged—typically 3 to 5 times—and allow managers more flexibility than more tightly structured arbitrage deals. CLOs are usually rated by two of the three major ratings agencies and impose a series of covenant tests on collateral managers, including minimum rating, industry diversification, and maximum default basket. By 2007, CLOs had become the dominant form of institutional investment in the leveraged loan market, taking a commanding 60% of primary activity by institutional investors. But when the structured finance market cratered in late 2007, CLO issuance tumbled and by mid-2008, CLO’s share had fallen to 40%.

Retail investors can access the loan market through prime funds. Prime funds were first introduced in the late 1980s. Most of the original prime funds were continuously offered funds with quarterly tender periods. Managers then rolled true closed-end, exchange-traded funds in the early 1990s. It was not until the early 2000s that fund complexes introduced open-ended funds that were redeemable each day. While quarterly redemption funds and closed-end funds remained the standard because the secondary loan market does not offer the rich liquidity that is supportive of open-end funds, the open-end funds had sufficiently raised their profile that by mid-2008 they accounted for 15% to 20% of the loan assets held by mutual funds.

Credit Facilities

Syndicated loans facilities(Credit Facilities) also known as type of loans are basically short\long term financial assistance programs which is designed to help financial institutions and other institutional investors to draw notional amount as per the requirement.

In general there are four main types of syndicated loan facilities: a revolving credit; a term loan; an LOC; an acquisition or equipment line (a delayed-draw term loan).

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