Syndicated Loans Defined: Types and Benefits for Canadian Borrowers
Put simply, a syndicated loan is a loan issued by a consortium of lenders to a single borrower. Because the sums involved are always substantial -- beyond the scope of what most banks and conventional lenders are able to comfortably risk on their own -- each lender in the syndicate contributes a portion of the total loan amount and shares proportionately in the risk.
Historically, major corporations are the most common borrowers of this type of loan, which they typically use to bankroll takeovers, acquisitions and expansion projects. Governments, however, have also been known to purchase syndicated loans, usually to fill a temporary gap in their national budgets or finance a large infrastructure project.
Increasingly, smaller and mid-sized companies experiencing rapid growth have also been pursuing this type of funding. While traditionally these loans have been to the tune of hundreds of millions of dollars, in recent years lenders have consolidated to provide syndicated loans for amounts as small as a few million dollars. Consequently, syndicated loans have become more commonplace over the past decade.
The providers of these loans are primarily large banks, but insurance companies, as well as major pension and hedge funds, will also engage in this type of lending as syndicated loans have traditionally proven to be notably profitable ventures.
How syndicated loans are structured
Each syndicated loan has a lead bank or underwriter (referred to as the arranger, agent or lead lender) who is responsible for the various administrative duties involved, such as dispersing cash flows among the other members of the consortium.
The arranging bank has no fiduciary duty nor obligation to advise either the borrower or their associate lenders. The financial terms negotiated between the lead lender and the borrower are contained in a term sheet detailing the amount of the loan, its duration, interest rate and repayment schedule along with any other related fees.
The primary motivation behind syndicated lending is to distribute the risk of default among numerous parties, as the loan amounts are typically so great that even one borrower-default could be extremely damaging to any single creditor. Each lender in the syndicate shares in the risk as well as the potential financial spoils of the loan.
The liability of each lender is limited to their share of the total loan, while the contract representing all members of the consortium is contained in one general loan agreement. The consortium of lenders can be a combination of different loan types, each with their own repayment terms negotiated between the creditors and the borrower.
Types of syndicated loans
There are three main categories of syndicated loan: underwritten deals, best-efforts syndication deals, and club deals, each with their own specific terms and structures.
Underwritten deal
With the underwritten deal, the lead underwriter both guarantees and syndicates the entire loan, and if the loan isn't fully subscribed the arranging bank has the option of absorbing its remaining portions.
From there, if the markets are bullish, the lead agent has the option of selling these remaining portions to other investors at a profit. However, in a bear market, the lead agent may be forced to sell the undersubscribed portions at a loss or write them off altogether.
The advantages of any bank taking on the role of lead agent in an underwritten deal are threefold. For one, syndicated loans can be hugely profitable because the risks involved with such large amounts of capital typically results in higher than average service fees. Secondly, this kind of loan makes the arranging bank appear to be more competitive. Thirdly, underwritten deals offer floating interest rates, and as such are exposed to less risk than debts that have fixed rates.
Best-efforts syndication deal
Best-efforts syndication is more common to North America than Europe. The lead agent doesn't commit or guarantee the full amount of the loan; rather, any undersubscribed portions are ideally filled by taking advantage of changes in market conditions.
For borrowers, however, should the remaining portions remain undersubscribed, they may have little choice but to accept a smaller loan amount or move to have the agreement cancelled in its entirety.
Club deal
This type of syndicated loan typically represents smaller amounts of money -- less than $150 million on average. The primary difference between the club deal and other syndicated loans is that with the club deal, the lead underwriter shares the fees earned from the loan facility equally, or close to equally, with the other partners in the consortium.
Advantages of syndicated loans
There are numerous advantages of syndicated loans for both lenders and borrowers. The following are a few primary benefits of this type of financial product.
Relative simplicity
Rather than trying to raise the required capital by pursuing multiple loans from multiple lenders, borrowers only need to negotiate terms with one party -- the lead underwriter of the arranging bank. The arranging bank is then responsible for establishing the consortium and determining how much credit each lender will contribute to the loan.
Diversification of terms
Because of the multiple lenders contributing to the loan, it can be structured with various types of loans and currencies. Each loan type offers flexibility, including risk management techniques, prepayment rights without penalty, and different interest structures such as fixed or floating interest rates. This provides greater adaptability for borrowers.
Borrowing in different currencies, borrowers are also better protected from currency risks and fluctuations resulting from external factors, such as inflation and the laws and policies of individual countries or states.
Reputation
Having multiple lenders finance a project reinforces the borrower’s good market image. Borrowers who have successfully paid off syndicated loans gain better credit ratings and positive reputations among lenders, making it easier to secure credit and optimal repayment terms from financial institutions in the future.
Furthermore, syndicate banks will sometimes share their thoughts and feedback on business concerns with agents, information they typically wouldn't offer to the borrowing business otherwise.
As a form of asset-based lending, syndicated loans allow lenders with expertise in various asset categories to team up and deliver the most favorable financing possible to clients. Contact us to find out more.