Syndication of Loan Meaning

Where a group of lenders usually collaborates through an intermediary being a lead financial institution, or syndicate agent, which organizes and administers the transaction, including repayments, fees, etc., to provide financial requirements to a single larger borrower (usually out of the capacity of a single lender) where the division of risk and returns takes place between each other is known as loan syndication.

In loan syndication, a group of banks provides loans jointly to a single borrower because one bank cannot meet the huge requirement of the borrower as it may be beyond its risk exposure. This type of loan syndication process is required by large companies working on a large project, and that project requires a huge amount of capital for their business.

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Features of Loan Syndication

  • Large amount.No separate agreement between an individual bank and the borrower.No ambiguity used to be there.The length of the contract is generally between 3 to 15 years.Low risk is found in loan syndication.Each bank is not necessarily to contribute an equal amount.

Example of How Loan Syndication Works

Suppose EFG Ltd. is a single national organization and now wants to be a multinational organization. The company requires a large amount of capital and has a good relationship with one bank to run the business. This large amount of money is so high that a single bank cannot finance and take that high risk alone.

EFG Ltd. approaches his preferred bank (lead bank) with which the company has a good relationship and says our company requires $2 billion. Bank gives an option to the company for syndication of loans because it is not feasible to finance such a large amount individually. The preferred bank now introduces other banks to the client (company) and will decide how to segregate the amount between them (it may or may not be equal). One of the banks will be appointed as an agent bank, and all other banks will be known as participating banks.

Participants of Loan Syndication

Below are the participants in loan syndication.

#1 – Lead Bank can also be called an Arrange Bank

  • The lead bank acts as a manager and is responsible by a borrower for organizing funding based on a specific term that the loan parties decide.The lead bank must find other banks as lending parties willing to bear risk together to participate in this syndication.The lead bank must discuss details of the agreement and be responsible for preparing loan documentation with participating banks.

#2 – UnderWriting Bank

  • The lead bank may underwrite the unsubscribed portions of the required loan, or a different bank may fund the loan.Underwriting banks will take the risk that will likely occur.

#3 – Participating Bank

  • All banks that participate in loan syndication are known as participating banks.Participating banks will charge fees for their participation.

#4 – Agent Bank

  • The work of the agent bank is to ensure that loan syndication is operating effectively.The agent bank acts as a mediator between the borrower and lender and has a contractual obligation for both the parties (borrower and lender).In some cases, the agent bank has additional duties in the agency agreement.The basic work of agent banks is to channel the funds from all participating banks to the borrower and channel back interest and principal amount from the borrower to participating banks.

Types of Loan Syndication

The following are the types of loan syndication.

Type #1 – UnderWritten Deal

Under this arrangement, the lead agent guarantees the entire loan. The lead agent can absorb the undersubscribed portion if the loan is not fully required. This loan syndication attracts higher service fees. These loans have an increased risk, making a huge profit for the bank.

Type #2 – Best-Efforts Syndication

Under this arrangement, the lead bank is not committed to guaranteeing the loan amount required by the borrower and undertakes to find other lenders to provide commitments for the remainder. It will fill up any undersubscribed portion of the loan by taking advantage of the changes in the market condition. If the loan is continuously undersubscribed, the borrower may be forced to accept a lower amount of loan or cancel it.

Type #3 – Club Deal

This syndication is of a smaller amount, up to $150 million. In this, all the members of the club have an equal share. Again, this borrower may arrange the club, or an arranger may be involved.

Process of Loan Syndication

Advantages

  • Financing takes less time and effort.The administration of the loan is extremely efficient.It is beneficial for borrowers to establish a good market image.Borrowers have flexibility in structure and pricing.The borrower need not go to each bank and not apply separate applications to all banks.The purpose and period of the loan are fixed.The system is simple.

Disadvantages

  • Time-consuming process since negotiating with the bank can take various days. Thus, loan syndication is a time-consuming process.Borrowers may also be adversely affected by syndicated loan agreements.If the problem arises, it may be difficult for borrowers to satisfy all banks simultaneously.Managing the relationship between multiple parties is a difficult task.If profitability fails, the smallest bank withdraws its capital.

Conclusion

In loan syndication, several different lenders provide various portions of a loan. Every lender has a responsibility towards their share of the loan. Therefore, every lender has less risk due to sharing a loan (big amount) between more than one lender. As a result, banks or financial institutions profit from loan syndication.

  • Initial discussion with promoters should be there. Then, a project assessment is required. Availability of alternatives for sources of funds needs to be done. Then, a preliminary discussion with lenders should be done. Then there is a requirement to prepare of loan application and follow up on it. Assisting in project appraisal by doing financial analysis. Lastly, one should obtain a Letter of Credit from a lending institution.

This article is a guide to Loan Syndication and its meaning. Here, we discuss types of loan syndication, process, examples, types, and participants. We also include some of its advantages and disadvantages. You can learn more about accounting from the following articles: –

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