Syndicated Loan Market

8/12/2019 Syndicated Loan Market

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Fire 437 Spring 2005

Topics:

Overview (definition, structure, markets)

What is it?

How does it work? History

Asymmetrical Information

Loan monitoring Risk and return

Ongoing changes


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Overview


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Overview

One one the largest and most flexible

sources of capital

Important corporate financing technique Both primary market and a secondary

market

Some characteristics similar to publiclytraded equity and bond markets

Maturity


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What is a syndicated loan?

Two or more lending institutions jointly

agreeing to provide a credit facility to a

borrower. All lenders share common loandocumentation.

A group of credit-risk-transfer instruments

Virtually any corporate & commercial loancan be syndicated


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What is a syndicated loan?

Basic Structure includes

Lead bank

Several participating banks

Syndicate is created to underwrite a particular

loan and disbands upon completion of the

loan


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Basic Structure


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Structure Cont

Lead banks

Represents and acts on behalf of the lending

groupOften presents the proposal to the borrower, but

sometimes the borrower is the initiator

There may be competing bids from several leadbanks with different terms

The mandate


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Structure Cont

Discussion

Difficulty

various roles

Loan Documentation

Lead bank takes greatest portion of loan,

though sometimes the entire loan can be sold toparticipating banks/institutions

Single loan agreement


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Underwriting

Two types of underwriting:

Best Efforts

Lead bank does NOT guarantee entire loan

Used in less active or nervous markets

Lead bank or borrower can cancel

Firm Commitment Lead bank DOES guarantee entire loan

Used in active deal making markets with frequent

mergers and acquisitions


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Best Efforts


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Firm Commitment


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How does loan syndication

work? After the mandate:

Beginning of the primary distribution phase

Lead bank generates memo with descriptiveand financial information

Recipients (prospective participants) review it

and enter a confidentiality agreementLead bank, borrower meet with prospective

participant banks

The goal


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Secondary Market

Allows lenders to buy/sell portions of the

syndicated loan.

Primarily in the U.S.

It can happen in two ways:

Assignment

Superceding participating

Participation


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Secondary Market: Assignment

A sale between two members of the syndicate or

between a syndicate member and a bank outside of

the syndicate.

Creates a new financial obligation between theborrower and the loan buyerwhich replaces the

contract between the borrower and the original

lender

Consent of the borrower is often requires

New buyer becomes a direct lender and is entitled

to full voting privileges


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Secondary Market:

Participation Creates a contract between the original lender

and a loan buyer.

Buyer becomes a participant in a share of theprimary lenders loan, thus the original contract

does NOT change.

Unlike the assignment lack of awareness of the borrower

lack of full voting privileges of buyer


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Benefits for Borrowers

Allows borrowers to access a larger pool of capital

than any one single lender may be willing to offer.

Allows the originating lender the opportunity to

provide greater customization than traditionalloans that involved just one bank.

One large syndicated loan is simpler to arrange

and likely to be cheaper than borrowing the sameamount from a number of lenders through

traditional loans.


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Benefits for Lenders

It is a way to spread the risk of a loan over several

lenders, which decreases the lenders exposure to a

single borrower. It can allow lenders to maintain an important

relationship with a borrower, while avoiding any

single lenders overexposure to the entire credit.

It may be attractive to smaller lenders as it allowsthem to lend to larger (and perhaps more

prestigious) borrowers than their smaller balance

sheets would allow in the case of bilateral loans


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History


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History of Syndicated Loans

1960sSyndicated loans originally started during

1960s in the international banking market

Led multinational group of lenders to come

together as syndicates to participate in large

loans, primarily to governments, but also forcorporate credits


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1960s-1980s

Corporate borrowers maintained a numberof bilateral loan arrangements with various

banks This gave the borrowers more control, but

was administratively costly and inefficient

An informal loan club of banks occurredoccasionally, where banks shared very largeloans


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1980s

Robust economic activity at during this

decade provided a great bull market, not

only to the stock market, but also to thecorporate loan market

Large, national money-center banks

happily facilitated the relationship betweencorporations hungry for loans and banks

eager to lend them


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1980s

Loan underwriting and syndication grew on an

unprecedented scale to fuel corporate expansion in

response to the economic growth of that decade

During the late 1980s, acquisition financingreached new heights, because no single bank could

afford to underwrite and carry the large amount of

debt to support the leveraged buy-out

Lured by increased profits, banks turned tosyndication as a way to limit risk and diversify

their portfolios.


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Acquisition Financing

Fostered the development of large corporate

loans with interest rates higher than before,

which provided higher returns, thereforeattracting non-bank buyers

Increased demand for the leveraged loan

product, enabling larger agent banks tounderwrite and distribute increasingly

bigger loans


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1990-91

U.S. recession caused banks to significantly

reduce their lending to the riskier leveraged loan

market and concentrated on loans to investment-grade companies

Laid the groundwork for todays syndicated

market as banks significantly reduced their

lending efforts, driving up loan pricing and pushedbanks to reduce their loan concentrations by

selling off pieces


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1990-91

Inventory of loans available for sale and the

increased return on investment attracted

institutional investors to the market, whichfed the secondary market

American Bankers Association (ABA)

initiated an effort to standardizedocumentation, settlement, and syndication

practices for the loan market (failed effort)


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1995-1997

Syndicated loans began to evolve as an asset class

Loan Syndication and Trading Association

(LSTA) was found in 1995Not-for-profit trade association

Develop standard settlement and operational procedures

Develop market practices

Develop other mechanisms to improve secondarymarket liquidity


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Then and Now

Corporate Loan Volume

1988- new issue corporate loan volume was less

than $140 billion2003 - $930 billion

Secondary Syndicated Loan Trading Volume

1991- $8 billion2003- $144.57 billion


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Then and Now

Loan Trading

Late 1980s - at least one inter-dealer broker

Early 1990s - a handful of banks andinvestment banks had full time loan traders

2004over 35 institutions have full time

resources dedicated to the loan trading activity


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Then and Now

Loan Dealers and Traders

1990s- dealers/traders couldnt take a principal

risk position while trading loans, onlynegotiating a transfer between a buyer and aseller of the loan

Today- many still act as brokers, but most have

trading lines established so they may takepositions, creating a significantly more liquidand active secondary market for loans


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Then and Now Banks vs. Non-Bank Investors

1994 - Domestic and foreign banks purchased 71% ofthe leveraged loans in the primary market and non-bankinvestors only had 29%

2003 - Reversed, with banks purchasing only 30% of theleveraged loans and non-banks taking 70%


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Global Market Overview

For the period of 1995-99, the U.S.

accounted for 69% of the US 8.1 trillion

gross issuance. Other countries accountedfor:

Canada: 4%,

Western Europe and UK 20%Asia 5%.


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Global Market Overview

Corporate borrowers75% of all issues

Financial institutions15-20%

Sovereigns sector (nation states and

international organizations)5%.


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Asymmetric Information,

Monitoring, Risk and Return


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Information asymmetries

Lead bank acts as an intermediary and

operates like investment banks

Information asymmetry between lead andparticipating banks could allow the lead

bank to retain a greater share of high quality

loans and a lower share of low quality loansthan would be retained if there were not

information asymmetry


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Loan Monitoring The lead bank may be the only bank in the

syndicate to have a significant relationship with

the borrower Because the lead bank can easily reduce it

exposures to the borrower through secondary loan

sales, their motivation to monitor the loan can be

weakened. Participating banks still do their own credit

assessment and use ratings from agencies.


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Credit Risk

Greater risk diversification

Trading of syndicated loans allows financial

institutions to easily take on or shed credit riskDue to the easy of risk transfer, credit risk can

be allocated more efficiently in the economy

The significance of the transfer of credit riskfrom the banking system to other financial

sectors is difficult to gauge


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Underwriting Risk In Firm Commitmentunderwriting, the lead

bank faces the risk that other banks may not join

as lenders The lead bank makes a commitmentto the

borrower based on terms it believes are acceptable

to other banks in the marketplace

A Material adverse changes (MAC)clauselists certain events that allow the lender to cancel

their commitment


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Return Syndicated Loans have a

much higher return giventheir level of risk thanmany other assets

For the 12 years from 1992

to 2004, syndicated loanshad almost a 7% annualreturn, with only 2.5%volatility

Returns for syndicatedloans tend to have lowcorrelations with other

asset classes.


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Ongoing Changes in the

Syndicated Loan Market


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New Underwriting

Arrangements Firm-commitmentunderwriting is currently the

most common type of syndication.

New types of arrangements are appearing to helpreduce the risks associated with firm-commitment

underwriting.

Since 1998 a new type of underwriting has been

gaining popularity. It is called Market Flex.


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Market Flex

Gives the lead bank the ability to adjust the loan

pricing depending on market conditions at the

closing of the loan. Market Flex also allows the syndicate arrangers to

adjust the structure or amortization schedule of the

loan to allow the whole loan to clear the market.

Market Flex applies in both directions and canwork to the benefit of the borrower.


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The Introduction of CUSIPs

A CUSIP number uniquely identifies issuersand issues of financial instruments.

CUSIP numbers consist of nine characters.The first 6 identify the issuer.

The last 3 identify the security.

CUSIPs are issued for stocks, bonds, mutualfunds, CDs, and a variety of other financialinstruments.


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The CUSIP Service Bureau

The CUSIP Service Bureau is run by the S&P.

A standard set of information is collected and

maintained about each financial instrument. They provide standardized descriptions for each

security, and attempt to keep the information up to

date and accurate.

The CUSIP Bureau disseminates this data to the

financial marketplace via various media.


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New CUSIP Services in 2004

January, 2004: The LSTA and S&P

launched CUSIPs for syndicated loans.

October, 2004: The S&P launched anelectronic service where banks can look up

up-to-date information on syndicated loan

CUSIPs.


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2004 Year End

22 bankshad registered with the S&P to

have CUSIP numbers assigned to their deals

4182loan CUSIPs had been assigned

2062of the CUSIPs were set up on S&Ps

electronic system


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Loan Information Databases

As information on syndicated loans has become

more standardized, several service providers have

appeared to sell that information.

In the past 3 years, the number of companies that

provide loan pricing information has grown from

9 to 16.

The amount of information each provider hasaccess to has risen significantly.


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Information Providers

S&Ps Electronic Service

The Shared National Credit program (SNC)provides a comprehensive measure of outstandingloans. The SNC is a database maintained by theU.S. Federal Reserve Board. It covers any loan ofat least $20 million that is shared by 3 or moresupervised institutions.

Loan Pricing Corporation (LPC)provides loan-pricing information. It is a New York based datacollection and research firm. The LPC compilesinformation on U.S. loan syndication transactions.


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Loan Pricing Databases

In 2002, companies that provided loan-pricing

services were only able to gather information on

$11.6 billion worth of transactions, or 39% of the

secondary market transactions.

In 2004, the companies that provide loan-pricing

information were able to gather data on $32.08

billion worth of transactions, or 76.6% of thetransactions.


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Mark-To-Market Pricing

The growing amount of information

regarding secondary market transactions is

improving the loan pricing services abilityto accurate quote loan prices.

The discrepancy between the prices that the

information services are quoting and theprices that actual trades are occurring is

narrowing.


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Bid/Ask Spreads

Bid/ask spreads

have fallen as

the market has

become moreliquid, and

more up to date

loan

information hasbecome

available.


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Secondary Market Loan Sizes

The size of secondary market transactions has

fallen dramatically.

In 1995, the size of the smallest piece of asyndication that could be sold to an investor was

$6.25 million.

This presented a considerable barrier to entry for

smaller traders and investors. The average secondary market trade size has fallen

from $10 million in 1994 to $1 million in 2004.

A L A i t


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Average Loan Assignment


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Assignment Fee Controversy

There is controversy in the marketplace about how

to handle assignment fees.

There are no standards for how the transactioncosts when buying or selling portions of a loan.

Each bank charges different fees, and the fees

have largely remained the same, even though the

size of the loan assignments has dramaticallyfallen.


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Evolving Standards

Additional Standardized Paperworksuch asletters of commitment, closing documents, transferagreements, etc.

Shorter Trade Times: Starting in May of 2004,the timeframe for settling the sale or purchase of aloan on the secondary market dropped to 7 daysfrom 10 days.

Non-Public InformationThe LSTA is proposingstandards on how to handle Non-PublicInformation about borrowers.


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THE END

Syndicated Loan Market

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