Syndicated Loan Market

Loan Syndication
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
Overview
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 publicly
traded equity and bond markets
Maturity

What is a syndicated loan?
Two or more lending institutions jointly
agreeing to provide a credit facility to a
borrower. All lenders share common loan
documentation.
A group of credit-risk-transfer instruments
Virtually any corporate & commercial loan
can be syndicated

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

Basic Structure
Structure Cont
Lead banks
Represents and acts on behalf of the lending
group
Often presents the proposal to the borrower, but
sometimes the borrower is the initiator
There may be competing bids from several lead
banks with different terms
The mandate

Structure Cont
Discussion
Difficulty
various roles
Loan Documentation
Lead bank takes greatest portion of loan,
though sometimes the entire loan can be sold to
participating banks/institutions
Single loan agreement
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
Best Efforts
Firm Commitment
How does loan syndication
work?
After the mandate:
Beginning of the primary distribution phase
Lead bank generates memo with descriptive
and financial information
Recipients (prospective participants) review it
and enter a confidentiality agreement
Lead bank, borrower meet with prospective
participant banks
The goal
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

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 the
borrower and the loan buyer which 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
Secondary Market:
Participation
Creates a contract between the original lender
and a loan buyer.
Buyer becomes a participant in a share of the
primary 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

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 traditional
loans that involved just one bank.
One large syndicated loan is simpler to arrange
and likely to be cheaper than borrowing the same
amount from a number of lenders through
traditional loans.
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 allows
them to lend to larger (and perhaps more
prestigious) borrowers than their smaller balance
sheets would allow in the case of bilateral loans
History
History of Syndicated Loans
1960s
Syndicated 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 for
corporate credits
1960s-1980s
Corporate borrowers maintained a number
of bilateral loan arrangements with various
banks
This gave the borrowers more control, but
was administratively costly and inefficient
An informal loan club of banks occurred
occasionally, where banks shared very large
loans

1980s
Robust economic activity at during this
decade provided a great bull market, not
only to the stock market, but also to the
corporate loan market
Large, national money-center banks
happily facilitated the relationship between
corporations hungry for loans and banks
eager to lend them
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 financing
reached 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 to
syndication as a way to limit risk and diversify
their portfolios.

Acquisition Financing
Fostered the development of large corporate
loans with interest rates higher than before,
which provided higher returns, therefore
attracting non-bank buyers
Increased demand for the leveraged loan
product, enabling larger agent banks to
underwrite and distribute increasingly
bigger loans
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 pushed
banks to reduce their loan concentrations by
selling off pieces

1990-91
Inventory of loans available for sale and the
increased return on investment attracted
institutional investors to the market, which
fed the secondary market
American Bankers Association (ABA)
initiated an effort to standardize
documentation, settlement, and syndication
practices for the loan market (failed effort)
1995-1997
Syndicated loans began to evolve as an asset class
Loan Syndication and Trading Association
(LSTA) was found in 1995
Not-for-profit trade association
Develop standard settlement and operational procedures
Develop market practices
Develop other mechanisms to improve secondary
market liquidity

Then and Now
Corporate Loan Volume
1988- new issue corporate loan volume was less
than $140 billion
2003 - $930 billion
Secondary Syndicated Loan Trading Volume
1991- $8 billion
2003- $144.57 billion
Then and Now
Loan Trading
Late 1980s - at least one inter-dealer broker
Early 1990s - a handful of banks and
investment banks had full time loan traders
2004 over 35 institutions have full time
resources dedicated to the loan trading activity

Then and Now
Loan Dealers and Traders
1990s- dealers/traders couldnt take a principal
risk position while trading loans, only
negotiating a transfer between a buyer and a
seller of the loan
Today- many still act as brokers, but most have
trading lines established so they may take
positions, creating a significantly more liquid
and active secondary market for loans

Then and Now
Banks vs. Non-Bank Investors
1994 - Domestic and foreign banks purchased 71% of
the leveraged loans in the primary market and non-bank
investors only had 29%
2003 - Reversed, with banks purchasing only 30% of the
leveraged loans and non-banks taking 70%

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 accounted
for:
Canada: 4%,
Western Europe and UK 20%
Asia 5%.

Global Market Overview
Corporate borrowers 75% of all issues
Financial institutions 15-20%
Sovereigns sector (nation states and
international organizations) 5%.

Asymmetric Information,
Monitoring, Risk and Return
Information asymmetries
Lead bank acts as an intermediary and
operates like investment banks
Information asymmetry between lead and
participating banks could allow the lead
bank to retain a greater share of high quality
loans and a lower share of low quality loans
than would be retained if there were not
information asymmetry

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.
Credit Risk
Greater risk diversification
Trading of syndicated loans allows financial
institutions to easily take on or shed credit risk
Due to the easy of risk transfer, credit risk can
be allocated more efficiently in the economy
The significance of the transfer of credit risk
from the banking system to other financial
sectors is difficult to gauge
Underwriting Risk

In Firm Commitment underwriting, the lead
bank faces the risk that other banks may not join
as lenders
The lead bank makes a commitment to the
borrower based on terms it believes are acceptable
to other banks in the marketplace
A Material adverse changes (MAC) clause
lists certain events that allow the lender to cancel
their commitment
Return
Syndicated Loans have a
much higher return given
their level of risk than
many other assets
For the 12 years from 1992
to 2004, syndicated loans
had almost a 7% annual
return, with only 2.5%
volatility
Returns for syndicated
loans tend to have low
correlations with other
asset classes.
Ongoing Changes in the
Syndicated Loan Market
New Underwriting
Arrangements
Firm-commitment underwriting is currently the
most common type of syndication.
New types of arrangements are appearing to help
reduce the risks associated with firm-commitment
underwriting.
Since 1998 a new type of underwriting has been
gaining popularity. It is called Market Flex.
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 can
work to the benefit of the borrower.
The Introduction of CUSIPs
A CUSIP number uniquely identifies issuers
and 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, mutual
funds, CDs, and a variety of other financial
instruments.
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.
New CUSIP Services in 2004
January, 2004: The LSTA and S&P
launched CUSIPs for syndicated loans.
October, 2004: The S&P launched an
electronic service where banks can look up
up-to-date information on syndicated loan
CUSIPs.
2004 Year End
22 banks had registered with the S&P to
have CUSIP numbers assigned to their deals
4182 loan CUSIPs had been assigned
2062 of the CUSIPs were set up on S&Ps
electronic system
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 has
access to has risen significantly.
Information Providers
S&Ps Electronic Service
The Shared National Credit program (SNC)
provides a comprehensive measure of outstanding
loans. The SNC is a database maintained by the
U.S. Federal Reserve Board. It covers any loan of
at least $20 million that is shared by 3 or more
supervised institutions.
Loan Pricing Corporation (LPC) provides loan-
pricing information. It is a New York based data
collection and research firm. The LPC compiles
information on U.S. loan syndication transactions.
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 the
transactions.
Mark-To-Market Pricing
The growing amount of information
regarding secondary market transactions is
improving the loan pricing services ability
to accurate quote loan prices.
The discrepancy between the prices that the
information services are quoting and the
prices that actual trades are occurring is
narrowing.
Bid/Ask Spreads
Bid/ask spreads
have fallen as
the market has
become more
liquid, and
more up to date
loan
information has
become
available.
Secondary Market Loan Sizes
The size of secondary market transactions has
fallen dramatically.
In 1995, the size of the smallest piece of a
syndication 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.
Average Loan Assignment
Assignment Fee Controversy
There is controversy in the marketplace about how
to handle assignment fees.
There are no standards for how the transaction
costs 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 dramatically
fallen.
Evolving Standards
Additional Standardized Paperwork such as
letters of commitment, closing documents, transfer
agreements, etc.
Shorter Trade Times: Starting in May of 2004,
the timeframe for settling the sale or purchase of a
loan on the secondary market dropped to 7 days
from 10 days.
Non-Public Information The LSTA is proposing
standards on how to handle Non-Public
Information about borrowers.
THE END

Syndicated Loan Market

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Loan Syndication

Fire 437 Spring 2005

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