Benefit of Syndication
The major benefit of syndication to Borrower is the large financing amount to be provided by a group of lenders for capital intensive project. Since all lenders share the same credit risk for a single transaction, Borrower do not have to approach and negotiate with numerous lenders to fulfil a single purpose substantial financing. Syndication loans save the time and most likely the cost of financing for Borrower. Imagine if a lender could save the time to conduct due diligence, terms negotiation and client acquisition, the lender would accept a lower lending rate due to saved staff cost and administrative cost. Since MLAB involve in syndication loan market everyday, it has the first hand information on risk appetite of lenders and market price benchmarking which Borrower usually do not have even though there is technological tool to access these information. Last but not the least, the repayment record of syndication elicits a positive reputation to lending market which makes borrower easier to obtain financing in the future.
From the lender side, syndication loan helps the lender to diversify credit risk which is substantial for a single lender to take up the whole syndication loan amount. MLAB act as arranger and bear major responsibility on administration. The MLAB earn an arrangement fee from Borrower which enhance the fee income to compensate the lost interest income from the shared syndication amount. Overall speaking, MLAB could enhance the Risk adjusted return on capital (RAROC) for the bank by arranging a syndication.
Pricing of Syndication
Syndicated Loan can be structured in different types of loans and securities. The varying loan types offer different types of interest, such as fixed or floating interest rates, which makes it more flexible for the borrower. A floating interest rate refers to a variable interest rate that changes over the duration of the debt obligation. Floating interest rate is usually calculated as a base rate plus interest margin. Below is a floating rate example from FinMonster Loan Market, the interest margin is 2.92% while the base rate is HIBOR. Common base rate is Prime Rate, HIBOR or LIBOR in Hong Kong which is determined by the interest fixing date. The most common fixing period is every three months (given 3-months period base rate is chosen).
Mentioned in last article, Pricing of syndication also include the Upfront Fee to be charged from loan proceed. The Upfront fee is a tiered fee base on the financing amount. From the example of Country Garden below, financing amount above HKD75M is top tier lender who change 2.35% Upfront Fee. Second tier lender financing above HKD50M charge 2.17% as Upfront Fee.
From the bank perspective, the higher the Upfront Fee is more attractive in terms of return between two identical deal with same all in yield. The higher Upfront Fee proportion means higher immediate return from the transaction. However, borrower has the other way round of measurement with bank given the available fund from the loan is deducted by the Upfront Fee.
Syndication loan is a committed loan. Lenders shall fulfil the obligation to fund the drawdown as long as drawdown conditions are complied. To mitigate the credit risk concern of lenders and closely monitor the credit risk during the tenor, other than borrower undertakings, financial covenants (“covenants”) are generally applied to control the borrower investment and monitor the borrower business performance. Compare with public debt, public bonds are widely held and easily transferable, permitting holders to inexpensively diversify, manage, and transfer credit risk. The result is typically less restrictive covenants in light of greater publicly available information about those borrowers, the higher cost to monitor and enforce compliance, and a decline in the ability to mitigate credit risk through contract. By contrast, private debt builds on the pre-existing relationship between lenders and borrowers. Covenants are applied in order to control the borrower’s activities. However, covenants can be expensive and imperfect predictors of management behaviour, reflecting the low possibility to assess business performance. Compare with public debt market, the risk that some covenants will limit profitable activity is offset by the ability, among a small group of lenders, to inexpensively renegotiate covenants that have become too restrictive, as well as to exercise control rights.
Covenant level are determined, in part, by the amount of borrower information that a lender possesses or can be cheaply acquired. If the lender is less well-informed, it is more likely to seek stricter covenants in order to more closely control a borrower’s future activities. The level of financial covenants are set base on the business forecast agreed by Borrower and Lenders. Below are the general financial covenants applied in syndication loan.
|Type of Covenant
|Type of Covenant
|Debt to EBITDA
|Debt Service Coverage
|Debt to Tangible Net Worth
|Cash Interest Coverage
|Debt to Equity
|Fixed Charge Coverage
|Loan to Value
|Tangible Net Worth
This article provides a high level of introduction to syndication loan. Detail of terms and mechanism is complex for syndication base on different financing purpose. A simple corporate loan is straightforward without complicated undertakings and covenants. However, a highly leverage financing such as Leverage Buyout or Project Financing, the terms could be lengthy and complicated. The role of MLAB is important for structuring a marketable transaction which can be concluded for Borrower. Other than structuring, execution is another key for MLAB as there is a lot of parties shall be involved such as participant, legal counsel, consultancy, regulator, etc. All the terms in the facility agreement are set in order to mitigate and control the credit risk to be taken by the lenders according to the business of borrower. Therefore, a gate keeper on documentation execution as last step is also crucial for borrower to avoid post transaction administration and potential default.
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