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Syndicated loans are loans extended by a group of lending institutions like banks jointly to a borrower. This kind of lending credits is a significant source of international financing whereby more than a third of all international financing emanated from international syndicated loan. In 2009, international syndicated lending amounted to about $1.8 trillion as compared to 1.5 trillion lending by non-financial firm participants in the international bond market (Madan, Sobhani, & Horowitz 1999).
Evolution of syndicated loan market
Syndicated loan market began around 1960s when the demand for credit was high and it was difficult for one bank to supply the demand. As a result, financial lending institutions decided to form syndicate market so as to satisfy the demand for credit borrowing. In 1970s credit syndications developed as a sovereign business. Between 1971-1982 developing countries like Africa, Asia and Latin-American were the major beneficiaries of medium-term syndicated loans from developed countries (McCauley, Fung, & Gadanecz 2002). By 1982 syndicate credits had grown from small amounts in 1970s to $46 billion. This lending stopped abruptly towards the end of 1982 due to the debt crisis when Mexico suspended interest payments on its sovereign debt leading to lending volumes decreasing to $9 billion in 1985. By 1989, US treasury secretary Nicholas Brandy established a plan which provided fresh impetus syndicate loan market. The debt crisis made banks to apply more sophisticated risk pricing to syndicated credits in 1990s. More data was made available on loan performance leading to the development of secondary markets which attracted non-bank financial bodies like insurance and pension firms. In the long run new risk management techniques like synthetic securitization enabled the banks to buy protection against credit risks while maintaining the loans on financial records. As a result of these developments in 2003, new loans including domestic facilities were signed amounting to $1.6 trillion which was three times more than the amount in 1993. Emerging markets and mature markets have also utilized the facility with the emerging markets recording 16% of the business and USA and Western Europe sharing the remaining percentage equally (Rule 2001). Syndicate markets have kept on showing rapid growth with mature markets showing a growth of $400 billion per quarter in 2002 to almost $1.3 trillion in 2007 in the second quarter while the emerging markets recorded a pick growth of $150 billion at the third quarter (Pennacchi 2003). Syndicated credit lending remained high in 2007 but collapsed in 2008 by 67% in mature markets and by the same percentage in developing countries, especially Africa and Middle East when Lehman failed. The year 2010 recorded slight pick-ups of the business due to the recovery process which began in late 2009.
Syndication is initiated when the lead bank or arranger wins the mandate from the borrower to lead the process. Usually senior international banks take the role of lead manager and draws up syndication mandate outlining the details of the contract i.e. pricing, size, timing, fees , underwriting methods (fully committed, partly committed or best-efforts) and key loan agreements (Dennis, & Mullineaux 2000).
Acquisition of syndicated business
After the mandate bank lending officers keep close contact with the potential borrowers. The lending manager negotiates with borrower over the size of loan, drawdown schedule, grace period, fees, tax issue, borrower information and legal loan covenants with the aim of balancing the borrowers need and market option. Depending on the borrowers needs they may choose to take the best offer from prestigious lead banks or lower cost proposal from aggressive banks. Pricing
A loan agreement establishes rights and obligations of all parties involved and appoints argent bank to run the loans books. Management group usually handles visible syndication tasks of negotiating the loan agreement.
Pricing in syndication reflects perceived markets receptivity and the risk-return trade-off relative to already existing loans in the market and the prospected ones. It tends to be a spread over a floating rate benchmark (libor) whereby interest is paid on a rollover basis and failure of syndication would be due to incompetence of managers (Coffey 2000).
Loan pricing characteristics
Loans emanating from European markets have lower spreads than those from us. Lenders usually demand collateral from high risk borrower, especially where high interest rates are involved. Newcomers face higher spreads than repeated borrowers. Priced loans are associated with state supported banks both senior and junior. Syndicated loan spreads wider in emerging markets for private borrowers and Latin American borrowers. If the borrower has a history of debt service problems, domestic lending booms and reserves of debt are low the spreads are widen (Allen 1990).
The rapid growth of syndicated loan markets has led to the development of increased efficiency and transparence of joint loan markets. Syndicated loans are beneficial to borrowers as well as lenders in several ways (Simons 1993). Syndication helps the borrowers to raise large sums of credit finance from a single bank; provides low cost /more efficient borrowing; enter the market due to access to funds; and it makes future transactions easier, hence, it is visible (Taylor 1998). To lenders syndication provides better diversification of assets portfolios; promotes economies of expertise and information more than any bank; promotes participation; increases market exposure; and finally reduces borrowers risk of default due to existence of certain legal protection in syndication (Robinson1996). These syndications allowed smaller financial institutions to be exposed to the larger markets without establishing a local presence.