Community Banks and Commercial Loan Syndications

Introduction to Commercial Loan Syndication – Tips for bankers

The purpose of this article is to give a small introduction to the syndicated loan market. The target for the article is the underwriter or lender in a community bank that might not be that familiar with the process. While there is a growing secondary market, I will be covering aspects associated with the origination assuming that your bank is invited to participate.

Why syndicate a commercial loan? The reason is simple. The borrower is looking for a large amount of money, and their bank cannot accommodate the request due to regulatory or risk management reasons. The primary lender gets to decrease its exposure while making additional fee income by acting as an arranger/agent.

Who is the typical borrower in a syndicated deal? The typical borrower for a syndicated loan is a large company. The funding provided by the proposed bank debt supports general corporate purposes, plant purchases, working capital, expansion, and sometimes even their own leveraged buyouts.

Is a syndicated loan as secured as a regular loan? Theoretically it should be. Syndicated loans are usually secured by first position liens on the assets of the borrowers, and would normally rank ahead of many bonds as well as subordinated debt. However, it is important to note that commercial loans can have a lot of customization, and that given the nature of a syndication your bank’s interests will be subject to bulky and extensive agreements.

Is my community bank taking a risk by participating in a syndication? My answer to that question would be: “Is it better to be a big fish in a small pond or a little fish in a big pond?” Because in the case of a syndication, the typical community bank will be the little fish and being the little fish cab create problems. The following are some challenges faced by a community bank that wants to start participating in syndications:

a)      You might not have the expertise. Underwriting a commercial loan for a large company requires a certain familiarity with the workings of large corporations. Not only are the financial statements going to be extensive, but they will be accompanied with additional financial information that require skill to understand. If your underwriters experience is purely small business and income producing property lending {the bread and butter of community banking}, they will need guidance.

b)      You might not have the infrastructure. Remember the bulky agreements that I mentioned earlier, your loan administrator might not be familiar with them. Your credit policy loan ratings might not be sophisticated enough to deal with large companies where tangible net worth is not as important a measure of leverage as the ability of cash flow to cover debt service or the relation between funded debt and profitability.

c)      Your position in the syndication might be so small that any decisions you want to take regarding the credit will be ignored. Most agreements give a lot of flexibility to the lead agent taking most decisions off your hands. Furthermore, big decisions can usually be approved by a majority of the lenders. You get votes that are proportional to your percentage participation in the syndication. If you have a $3 Million stake in a $500 Million syndicated loan, it is clear that your objections will not count for much. I have personal experience with such a situation, and we had to let the changes to the loan we disagreed with proceed as we could not stop them.

Is there anything else that I might consider as a community bank regarding syndications? These types of facilities are great at achieving their purpose “putting a big chunk of money to work at once”. However, your bank will most likely not get any compensatory balances, and the yield on the money will probably be small as large companies have the ability to negotiate better rates.

What is exactly the syndication process? Usually your bank will be invited to participate if the lender or someone in your organization has contacts with one of the large commercial banks or investment banks that are leaders in syndicating loans. There is usually a bank meeting where a “confidential information memorandum” is passed around. You can expect the lead bank/arranger to be there as well as representatives of the borrower. There will be a lot of PowerPoint presentations meant to introduce you to the company and give you information about the proposed facilities and the financial performance of the borrower. At the end of the day, a syndication is underwritten just like any other loan.

Is there any more information available? Yes there is even an industry that was created to facility this. After the meeting, all banks interested in participating are invited to a shared electronic depository that is usually managed by one of two firms (Syndtrak or Intralinks). There is usually a lot of information there available for the underwriting of the deal. This brings me to a couple of points that I want to make about this:

a)      Unsophisticated underwriters will copy/paste a lot of the information in the memorandum without digging into the numbers themselves. It is important to note that the bank is relying on independent due diligence and regurgitating a memo is not independence.

b)      Sometimes the lender will attend the meeting and afterwards it will give the underwriter the memo and the financials and consider that enough. In my opinion, it is important that the underwriter get access to the electronic depository as there usually is additional information in those sites. Off the top of my head I remember getting excellent collateral reports for one deal where we financed a home builder as well as detailed projections from a fast food chain deal. None of that information was available in the original package, but became an integral part of my analysis.

What is this about public and private information in commercial loan syndications? A lot of these large syndicated borrowers are public companies. The dissemination of information for public companies is highly regulated. However, lenders are allowed to see a lot of this information before it gets publicized. The problem is that a lot of large commercial lenders are also involved in the investment side. The way that this is handled during the syndication process is that participants are required to declare if they should be allowed to see the private information, and if they don’t they do not get access.

The topic of bank syndications is a complicated one. If you are interested in the subject, you can learn more by buying the following books from Amazon: Syndicated Lending (Essential Capital Markets)
or Corporate Credit — A CFO’s Guide to Bank Debt and Loan Agreements

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