Loans for the public not exceeding a few crores is an easy trip for a reputed bank or financial institution.
Wonder where the big market sharks who need surplus capital get their loans sanctioned? There's a high risk of procuring losses and undoubtedly a cumbersome task to sanction big amounts.
Credit syndication is the process in which multiple financial institutions opt for transactions like this.
What is Credit Syndication?
In such scenarios where a single borrower asks for a large amount of loan, several banks and financial institutions come together as a syndicate to fund the transaction.
This process of association of numerous money lenders to raise funds to sanction a big loan to a single borrower or company is known as loan syndication/ credit syndication.
The basic credit syndication meaning/loan syndication meaning for most institutions is a good investment with lower risk and secure returns.
Loan syndication is mostly done when
1. there is the involvement of large credit and high risk such as financing, mergers, acquisitions, takeovers, etc.
2. A single lender can't fulfil the requirements of the loan.
How does it work?
The loan syndication process is a complex step-wise process that involves different prospects.
One such is a risk manager, one of the lenders acts as a chief organizer who arranges the credit amount from other lenders and gives them equity accordingly.
When there is the involvement of high stakes, there ought to be a risk manager.
1. A thirsty man walks to the well, but the well doesn't follow him. Likewise, the borrower here initiates the process by asking the organization for a loan or inviting bids for investment in the form of debt. Once the lender is finalized, the process goes ahead.
2. If the concerned institution cannot fulfil the borrower's demands, it arranges the credit amount from other banks and proposes an information memorandum.
An encyclopedia to the whole syndication process. It lists key information like terms and conditions of investment, background review, risk litigation, detailed assessment and evaluation of the accounts, loan term, guarantee or underwritten deal, etc.
3. A whole set of agreements, legal contracts, and equity distribution make them liable for their share of the money.
After a series of lenders propose and accept the memorandum, they legally admit to funding it and form an association. The risk manager is responsible and ensures that the funds are directed to a trusted client after conducting in-depth due diligence.
4. Once the legal formalities are held, the loan is sanctioned by the syndicate. This is done after a mutual agreement on the terms and conditions of the borrower, also adhering to the market discrepancies.
5. Post sanction phase has to be monitored well as it's time for money lenders to get some revenue. The escrow services provide a detailed overview of repayment of loans, collection of interest, and financial performance.
Merits of credit syndication
Several well-known business tycoons go for their credit syndication; let's find out why?
1. Resource conservation
A syndicated loan is a crucial time saver for the borrower as one doesn’t need to invite, propose or deal with different lenders. The executive may only deal with a single lender who then takes responsibility for the arrangement of funds and other stakeholders.
2. Surplus transactions
It might not be feasible for a single lending authority to arrange a large amount of money in a small period of time.
Loan syndication provides flexibility to the lenders and lowers the risk value of their investment.
From the borrower's perspective, money is a big factor in crucial business modalities like new launches, mergers and acquisitions, global expansions, and company aid.
3. A positive reflection
It is a big positive for any leading business in the market when an association or syndicate invests in it. It reflects their trust, the company's growth potential, and goodwill. The more, the merrier.
4. A good bargain
When there's an involvement of several money lenders, there are diversified terms of loans and agreements.
This is a positive sign for the borrower as it creates space to bargain with different lenders offering different interest rates, repayment periods, and other loan-related commodities.
Drawbacks of loan syndication
1. Problem of plenty
Dealing with different terms and conditions due to the involvement of several lenders can turn out to be a menace.
It is a possibility that many institutions with a smaller stake may withdraw their share due to unsatisfactory returns. This is generally a problem with small merchant banks.
3. Keeping up with everyone
In long-term loan agreements, it's not easy to keep all the lenders and investors happy in times of recession.
There are various practices lenders won't appreciate, like delayed repayments and interest bargains according to the state of the market.
A single lender won't pose such a big problem, but the whole syndicate is hard to deal with from a borrower's standpoint.
Types of loan syndication
1. Underwritten deal
In this case, the whole amount of the loan is guaranteed by the lead bank or money lender. It involves higher risk coupled with a high return on investment due to a larger stake held by a single authority.
2. Club deal
It involves equal amounts of shareholding. The amount may go up to 150 million$, but it ensures efficient management and low risk, and all the banks and the lead bank are equally liable.
A credit or loan syndication has its own pros and cons, but if there's anything that can solve your big-budget loan problem with lower risk, is this only?
This also creates a larger market for investment by creating opportunities for several lenders in the same target community.
Syndication finance has been a boon for startups as they are most likely in need of expansions in which capital plays a crucial role.
Credit syndication in merchant banking is also performed to provide the borrower with a wider range of options.
Banks are lured toward high returns, which leads them to arrange for other underwriting banks to fund the business.