By Sophie Papasavva
Ask any CFO to describe their past experience of putting in place a syndicated loan financing and the answer will inevitably be ‘excruciatingly painful’ but a ‘necessary evil.’ Bankers lend every day, all day long. Corporates tap into the loan market on average once every 3 years. The odds will always be in favour of the lenders, yet it doesn’t need to be so. This article introduces the most common mistakes made by corporate borrowers seeking syndicated loan financings and argues that with a little effort and better understanding, syndicated loans may become a more efficient and less painful experience for all. Firstly, a little introduction on syndicated lending...
Lead Banks
Whereas a self-arranged syndicated loan is common enough amongst investment grade or repeat borrowers, undoubtedly, the appointment of a lead bank to act as Mandated Lead Arranger (“MLA”) is a must for a smooth syndication. The MLA contributes enormous value in taking a lot of the day-to-day deliverables of the syndication away from the borrower, but most importantly, it is the MLA that holds the direct relationship with numerous banks that comprise the syndicate. The MLA may offer an underwrite, giving the borrower certainly of funding (for a premium of course), albeit in the current economic environment a ‘hard’ underwrite is unlikely to be forthcoming. The MLA is key in structuring and pricing a loan that will maximise the chances of success. MLA banks typically syndicate loans in primary and sell loans in secondary, all day every day. It is a hugely profitable business and the relationship between MLA bank and those investor banks looking for assets, is crucial to both sides. A strong MLA will structure profitable, well-performing loan facilities, that it too is willing to hold. Investor banks take comfort from MLAs’ track record in syndicating successful transactions and the repeat business between the two keeps the loan market liquid.
Syndication Process
Raising a syndicated loan entails a 20-step process, beginning with the initial phone call by the corporate borrower to one or two of its house banks and ending with the first drawdown.
Syndication Process
The 20-step process ensures that, corporate and MLA, together prepare a marketable deal that will be attractive to investor banks. A corporate should attract multiple banks for a number of reasons, including building track record for those all-important future financing needs and ensuring every possible morsel of liquidity is tapped into, as banks’ strategies may shift away at a future date. MLAs need to attract multiple banks to ease pressure on their own balance sheets (originate to distribute business model). Importantly, unlike the bond or equity markets, banks are not speculative or opportunistic - they prefer to pursue long-term relationships and often pride themselves in supporting their core clients through thick and thin; the bank market is far less volatile.
Some investment grade repeat borrowers can complete the 20-step syndication process in less than four weeks; this is typically where the borrower is a listed blue-chip entity, commanding unsecured borrowings and with impeccable track record on previous loans. Leveraged finance borrowers, with the benefit of savvy private equity sponsors and quasi cookie-cutter structures, can complete the 20-step process in 8 weeks. But outside of these two groups, there are plenty of corporates that struggle to raise bank debt in a timely manner. Examples are:
first-timer borrowers;
project finance borrowers;
corporates with limited internal finance resources or know-how;
emerging markets borrowers with limited access to anything but basic, local liquidity;
early-stage borrowers that require the benefit of a developmental or multilateral institution to facilitate commercial bank liquidity;
borrowers operating in less-popular industry segments (eg. technology) etc, etc.
The list for whom the 20-step process takes 3 to 4 months or longer, is endless. The drain on resources for any finance team over a 3-4 month period comes at a high price, with distraction of senior management’s attention away from the day-to-day running of the business. This is precisely why many CFOs and Finance Directors will attempt to look at the bond market before they look to the bank market for funds, and who could blame them?
The Common Mistakes
The 5 most common mistakes made by corporate borrowers entering into a syndication, typically lead to longer lead-times and higher costs for their business; this is even with the best intentions on the part of the bankers. Perhaps such mistakes stem from the unfounded belief that the MLA will take care of everything. Whereas they clearly could, even the most conscientious banker with 2 or 3 deals running in parallel, will not be able to meet such high expectations in a timely manner. Hence, below the 5 most common mistakes on the part of borrowers:
1. Being unprepared
This may seem obvious, yet most often than not, the syndication process begins with a phone call to one or two house banks with a request along the lines of: “We are looking to expand / invest / acquire etc, and we think we’ll need about US$ x million. I can send our internal finance model. Can you send across a term sheet?” Seriously? Even an artisan baker, looking to bake his day’s supply of loaves, will be better prepared than that!
2. Expecting fast results
There is a process that is absolutely required to be followed for the best results. To use the artisan baker analogy, it might entail combining flour, yeast, water, oil etc, and for the MLA it will be structuring a marketable term sheet, agreeing a conservative base case and writing a comprehensive Info Memo. All this, before any ingredient is placed anywhere near an oven - or in this case, sent to prospective syndicate member. Approaching potential bank investors before the necessary steps are complete or presented in a manner other than the one they expect, risks a disorganised financing process which will inevitably lead to delays.
3. Not shopping around
This may be a comfort issue, because it certainly cannot be a loyalty issue. Banks are not loyal to corporates, so the latter shouldn’t be either. Our baker will research constantly to source the best quality ingredients for his artisan loaves. So why not approach more than one potential MLA instead of the same house bank again and again? In times of ample bank liquidity, shopping around offers the benefit of competitive tension, which should lead to lower pricing and a better overall deal for the borrower. In times of restricted lending, shopping around could offer an opportunity to tap into otherwise unexplored pockets of liquidity. It is certainly worth a try.
4. Believing banks act rationally
Actually, banks are sheep. Even the healthiest bank balance sheet will look to what peers are doing, before considering extending a new loan facility. Credit committees considering a ticket in a syndication, will always, without fail, ask to know which banks have already committed to the deal. This also explains why the syndicated loan market has such a healthy social scene.... syndicators absolutely need to know what their peers are doing, who they are lending to, which deal is oversubscribed, which is being flexed etc. Their sheepish nature is best demonstrated the moment the bank market quivers. In times of economic uncertainty, even the most core relationship borrowers see credit lines all but dry up - Q4 2008 / Q1 2009 proved this. As bank after bank withdrew credit lines, even those unaffected by toxic assets would not lend bilateral loans, let alone syndicated.
5. Thinking the MLA is on your side
And this is the deepest, darkest secret in loan syndications. The very moment a borrower signs a term sheet and mandate letter with the chosen MLA, literarily from that moment onwards, the MLA’s focus shifts away from the borrower and towards a successful syndication. The MLA cares about fees, which they get by structuring a deal that will have the widest possible appeal to investor banks, thus be in high demand. The balancing act of fees retained versus fees paid to the market, is what syndicators excel at. The MLA cares about market standard documentation and transferability of the loan so that no one is ‘stuck’ with an unwanted asset. Clear evidence of this, is the mere fact that the MLA negotiates facility documents across the table from the borrower, ie representing the other side - the syndicate. So who (apart from lawyers) is on the same side as the borrower, navigating them through the loan process? Usually, no one. The MLA seeks to satisfy its daily clients - investor banks - being the ones that buy loans from them in primary and secondary every day. Those corporate borrowers come round on average once every 3 years. Whereas it is not quite a conflict, it is certainly a shift of focus away from the corporate.
Granted, in their support, bankers are not all bad. They will chop and change, waive and amend, structure and restructure, before resorting to exercising their security on a problem loan, which is absolutely a very last resort. Banks do not want to own and run your business - they want to sell ancillary business to earn fees and interest. So if the above seems like the bankers are all to blame, they are not.
Corporates’ Responsibility
If corporate borrowers were to take responsibility for some matters, if they were better prepared for syndication and if they had realistic expectations of an MLAs’ deliverables, perhaps loans could overcome their association with time-consuming, painful borrowing and become the darling of the debt market. The most important time-saving exercise that a corporate can perform, is to spend time preparing, before the banks are involved. In simple terms, articulate your business well and you are far more likely to achieve a more cost effective financing.
The first element that requires preparation is the base case model that represents the corporate’s business plan. The model is often delivered with limited thought given to who its new audience may be. Sometimes, corporates hand over little more than their internal budget. Banks need a reasonable set of projections, validated by independent sources and benchmarked against peers and competitors. Banks need sensitivity scenarios. It is the analysis of the business plan projections that drive most of the structural elements of the financing: the loan amount, the tenor, the repayment schedule, the financial covenants. Unless a corporate offers a ‘bankable’ model, it risks weeks, if not months, of to and fro to reach an agreed base case that satisfies the MLA.
The second element that requires preparation is the Request for Proposal (“RFP”). This is actually a step most often skipped in its entirety by novice corporate borrowers. The RFP partly serves as the first sales document to the financing (predecessor to the Info Memo), but it also articulates the wants and wishes on the part of the borrower. The great value of an RFP is that it forces the CFO to consider and articulate what the business requires in terms of a financing: amount, tenor, security, underwrite request, pricing etc.. Based on a well-thought through business plan, the RFP should act as an invitation to the privilege of arranging a syndicated loan.
Conclusion
Don’t leave it all up to the MLA; take responsibility for your financing! Whilst the base case model and the RFP are a good start and possibly just a teaser for more debate, there are several elements in the 20-step process that a corporate borrower can control, but often neglects. Syndicated loan enthusiast are welcome to read more on each of the 5 common mistakes in subsequent parts to this article.
