The Economic Basis of Syndicated

Lending

William Wild B.Com LLB (Qld) LLM (Deakin)

submitted in fulfilment of the requirements

of the degree of
Doctor of Philosophy

The School of Economics and Finance

Queensland University of Technology
Brisbane, Australia
2004
 Keywords
• Syndicated Loan

• Lending

• Commercial Bank

• Loan Pricing

• Underwriting

• Arranger

• Borrower

• Participant

• Credit Risk

• Capital Charge

• Credit Exposure Limits

• Final Hold

• Relationship Banking

i
 Abstract
This work undertakes the first comprehensive theoretical assessment of syndicated
loans. It is shown that syndicated and bilateral (single lender) loans should be good sub-
stitutes in meeting a borrower’s financing requirements, but that syndicated loans are
more complex and impose additional risks to the parties in the way they are arranged.
The existing explantions of loan syndication - that they are hybrids of private bank
loans and public debt instruments, that syndication is a portfolio management tool,
and that loans are syndicated where they are too large to be provided bilaterally - are
unable to substantially explain both the nature of syndicated loans and practice in the
loan markets. A rigorous new explanation is developed, which shows that syndication
reduces the rate of lending costs, so that the return to the loan originator is greater,
and the borrower’s cost of financing is lower, where a loan is syndicated rather than
provided bilaterally. This explanation is shown to hold in competitive loan markets
and to be consistent with the observation that syndicated loans are generally larger
than other loans. Incidental to this new explanation, new expressions of the return to
a bank from providing a loan on a bilateral basis and from originating a syndicated
loan are also developed. New algorithms are also developed for determining the distri-
bution of the commitments from syndicate participants and thus the originator’s final
hold, the amount it must lend itself, where the loan is underwritten. This provides,
for the first time, a rigorous basis for assessing the expected return, and the risk, for
the originator of a given syndicated loan. Finally, empirical testing finds that a bank’s
observed lending history is significant to its decision to participate in a new syndicated
loan but that predictions of participation, which are fundamental inputs into the final
hold algorithms, based on this information have relatively little power. It follows that
there is competitive advantage to loan originators that have access to other, private
information on potential participants’ lending intentions.

ii
Contents

Keywords i

Abstract ii

Declaration vi

1 Overview 1
1.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.2 Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

2 Use of Syndicated Loans 9

2.1 Snapshot of Syndicated Loan Usage . . . . . . . . . . . . . . . . . . . . 9
2.2 Short History of Syndicated Loans . . . . . . . . . . . . . . . . . . . . . 14
2.3 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

3 Structure of Syndicated Loans 21

3.1 Syndication Terms and Conditions . . . . . . . . . . . . . . . . . . . . . 22
3.2 Arrangement of Syndicated Loans . . . . . . . . . . . . . . . . . . . . . 26
3.3 Syndication Risk, Best Efforts and Underwriting . . . . . . . . . . . . . 28
3.4 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

4 Returns from Syndicated Lending 35

4.1 Loan Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
4.1.1 Loan Availability and Utilization . . . . . . . . . . . . . . . . . . 38

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 4.1.2 Net Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
4.1.3 Credit Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
4.1.4 Opportunity Cost . . . . . . . . . . . . . . . . . . . . . . . . . . 49
4.1.5 Other Major Income and Costs . . . . . . . . . . . . . . . . . . . 51
4.1.6 Return from a Bilateral Loan . . . . . . . . . . . . . . . . . . . . 52

4.2 Syndicated Loan Return . . . . . . . . . . . . . . . . . . . . . . . . . . . 54

4.3 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

5 Why Are Loans Syndicated? 57

5.1 Syndicated Loans as Hybrid Debt Securities . . . . . . . . . . . . . . . . 59
5.1.1 Preference Ranking of Debt Financing Alternatives . . . . . . . . 61
5.1.2 Syndication as Disintermediation . . . . . . . . . . . . . . . . . . 63
5.1.3 HLT Syndicated Loans . . . . . . . . . . . . . . . . . . . . . . . . 68
5.1.4 Empirical Findings . . . . . . . . . . . . . . . . . . . . . . . . . . 69
5.2 Active Portfolio Management . . . . . . . . . . . . . . . . . . . . . . . . 72
5.3 Loan Size . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
5.4 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78

6 Syndication and the Costs of Lending 79

6.1 Credit Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
6.2 Capital Charge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82
6.3 Opportunity Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
6.4 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

7 New Loan Syndication Model and Hypothesis 93

7.1 Marginal Return from Syndication . . . . . . . . . . . . . . . . . . . . . 96
7.2 Efficient Loan Originator . . . . . . . . . . . . . . . . . . . . . . . . . . 101
7.3 Loan Size . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105
7.4 Risk, Return and Sharing of Marginal Return with the Borrower . . . . 108
7.5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110

iv
 Appendix 7.1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111
Appendix 7.2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113

8 Final Hold 115

8.1 Overview of Final Hold . . . . . . . . . . . . . . . . . . . . . . . . . . . 116
8.1.1 Industry Practice . . . . . . . . . . . . . . . . . . . . . . . . . . . 116
8.1.2 Research . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117
8.2 Final Hold Algorithms . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120
8.2.1 Algebraic Method . . . . . . . . . . . . . . . . . . . . . . . . . . 123
8.2.2 Numerical Method . . . . . . . . . . . . . . . . . . . . . . . . . . 123
8.3 Distribution of Final Hold . . . . . . . . . . . . . . . . . . . . . . . . . . 124
8.4 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128
Appendix 8.1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129
Appendix 8.2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134

9 Syndicated Loan Participation 137

9.1 Loan Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139
9.2 Theoretical Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141
9.2.1 Classic Relationship Banking Hypothesis . . . . . . . . . . . . . 141
9.2.2 Extended Relationship Banking Hypothesis . . . . . . . . . . . . 144
9.2.3 Overall Activity Hypothesis . . . . . . . . . . . . . . . . . . . . . 146
9.3 Variables and Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147
9.4 Econometric Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157
9.5 Testing, Results and Interpretation . . . . . . . . . . . . . . . . . . . . . 161
9.6 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171

10 Summation 173

Bibliography 178

Index 187

v
 DECLARATION

The work contained in this thesis has not been previously submitted for a degree
or diploma at any other higher education institution. To the best of my knowledge
and belief, the thesis contains no material previously published or written by another
person except where due reference is made.

Signed:
Date:

vi
Chapter 1

Overview

1.1 Introduction

A syndicated loan is broadly defined as a loan facility that is provided by two or more
lenders, the syndicate, on common terms. Each lender who participates in the syndicate,
usually called a participant, makes a commitment to provide a given proportion of the
total loan amount and has a right to receive the same share of all payments from the
borrower. For the convenience of the parties all the facility cash flows1 , as well as flows
of information between the borrower and participants, are passed through a designated
facility agent. Nevertheless, the fundamental right of each participant to receive its
share of the agreed payments, as scheduled, is always protected.
It might be suggested, therefore, that syndicated loans are just an obscure variation
of the commonplace bilateral - single lender - commercial bank loan facility; and there
are relatively few works that consider syndicated loans specifically. Yet syndicated
loans have been described as “a major component of today’s financial landscape”, “a
powerful third arm of the capital markets” and “one of the workhorses of the inter-
national capital markets” (Jones, Lang and Nigro, 2000; Garrity, 2000; Eichengreen
and Mody, 1998). This rhetoric is supported by the statistics. In the year 2000 there

1
Facility cash flows include loan advances, repayments, fees and interest.

1
were over US$2.2 trillion2 equivalent of new syndicated loans executed worldwide, rep-
resenting compound growth in excess of 10% annually over the previous decade (Esty
and Megginson, 2000). The leading arranger of syndicated loans has completed over
US$300 billion in new transactions in a single year, over 3,000 banks participate as
lenders in loan syndicates globally, and syndication of one individual loan generated
commitments from participants of over Euro70 billion during syndication3 .
While there are comprehensive guides to syndicated lending practice (see Rhodes,
2000), this work outlines the first general economic theory of syndicated loans, develop-
ing a rigorous model that shows why certain loans should be syndicated and methods
for assessing the trade-off between risk and return for the banks that originate them.
The question of why loans are syndicated is raised not only by the fact that syn-
dicated loans are so widely used, but by the fact that it is not immediately obvious
that they favour any of the parties to them. While they are a form of commercial bank
loan it is also clear that they are more complex, and potentially more difficult and
costly for borrowers to arrange and manage, than the bilateral form of loan. For their
part, it is not clear why banks should desire to share the loans they originate, and the
potentially lucrative lending relationship that goes with them, with other lenders, their
competitors, by syndicating them.
It is certainly not possible to ascribe motives to all institutions that participate in
the syndicated loan markets, and without doubt some syndicated loans are undertaken
for reasons that may not be rational on a purely economic basis. Furthermore each
syndicated loan is unique in its circumstances, and the product is used for a large
variety of purposes and for a diverse range of borrowers. This work therefore develops,
based on the nature of commercial banks and their operating environment, a general
economic model and explanation for the use of syndicated loans that shows why certain
loans should, under reasonable assumptions, be syndicated by bank loan originators who

2
There are a number of syndicated loan databases that vary in their methodologies and so generate
different statistics. The value of $2.2 trillion in new syndicated loans in 2000 is the minimum amount
recorded by the major databases.
3
See Chapter 2 for more information.

2
seek to maximize their returns and for borrowers who wish to minimize their costs of
borrowing. It is demonstrated that this model and explanation are compatible with,
and able to significantly explain, observed practice in the syndicated loan markets. This
work also describes and considers the popular alternative explanations for syndication.
These are not strictly economically based and, it is observed, leave significant aspects
of observed syndicated loan market practice unexplained.
The new explanation can be summarized as follows. Given reasonable assumptions,
a loan with given pricing will generate greater expected return to the bank that origi-
nates it where it is syndicated rather than provided on a bilateral basis. The incentive
for both parties to select the syndicated loan comes from the originator sharing this
expected marginal return from syndication with the borrower by reducing the pricing,
and thus all-in costs of the loan to it, to below that of the alternative bilateral loan.
The model demonstrates the existence of this expected marginal return to the origi-
nator under realistic conditions, including that the originator is equally as efficient as
the syndicated loan participants in providing loan commitments; vital to explaining
syndication in competitive loan markets. It also demonstrates a positive relationship
between expected marginal return from syndication and loan size which is consistent
with the observation that larger loans are more likely to be syndicated. It also explains
the advantage of syndication where the loan is fully underwritten.
At the heart of the model are new, general expressions of the return to a bank from
lending on a bilateral basis and its extension into an expression of the return from
originating an underwritten syndicated loan. The former is developed by comparing
and contrasting loans with their major alternative, bonds issued in the capital markets,
and so provides important insight into the unique nature of loans that enables them
to provide financing of a kind that cannot be provided by other debt instruments.
The expected marginal return from syndication demonstrated by the model is due to
syndication reducing the rates of the lenders’ major costs of providing the loan facility,
which are major elements in the expressions of loan return; namely credit, capital and
opportunity costs.

3
 The expression of syndicated loan return is more specifically an expression of the
expected return from syndication, reflecting the fact that syndication of a loan intro-
duces a new risk, and thus additional uncertainty in return, that is not present if the
loan is provided on a bilateral basis. Called syndication risk, it is the uncertainty as
to which institutions will participate in the loan syndicate and the amount each will
commit. In competitive loan markets the bank that originates a syndicated loan is
usually required to accept syndication risk by underwriting the borrower’s desired loan
amount, in which case it faces uncertainty in the residual amount it must lend itself,
called its final hold. So an important contribution of the model, and the further work
on its interpretation, is to make explicit the relationship between its return and the
acceptance of syndication risk by the syndicated loan originator.
This work is then extended to the development of new algorithms for determining
the probability distribution of an originator’s final hold in a given syndicated loan. The
new syndication model shows that the return to the originator is sensitive to its realized
final hold amount, and so these algorithms provide the basic tools for quantifying the
distribution of return, and thus the expected return and the risk, from originating a
syndicated loan on given terms. Two alternative methods are proposed, an efficient
algebraic method and a conceptually simpler numerical approach. These new tools are
also used to investigate the general form of the distribution of final hold, which is found
to be a truncated normal distribution, with greater risk to the loan originator in the
direction of higher final hold.
The final important contribution of this work is in considering the question of
whether an institution’s observed lending history has any power to predict its partici-
pation in syndicated loans, and this is empirically investigated. This is an important
question because it is the decisions of potential participants to participate that deter-
mine the originator’s final hold in any given syndicated loan. It is found that, while
statistically significant, such information has relatively limited power to explain the de-
cision to participate. This suggests that there is a competitive advantage for originators
who invest in acquiring additional private information.

4
1.2 Structure

The body of this work is structured as follows. Chapter 2 briefly describes the use
of the modern form of syndicated loan; not just the bare transaction volume, but
the type and location of borrowers and lenders, and the financing purposes to which
they are applied. A short history traces the modern form of syndicated loan from the
euromarkets in the 1970s through to the integrated global markets of today, and notes
their central place in some of the major financial market events of the time. The use
of syndicated loans is described first, even before the nature of the instrument itself,
because it is their widespread use by such a diverse array of borrowers and for such a
range of financing purposes that provides a fundamental motivation for this work.
Chapter 3 then begins to focus on the syndicated loan specifically. The generic
syndicated loan agreement is considered, and is shown to be a standard commercial
bank loan agreement onto which has been overlaid terms governing the additional
relationships between the parties. Next the process by which syndicated loans are
arranged, including the major tasks of the originator and its obligations to the other
parties, is outlined.
Chapter 4 undertakes the first major analytical work, generating a new expression
of the return to the institution that originates a syndicated loan. As well as being
an important result in its own right, providing a tractable return model and a clear
exposition of the unique nature of commercial bank loans, this is the basis of the new
model and explanation for syndication that is developed in subsequent chapters.
The following chapter, Chapter 5, introduces the fundamental question in this field:
Why are loans syndicated? The most popular existing explanations are each described
and considered. These are that syndicated loans are a hybrid of public debt securities
and private bank loans, that syndication is a loan portfolio management tool akin
to secondary loan sales, and that syndication of a loan is a means of avoiding the
constraints of banks’ credit exposure limits. It is observed, however, that some of
the major assumptions underlying these explanations are not consistent with, nor are
they able to adequately explain, some important aspects of observed practice in the

5
syndicated loan markets. This means that there is a place for an alternative hypothesis
that both is and can do so.
The next chapter, Chapter 6, begins to set out the basis for a new hypothesis.
The effect of syndication on the three major costs of lending, identified in the new
expressions of return developed earlier, is considered. It is shown that, again with
reasonable assumptions, syndication of a loan reduces the rates of credit loss provision,
capital charge and opportunity cost for the loan originator compared with the provision
of the loan on a bilateral basis.
Chapter 7 then develops the new model of loan syndication that shows exactly how
this lower rate of lending costs can translate in a lower overall cost of financing for the
borrower, compared with the alternative bilateral loan, in realistic market conditions.
The model is then expanded and analysed to show how this is the case even where
participants are equally as efficient as the originator in providing loan commitments,
a pre-requisite for the existence of syndicated loans in competitive loan markets. A
positive relationship between loan size and marginal expected return from syndication,
which should more highly motivate the syndication of larger loans, is then demonstrated
to flow from this economic structure. Finally, it is shown that the originator’s return
from a syndicated loan is sensitive to its final hold. While this does not affect the
validity of the new hypothesis it does mean that the amount by which the originator
can reduce the pricing on a syndicated loan below that of the alternative bilateral loan
will be sensitive to the distribution of final hold and its own risk tolerance. As such
it makes explicit the relationship between syndication risk and the loan originator’s
return.
As the distribution of final hold should be a vital element of the decision to syndicate
a loan, or the terms on which it might be done, Chapter 8 considers how final hold is,
and should be, estimated. It begins by describing current industry practice, which is
characterized as qualitative and based on expert judgement. It then goes on to assess a
small number of academic works that identify, empirically, features of syndicated loans
that they contend are significant to the level of final hold. It is observed, however,

6
that these works do not account for the fact that loan originators ration participation
in syndicated loans in an attempt to achieve pre-specified final hold targets. The
major contribution of the chapter is the development of new final hold algorithms for
generating the distribution of final hold that, among other things, do capture this
rationing effect. The fundamental parameters of these algorithms are the participation
probabilities, parameters that quantify the probability that any potential lender will
join the loan syndicate and the amount it will commit. The new algorithms offer two
alternative methods for transforming the participation probabilities into a distribution
of final hold; an efficient algebraic method and a numerical simulation method. The
general form of the distribution of final hold is also described.
The final substantive chapter, Chapter 9, addresses the question of whether prior
public information as to an institution’s lending history has any power to predict its
decision to participate in a syndicated loan, and implicitly its participation probability.
Three separate hypotheses are proposed to explain why this information might be
significant. These draw on classic relationship banking theory and actual banking
industry practice. A suitable empirical model is developed and then data drawn from
one of the leading commercial syndicated loan databases, of the type used by syndicated
loan practitioners, is recompiled to generate a suitable sample. This is tested using a
binary probit technique and the anticipated result found that, while an institution’s
observable lending history is significant, it has relatively limited power to predict its
decision to participate in a new syndicated loan. Further analysis draws the conclusion
that participants in syndicated loans fall into two main groups; relationship banks who
are captured relatively well by the empirical model and transactional banks who are
not and who, it is observed, comprise a significant proportion of all syndicated loan
participants.

7
8
Chapter 2

Use of Syndicated Loans

The significance of syndicated loans is demonstrated in this chapter. Section 1 outlines

the geographical distribution of syndicated loans, identifies the major borrowers and
arrangers, and provides examples of the diverse financing requirements that syndicated
loans are able to meet. Section 2 provides a brief history of the modern form of syndi-
cated loans, describing how they have diversified from an important, albeit relatively
specialized, source of sovereign finance in the 1960s and 1970s, to become a vital source
of capital for all aspects of the global economy.

2.1 Snapshot of Syndicated Loan Usage

There were approximately US$1.9 trillion equivalent in new syndicated loans completed
globally in 2003 (Thomson Financial, 2004). This represents a small fall from the peak
in the year 2000, but it is consistent with the change in general economic conditions
over that time and does not represent any decline in the relative use of the product.
The broad geographic distribution of syndicated lending for the year 2003 is shown in
Table 2.1.
Over fifty percent of new syndicated loans are completed in North America, which
reflects the relative size of the US economy and the sophistication of the commercial
banking sector in that country. Yet while the European syndicated loan market is less

9
 Region US$ billion

North America 1,010

Europe, Middle-East, Africa 642
Latin America 21
Asia-Pacific 197
Total 1,870

Table 2.1: New Syndicated Loans by Region, 2003. Source: Euromoney.

than two-thirds of the size of its US equivalent, it has been the location of some of
the largest single private financings in history. In 2000, for example, France Telecom
raised a syndicated loan to finance its acquisition of mobile telephone company Orange.
The banks invited to join that loan syndicate committed, between them, a staggering
Euro71 billion, which was scaled-back to the borrower’s required loan amount of Euro30
billion (International Financing Review).
The Asia-Pacific accounts for just over ten percent of global syndicated loan volume,
but this belies the fact that the dominant source of capital for Asian economies1 was and
remains commercial banks, particularly non-Asian commercial banks, provided mainly
through syndicated loans (Eichengreen and Mody, 1998). While the Asian crisis of
1997-98 has been relatively well documented, what has been generally overlooked in
the literature is that it was a banking crisis as well as a currency crisis, caused by
the fragmentation and shrinkage of the commercial bank market for Asian risk (Wild,
1998). This is demonstrated in Table 2.2 which shows the changes in syndicated lending
in the region from the second quarter of 1997, the last full quarter before the onset of
the crisis, to the third quarter of 1998, when the crisis had taken full effect across the
region.
Borrowers under syndicated loan facilities now cover the entire spectrum of commer-
cial and financial entities, from sovereigns to corporations to special purpose financing
vehicles. The volume of syndicated loans completed by some borrowers is very sub-

1
Excluding Japan and China.

10
 Asian Syndicated Loans (excluding Japan) 2nd Qtr 1997 3rd Qtr 1998

Volume of new syndicated loans (US$ million) 13,584 3,466

Number of new syndicated loans 193 38
Average annualized interest margin and fees 0.94% p.a. 1.33% p.a.
Number of participants in new syndicated loans 326 128
Number of participants by nationality 37 24

Table 2.2: Asian Syndicated Loans and the Asian Crisis. Source: Loanware.

stantial. In the 25 years to 1999, AT&T entered into syndicated loan facilities in the
total amount of $128 billion. Table 2.3 shows the top 30 syndicated loan borrowers for
the 25 years up to 1999 (Hurn, 1999).
In the United States alone, $242 billion in new syndicated loan facilities were com-
pleted for investment-grade borrowers2 in just three months in the second quarter of
2004 (Loan Pricing Corporation, 2004). As well as being a direct source of short and
medium-term capital3 , syndicated loans have also developed an indispensable role in
enabling investment-grade firms to utilize the attractive short-term commercial paper
(CP) 4 markets as a source of core debt funding. Firms reliant on CP for anything
other than very short-term funding requirements leave themselves open to the risk that
disruption to the capital markets may leave them unable to refinance outstanding CP
when it comes due.
The solution is to put in place syndicated standby loan facilities that may be drawn
to fund the repayment of CP in adverse circumstances. In fact the credit major ratings
agencies require the commitment of such liquidity as a precondition to the investment-
grade credit rating firms needed to access the CP markets (Hahn, 1998). This use for
syndicated loans has developed to the point where Duran (2001) observed that, out
of $2.1 trillion in US domestic syndicated loan facilities available in 2001, only $769

2
Investment grade firms are those with a credit rating of BBB or above from Standard & Poor’s or the
equivalent rating from another recognized agency. An investment grade credit rating is a precondition
for debt issuance in most parts of the public capital markets.
3
Syndicated loans for investment-grade borrowers typically have a maximum maturity of 5 years.
4
Commercial paper has short maturities, at most one year, and more typically 30 days.

11
 Rank Borrower US$ million

1 AT&T 128,769
2 General Motors 93,539
3 DaimlerChrysler 90,515
4 Philip Morris 76,824
5 Morgan Stanley DW 52,635
6 ARCO 45,506
7 RJ Reynolds 44,168
8 Sears Roebuck 44,070
9 Viacom International 42,676
10 Hanson Trust 42,515
11 ITT 39,396
12 IBM 38,946
13 MCI WorldCom 37,110
14 Time Warner 36,882
15 BP 33,074
16 American Home Products 32,775
17 Kingdom of Spain 32,206
18 Xerox 31,488
19 HCA 31,004
20 Canada 30,875
21 Dai-Ichi Kangyo Bank 30,159
22 Deere 29,795
23 Westinghouse Electric 29,570
24 Fuji Bank 29,071
25 News Corp 28,527
26 Texaco 28,287
27 American General 27,465
28 Walt Disney 27,109
29 Kingdom of Sweden 26,942
30 Olivetti 25,455

Table 2.3: Top 30 Syndicated Loan Borrower by Volume of Transactions, 1974 - 1999.
Source: International Financing Review 25th Anniversary Issue.

12
billion (37.5%) had actually been drawn as advances in that year. Investment-grade
rated firms are not the only entities to benefit from syndicated liquidity facilities. For
example the high-profile hedge fund Long Term Capital Management, famous both for
the lack of transparency of its operations and its eventual collapse, was supported by
a US$900 million syndicated standby loan facility (Shirreff, 2004).
Syndicated loans are also major sources of funds for such diverse applications as
sovereign balance of payments financing, construction finance, trade finance and bridg-
ing finance. A very important application is as a source of limited recourse project
finance. At the peak in 1997 there were US$102 billion of new syndicated project fi-
nance loans completed globally, and syndicated loans have historically accounted for
more than 90% of total project finance debt (Esty and Megginson, 2000). While vital to
the economic development of emerging economies, this financing structure also became
integral to infrastructure development in developed countries. The Eurotunnel project,
for example, was initially financed through a $13 billion syndicated loan provided by
220 different financial institutions (Grant, 1997).
One of the fastest growing, and by far highest profile, applications of syndicated
loans is in highly leveraged transactions (HLTs)5 , particularly in the United States but
increasingly in Europe. This is not a new use for the product, however, and one of the
signature transaction of the 1980s, the acquisition of RJR Nabisco by Wall-street buy-
out firm KKR, was funded by a $13.5 billion syndicated loan (Miller, 2002). By 1998
the annual volume of leveraged syndicated loans had grown to $256 billion (Miller,
2004). What has garnered so much recent attention about this form of syndicated
loan is the increasing participation of non-bank institutional investors as syndicate
lenders, with over 144 funds investing regularly in HLTs by 2001, representing almost
40% of the participants’ commitments in these loans (Garrity, 2000). Nevertheless
the global syndicated loan market remains one dominated by commercial banks. Non-
bank institutional investors participate exclusively in HLT syndicated loans, which still

5
HLTs are defined by the large proportions of debt in their borrower’s capital structures and the
consequently high levels of credit risk they represent. They are typically used to finance mergers and
acquisitions.

13
comprise a relatively small proportion of total syndicated loan volume. Over 3,000
banks joined syndicated Eurocurrency loans, just one class of syndicated loans, during
the 1980s (Chowdry, 1991) and a similar number still participate in syndicated loans
throughout the world today.
Syndicated loans are also significant to a smaller group of commercial banks for
another reason. These are the banks that originate and arrange them. The leading
arrangers of syndicated loans represent most of the world’s largest financial institutions,
and the arrangement of syndicated loans is a significant business line in its own right.
The two leading arrangers in 2000, JP Morgan and Bank of America, arranged new
syndicated loans in a cumulative amount of over US$600 billion equivalent in that year
alone. Even the 50th ranked arranger in that year completed new syndicated loans
in excess of $5bn equivalent. And in the late 1990s, for example, it was reported that
Chase Manhattan Bank’s6 "syndicated finance business is now grossing close to US$2bn
a year in fees." (Hurn, 1999). Table 2.4 lists the top syndicated loan arrangers in 2000.

2.2 Short History of Syndicated Loans

The modern form of syndicated loan was noted in the late 1960s in the eurocurrency
market, and they are referred to in the early literature as international or eurocurrency
syndicated loans. A number of authors have traced the development of the eurocur-
rency syndicated loan market through the 1970s and early 1980s, with the significant
statistic being the growth of transaction volume from US$4 billion equivalent in 1970
to US$100.9 billion at its peak in 1981 (Goodman, 1980; Allen, 1990; Chowdry, 1991;
Clark, Levasseur and Rousseau, 1993).
The Eurocurrency market developed in the 1950s when communist bloc countries,
concerned that their US dollar deposits in the United States might be frozen for po-
litical reasons, transferred them to European banks outside of US government control
(Skerman and Barrett, 1989). Not only were these banks outside the control of the US

6
Chase is now part of the JP Morgan group.

14
Rank Institution Nationality # loans US$ million

1 Bank of America USA 1,465 299,576

2 JP Morgan USA 977 305,202
3 Citibank/SSB USA 799 225,739
4 BancOne USA 442 81,617
5 FleetBoston USA 437 44,929
6 Deutsche Bank Germany 400 87,994
7 ABN-AMRO Netherlands 365 76,381
8 Barclays UK 351 115,782
9 Mizuho FG Japan 330 70,731
10 First Union USA 298 34,655
11 BNP Paribas France 212 41,427
12 Societe Generale France 210 41,424
13 Commerzbank Germany 203 32,921
14 Scotiabank Canada 188 27,083
15 Credit Suisse First Boston Switzerland/USA 182 51,708
16 Credit Lyonnais France 176 21,232
17 Westdeutsche Landesbank Germany 171 26,317
18 Bank of Tokyo — Mitsubishi Japan 166 32,130
19 Dresdner KB Germany 154 30,379
20 HSBC Hong Kong/UK 152 46,433
21 Royal Bank of Scotland UK 148 31,798
22 ING Barings Belgium 124 15,517
23 CIBC Canada 120 17,661
24 Bank of New York USA 116 25,968
25 Toronto Dominion Canada 113 24,549

Table 2.4: Leading arrangers of syndicated loans, 2000. Source: Loanware.

15
government as far as depositors were concerned, they were also outside the control of
domestic banking regulators which limited prudential oversight and, without the costs
of strict regulation, increased their competitiveness in providing financing. US banks
soon set up offshore branches to compete in what were now described as the euro-
markets, a term which in time came to mean all markets for currencies traded outside
their domestic jurisdiction. The alternative, domestic markets, are those within the
domestic jurisdiction of the parties and under the direct supervision of prudential and
other financial regulators.
Today the globalisation of capital flows and the competition amongst countries for
international capital, which is reflected in increasing financial liberalization, has greatly
reduced the practical distinctions between domestic and offshore financial transactions.
Furthermore, the increasing global reach of banking regulators has generally meant
reduced benefits for banks in lending from offshore as opposed to domestic jurisdictions.
This is, however, a relatively recent development and even as recently as the mid-
1990s these markets were to a greater or lesser extent separate; which explains a clear
distinction between the two implicit in the early literature on syndicated loans.
While the United States has always been the major domestic syndication market,
the historical distinction between euro- and domestic syndications was not limited to
that country. For example, Australian borrowers have only since the late 1990s been
entering into loans with syndicates comprising domestic and offshore participants to-
gether. This was when the first round of changes to the regulations on interest withhold-
ing tax made it practical for Australian borrowers to source loans directly from offshore
lenders7 . Prior to this Australian borrowers who wished to raise loans from offshore
lenders generally did so through specially created offshore financing subsidiaries.
What provided the major impetus for the development and growth of the eurocur-
rency syndicated loan market was the massive transfer of wealth to OPEC from non-
OPEC countries in the 1970s, reflected in the current account deficits that were run

7
Interest withholding tax is deducted at source by a resident borrower on interest paid to a non-
resident lender.

16
by oil-importing nations. The syndication market stepped in as a conduit by which
eurocurrency deposits from OPEC countries were re-channelled to non-OPEC coun-
tries in the form of loans. This was actively encouraged by governments for political
reasons, and so quickly did this form of financing develop that the syndicated loan
market provided more than 85 percent of the medium and long-term funds for devel-
oping economies and 98 percent for centrally planned economies between 1973 to 1979
(Goodman, 1980). Given the significance of the product to the international financial
system at that time it seems odd to now describe the original eurocurrency syndicated
loan market as limited, but in the context of the market today it certainly was. In 1970
only ten borrowers accounted for over 80 percent of the market and never in the next
10 years did the top 10 account for less than 50 percent (Goodman, 1980). Sovereign
borrowers dominated the market, usually to finance balance of payments deficits or for
development projects.
The infatuation of the syndicated loan market with sovereign borrowers continued
through the 1970s and early 1980s with increasing, as it turned out, recklessness. The
accepted wisdom that countries could not go bankrupt was shown to be, for all practical
purposes, false when in 1981 Poland deferred payment on part of its debt. It was
followed in 1982 by Mexico and shortly thereafter by Brazil, Yugoslavia, Chile and
Nigeria. Although there was sovereign lending activity recorded up until 1985, almost
all represented forced refinancing of defaulted sovereign debt (Clark, Levasseur and
Rousseau, 1993). Figure 2.1 illustrates the dramatic rise and fall of the eurocurrency
syndicated loan market over the period 1970 to 1985.
While the common perception is that domestic loan syndication markets developed
after the collapse in sovereign syndications required lenders to look for alternative
sources of business, they certainly existed well before then, at least in the United States.
As early as 1977 the Federal Reserve, the Federal Deposit Insurance Corporation and
the Office of the Comptroller of Currency felt it necessary to establish the Shared
National Credit (SNC) program for monitoring the credit quality of large US syndicated
loans extended by banks monitored by those agencies (Federal Reserve Bank of San

17
Francisco, 2001).

120

100

80
US$billion

60

40

20

0
70

71

72

73

74

75

76

77

78

79

80

81

82

83

84

85
19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

19
Figure 2.1: Annual eurocurrency syndicated loan volume 1970-85.
Source: Clark, Levasseur and Rousseau, 1993.

It is true, however, that it was the latter half of the 1980s that saw the dramatic
resurgence of the syndicated loan in domestic form. In 1987, even as some were pre-
dicting the demise of the syndicated loan following the sovereign debt crisis, it was
accelerating into a new phase on the back of a vital corporate sector and domestic, as
opposed to offshore, liquidity. The huge demand for corporate financing during this
period is well-documented, with many classes of financial instrument experiencing sub-
stantial growth to meet it. Bond and equity markets, and the new high-yield (also
called junk) bond markets, grew dramatically. It was this growth in disintermediation,
where investors "loaned" directly to firms through the capital markets without the in-
termediation of banks, that fuelled new predictions of the syndicated loan’s decline (see
Norton, 1997). Yet syndicated loans continued to develop as a vital source of capital
and it is significant that the RJR Nabisco deal mentioned previously, the signature
transaction of the period, was funded through a syndicated loan. The growth in do-

18
mestic syndicated loans in the US during this period was mirrored in other countries
as well. Elsewhere it was the trend to privatization and private financing of public
works, together with increased corporate activity, that shifted demand for financing
from public to private entities.

2500

2000
US$billion

1500

1000

500

0
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
20
20
Figure 2.2. Annual global new syndicated loan volume, 1986-2003.
Source: LoanConnect.

As the 1980s closed it became clear that the syndicated loan markets were not
immune to the effects of overheated economies, unsuitable financing structures and
poor credit control that characterized bank lending in this period. The consequent
capitalization problems suffered by many of the world’s leading banks translated into
a significant drop in the volume of syndicated loans completed. By now, however,
the syndicated loan had proved itself as an indispensable part of the global financial
infrastructure. It rebounded and continued to develop during the 1990s, building up
the significant transaction volume (see Figure 2.2) and broad scope of financing that
have already been noted as characterizing the product today. In just the United States
alone the Shared National Credit program now reviews in excess of 10,000 separate

19
domestic syndicated loans annually, each in an amount of greater than US$20 million
(Duran, 2001).

2.3 Conclusion

The growth in syndicated lending has been dramatic since the modern form arose in
the late 1960s. It has paralleled the development of the global economy and it is
not unreasonable to suggest that the syndicated loan was actually one of the driving
forces behind the mobilization of global capital in the last 30 years. This contention is
supported by the work in the Chapter 4 where it is shown that it is their combination of
flexibility and financing capacity that enables syndicated loans to provide financing of
a type that is not available in the public capital markets, but which is vital to the sort
of transactions that underpinned the development of the global economy that exists
today.

20
Chapter 3

Structure of Syndicated Loans

In this chapter the structure of syndicated loans is described, with two aspects addressed
in particular. The first is the syndicated loan agreement itself, and more specifically
the major terms and conditions that distinguish the syndicated loan agreement from
the generic bilateral loan agreement. These are shown to relate almost exclusively to
the nature of each participant’s rights against, and obligations to, the borrower and
the other syndicate participants. As such it is reasonable to conclude that, from the
borrower’s perspective, there should be relatively little difference between a bilateral
and syndicated loan in meeting its financing requirements in normal circumstances.
The second aspect to be addressed is the process by which a syndicated loan is
arranged; that is, brought from initial mandate through to execution of the syndicated
loan agreement. It is shown that it is in the way they are arranged, and the risks
this poses for the parties, that syndicated loans differ most significantly from bilateral
loans. The process itself is described and shown to be more complex, time consuming
and costly for the parties than a bilateral loan. The most significant difference, however,
is the introduction of syndication risk, arising from uncertainty as to which institutions
will participate in the loan and the amount they will commit. Syndication risk is
allocated either to the borrower or the loan originator, and the manner in which this
is done and the consequences for the parties is described.
The chapter is structured as follows. Section 1 addresses the syndication-specific

21
terms of the syndicated loan agreement. Section 2 then describes the process by which
syndicated loans are arranged. Section 3 concludes the chapter by considering the
nature and consequences of syndication risk.

3.1 Syndication Terms and Conditions

The major difference between an executed syndicated and bilateral loan agreement is
the addition, to the former, of syndication specific terms and conditions to govern the
additional relationships between the parties. In this section a number of standard pro-
visions from syndicated loan agreements are cited and considered. These are drawn
from the Asia Pacific Loan Market Association’s (APLMA) documentation precedents
released to the author in June 2003. They reflect the consensus of all the major players
in the international loan market active in the region. They are also consistent with
market practice in the European loan markets, represented by the Loan Market Asso-
ciation in London. Before commencing it must also be noted that, for this section only,
the term lender is used to describe a participant, reflecting the language used in the
APLMA documentation.
That syndicated loans are a type of loan facility is made clear in the foundation
provision of any syndicated loan agreement. The provision in the APLMA documentary
precedent is typical.

Subject to the terms of this Agreement, the Lenders make available to

the Borrower a loan facility in an aggregate amount equal to the Total
Commitments.

What is significant about this provision is that it defines the aggregate loan amount
as being equal to what are called the total commitments, which are in turn defined as
the sum of the commitments of each of the syndicate lenders. This is, notwithstanding
the single set of syndicated loan documentation, suggestive of the retention of individual
rights by each lender. This supposition is confirmed by three further provisions that
set out the specific nature of the relationships and explicitly provide that a syndicated

22
loan is, at heart, a composite of separate legal relationships between the borrower and
each individual lender.

Lender’s Rights and Obligations

(a) The obligations of each Lender are several. Failure by a Lender to perform its
obligations does not affect the rights of any other party. No party is responsible
for the obligations of another party.

(b) The rights of each Lender are separate and independent, and any debt arising shall
be a separate and independent debt.

(c) A party may, except as otherwise stated, separately enforce its rights.

The retention of individual rights by lenders has important consequences for the
borrower under a syndicated loan. It means that the financial capacity of each lender
is important, as each is solely responsible for providing a given proportion of the bor-
rower’s loan requirement. This differs from the floating rate loan product in the capital
markets, under which the initial subscribers are jointly responsible for providing the
funds to the issuer. Obviously the separation of each lender’s rights and obligations is in
their interests when it comes to the enforcement of the borrower’s obligations. A strict
segregation would, however, make day-to-day utilization of the facility by the borrower
more difficult than an equivalent bilateral loan. So there are a number of subsequent
provisions which act to modify this basic position. These allow the borrower the con-
venience of utilizing the loan as a single facility, at least in normal circumstances. The
clearest example is that certain decisions of the lenders are made by a majority of the
syndicate which is binding on all of them. In fact syndicated loans are usually struc-
tured so that all decisions are by majority lenders except for those that are specifically
excluded. Those excluded relate to changes to the fundamental terms of the loan such
as the amount of each lender’s own commitment, the interest margin on the loan and
the timing and amount of scheduled repayments.

23
 The mechanics of syndicated loan utilization are relatively straightforward and need
not be excessively complicated here. Each lender is required to provide a share of all
loan advances, and receives a share of all payments from the borrower, according to
the proportion of the total loan commitments that it provides.
Dennis and Mullineaux (2000) propose that the structure of syndicated loans might
create agency conflicts of two major kinds. The first they categorize as an adverse
selection problem, in that the institution that originates a syndicated loan might have
more information about the risks of the borrower and the loan than the other par-
ticipants. It may have an incentive not to disclose adverse information to potential
participants. The second they categorize as a moral hazard problem. They assume
that the originator continues to monitor the loan and borrower on behalf of the other
participants, but has less incentive to be rigorous in this task as it is not taking all of
the risk of the loan.
Clearly action of this kind by the originator (in its role as arranger of the syndicated
loan) might expose it to legal sanction, and so firms undertaking this role are very aware
of the potential or perceived conflicts and take steps to eliminate them. There are two
main ways this is done. The first is that written information provided to the potential
lenders prior to signing of the loan facility is always deemed to have been provided
by the borrower, and the arranger disclaims all liability for it. Arrangers also take
potential legal liability into account when discussing the facility with potential lenders
during syndication. These aspects of the syndication process are considered in more
detail in the next section. What is important and relevant for this section is the second
way; that arrangers explicitly contract out of any informational relationship with the
lenders. That the following provisions represent a new standard for syndicated loan
documentation seems to limit the relevance of adverse selection issue as an issue in this
context.

(a) ... the Arranger has no obligations of any kind to any other Party under
or in connection with any Finance Document.

(b) Nothing in this Agreement constitutes the Agent or the Arranger as a

24
 trustee or fiduciary of any other person.

(c) ... each Lender confirms to the Agent and Arranger that it has been, and
will continue to be, solely responsible for making its own independent ap-
praisal and investigation of all risks arising under or in connection with any
Finance Document including but not limited to: ... the financial condition,
status and nature of each member of the (borrower) Group.

Along the same lines are provisions granting certain of the lenders’ rights and re-
sponsibilities to a designated facility agent. This role is created by the loan agreement
and is one that is not found in other forms of loan. It means that ongoing management
of the loan is undertaken by a dedicated and independent entity whose legal obligations
are to the members of the lending syndicate as a whole. Agents are highly protective
of their legal position and so there are also provisions which strictly limit their liability
for actions they take on behalf of lenders. While it is common for the agent to also be
the same bank that originates, arranges and participates in the loan, there are almost
always strict legal firewalls between the different parts of the bank that act as agent and
undertake these other roles. This all suggests that the moral hazard problem proposed
by Dennis and Mullineaux is far less significant in syndicated loans than in other forms
of loan participations or loan sales.
Apart from setting out the legal relationships, the agency provisions of a syndicated
loan agreement also describe the mechanical tasks of managing the facility and ulti-
mately give the borrower the convenience of having to deal only with one party, the
agent, rather than each of the syndicate lenders on an ongoing basis. For example,
a notice given to the agent in proper form by the borrower is deemed to have been
given to all syndicate lenders. And one of the agent’s major tasks is the receipt and
disbursement of payments, both the funding of loan advances by the lenders and their
repayment, together with interest and fees, by the borrower. Again the receipt by the
agent of sufficient funds is taken as satisfying the borrower’s payment obligations.

25
3.2 Arrangement of Syndicated Loans

The formal appointment by the borrower of an institution or group of institutions to

arrange a syndicated loan is called a mandate. The mandate obliges the arranger1
(also called the agent 2 or lead bank in the United States) to provide the borrower
with an executable syndicated loan on the terms agreed. In pursuance of this, the
arranger has two major tasks, which can be conveniently described as syndication and
documentation.
At the time the mandate is agreed, the borrower and arranger are the only parties
with binding legal commitments in relation to the loan; there are at this time no legal
commitments by any other institutions to participate as lenders. An important task of
the arranger is therefore securing these commitments from participants, and this is un-
dertaken in a process known as syndication. Syndication usually commences with the
arranger finalising, sometimes in consultation with the borrower, a list of institutions
to be invited to participate in the loan. Syndication is then launched by the arranger
when it issues formal invitation letters to each of the selected institutions. An invited
institution may respond within a defined time period by agreeing to participate with
a particular commitment amount. The invitation and the acceptances are strictly be-
tween the arranger and the participant; at no time prior to execution of the syndicated
loan agreement does the participant have any direct legal relationship with the bor-
rower. This does not, however, absolve the borrower of responsibility for information
given during this time.
It is very common for the arranger to provide an information memorandum together
with the invitation. This document is usually produced by the arranger and includes
information on the proposed loan and the borrower which is designed to help the
potential lender in its assessment of the lending opportunity. Information memoranda

1
In this work the term "originator" is used to describe the bank that proposes a loan, whether
syndicated or bilateral, to meet a borrower’s financing requirement. If the borrower chooses a syndicated
loan, then the originator takes up the role of arranger.
2
The role of the "agent" as arranger must be distinguished from that of the facility agent described
in the previous section.

26
vary in detail and complexity depending on the nature of the borrower and the loan,
but in every case the arranger insists that the borrower take full responsibility for its
contents and disclaims any responsibility for itself. The provision of information often
goes beyond simply providing an information memorandum. It is also common for
the borrower and arranger to present information directly, in what is usually called a
roadshow, to potential participants. And even after the roadshow, potential participants
often seek clarification or additional information. Management of this information flow
is another part of the arranger’s role.
A very important feature of syndication is that the arranger almost always offers
participants a fee, called the participation fee, as an incentive to participate. The
participation fee is typically a flat fee expressed as a percentage of the participant’s final
commitment amount. It is paid from the arranger’s own account, and so the arranger
is free to set or vary the rate of participation fee after mandate without affecting the
cost of the loan to the borrower.
The arranger’s second task, documentation, refers to the preparation of the syndi-
cated loan agreement and related legal documents. The major element of the mandate
between arranger and borrower is a term sheet, which is a summary of the major terms
and conditions of the proposed loan. This mandated term sheet is reproduced in the
invitation letter to potential participants. Clearly these summaries of proposed terms
and conditions need to be turned into completed legal loan documents for ultimate
execution by the parties. The arranger retains legal counsel - the lenders’ counsel - to
act for it and on behalf of the other participants that subsequently commit to join the
loan. It is usual for the lenders’ counsel, rather than the borrower’s counsel, to produce
a first draft of the loan documents based on the term sheet. The documentation process
then continues simultaneously with the syndication process. The arranger and borrower
negotiate and reach agreement over the form of the loan documentation, which they
usually try to conclude prior to the completion of syndication. The participants who
have committed to the loan are then given an opportunity to review the documentation
and possibly request changes prior to execution. Arrangers, in their mandate letters,

27
and participants, in their acceptances, inevitably condition their commitments to the
loan on their satisfaction with the final form of documentation. They are not obliged
to execute a syndicated loan agreement in a form with which they do not agree.
An exception to the usual process occurs in the case of what is called a bought
deal, under which the loan is structured as a syndicated loan but is executed by the
borrower and the arranger, as sole lender, prior to the completion of syndication. After
the subsequent completion of syndication, the new syndicate participants join the loan
by way of an assignment of their commitment amount from the arranger. In this case
participants must accept the form of loan documentation as already agreed between it
and the borrower without opportunity for input. Bought deals are generally used in
circumstances where, for some reason, it is impractical, impossible or undesirable to
complete the syndication process prior to execution of loan documentation. A good
example is where the loan is to fund a hostile acquisition. The borrower, as potential
acquirer, usually requires funding to be available at the moment the bid is launched. As
syndication is a public process, confidentiality requirements would certainly preclude
the underwriter undertaking syndication until after this time.
In this work a distinction is also made between syndicated loans and what are called
club loans, even though the two forms of loan in executed form are identical. The
difference comes from the way in which they are arranged. Club loans are arranged,
jointly, by those institutions that will comprise the final lending syndicate. There is no
general syndication of a club loan.

3.3 Syndication Risk, Best Efforts and Underwriting

Looming over all of the arranging process is the presence of syndication risk. This
describes the uncertainty, at the time the borrower selects a syndicated loan and the
mandate is entered into, as to which institutions will participate in the loan and the
amount each will commit. Where the mandate provides for syndication risk to lie
with the borrower, it is described as a best efforts mandate. The arranger undertakes

28
to use its best efforts to secure commitments from participants sufficient to meet the
borrower’s desired loan amount3 . In this case syndication risk manifests in uncertainty
in the total loan amount. Usually, the arranger agrees as part of a best efforts mandate
to commit some amount to the loan itself (Fight, 2000). The greater the amount of
the arranger’s own commitment, the less that needs to be secured from other lenders
and, all else being equal, the less the syndication risk to the borrower. Competition
between institutions for arranging mandates tends to ensure that the arranger usually
commits a not insignificant amount.
An alternative is for syndication risk to be accepted wholly by the arranger. It can
do so by unconditionally underwriting the syndicated loan (and the arranger that does
so is now described as the underwriter ). In its simplest terms, underwriting is an oblig-
ation to lend, as a member of the syndicate, the difference between the total amount
committed by other participants and an underwritten loan amount. More specifically,
the underwriter underwrites not just the total amount of the syndicated loan, but the
loan in that amount and with terms and conditions in accordance with those in the
term sheet agreed in the mandate letter. Where the loan is unconditionally underwrit-
ten, syndication risk manifests entirely in uncertainty in the amount the underwriter
must commit to the loan itself. This amount is called its final hold 4 .
Underwriting commitments are rarely unconditional, however, and there are a num-
ber of conditions which underwriters impose to allocate some syndication risk back to
the borrower. Where this is the case syndication risk manifests itself in different ways

3
The arranger is not otherwise responsible for the outcome of syndication, although an unfavourable
outcome certainly reflects poorly on its credibility and ability as an arranger. It may also have adverse
consequences for the relationship with the borrower and it is not unheard of for an arranger to increase
its own commitment amount to make up a shortfall, notwithstanding that it is not legally obliged to
do so.
4
It is necessary to address some confusion in terminology. The term underwriting is used in this
work in the very specific sense described above. However the term is commonly used, particularly in
the United States, to describe the provision of loan commitment by a bank, whether on a bilateral
basis or as participant in a syndicated loan. And the term "underwriting standards" describes the
level of credit risk a lender is accepting in providing a loan, and does not relate in any way to what
we call syndication risk. Most confusingly, underwriting standards are often discussed by US financial
regulators specifically in relation to syndicated loans. But there, however, the term is accepted as
describing the credit risk of the loan, and the relevance of syndicated loans is simply that such a large
proportion of loans made in the US are syndicated.

29
depending on the occurrence of events after the award of the mandate. If an event oc-
curs which breaches an underwriting condition, then the underwriter can withdraw and
the borrower faces uncertainty in the loan amount. If the underwriting conditions are
not breached, then the underwriter must meet its obligations and faces uncertainty in
its final hold amount. There are four major underwriting conditions; material adverse
change, clear market, commitment expiry and market flex.
The first provides that the underwriting commitment is conditional on there being
no material adverse change in the financial condition or business of the borrower, or
in the international capital markets, which would affect the successful syndication of
the loan. Usually referred to as the MAC, this condition applies from the date of
the underwriting mandate until completion of syndication. While protection of the
underwriter by a MAC is a feature of all normal syndications, it is necessarily given
up where it provides a bought deal. In that case the loan is executed and fully funded
by the underwriter prior to syndication and so the underwriting commitment cannot
be subsequently revoked. The possible consequences of this were demonstrated in a
bought syndicated loan provided to Sunbeam by Bank of America and First Union
Bank. Disclosures, subsequent to the funding of the loan by the underwriters but prior
to syndication, that the borrower had breached accounting standards meant that the
underwriters were unable to syndicate successfully and were forced to provide most of
the loan themselves (Eavis and Kinsella, 2000).
The second major condition prescribes that the borrower must provide a clear mar-
ket for the underwritten transaction, usually defined to mean that no other loan or se-
curities issue for the borrower or associated company has been launched or is expected
to be launched into syndication and which would thus compete with the underwritten
loan in the market. The third standard condition is that the underwriting commitment
will expire if the loan is not executed within a defined time period. The fourth under-
writing condition is usually described as market flex. An example of the wording of
this provision, from one of the leading law firms in this area, Millbank & Tweed, is as
follows:

30
 "Before the close of syndication, the underwriting banks shall be entitled
to change the pricing, structure, tranches or terms of the facilities (other-
wise than by reducing the terms of the facilities) if, having regard to the
then prevailing conditions in the domestic and/or international capital mar-
kets, they determine that such changes are advisable in order to ensure a
successful syndication of the facilities."

Market flex provisions remain controversial and are significantly rarer than the
other provisions. They appear to defeat the objective of loan underwriting, and so a
requirement for market flex protection would be expected to represent a competitive
disadvantage for any prospective syndicated loan underwriter5 .
The common feature of the conditions is they represent a desire by underwriters to
protect themselves against unsuccessful syndication, which begs the question of what
it means for a syndication to be successful. Given the nature of syndication risk and
underwriting, and the operation of these conditions, it is uncontroversial to suggest
that an unsuccessful syndication is one in which the underwriter is left with a final
hold greater than it desires. This is confirmed by market practice, where the desired
amount is known as the underwriter’s target final hold and is always identified by the
underwriter prior to entering into the mandate.
While a shortfall in commitments raised in syndication means the underwriter may
end up with a final hold in excess of its target, it is also necessary to consider the case
where there is an excess of commitments, called an oversubscription. In some cases, the
borrower may choose to accept the oversubscription and increase the loan amount, so
that the underwriter realizes its target final hold and all participants keep their initial
commitment amounts. This would, of course, require the approval of the underwriter
and the participants as it is a variation of the terms and conditions of the loan to which
they committed. Sometimes the term sheet itself will provide that the borrower may

5
The comments of one syndicator are interesting. "...Syndicators are paid to judge current markets
where possible for immediate distribution of transactions. If we can’t do that then we can’t do our
job. We don’t want to end up using market flex as an excuse not to do our job." Tony Rhodes, Head
of syndicated loans at HSBC. Quoted in Dyson (1999).

31
accept oversubscription.
Often, however, the borrower may not desire to increase the loan amount or the
lenders may not approve. The practice in this case is to scale-back the commitments
of both the participants and the target final hold of the underwriter, so that each
participant executes the loan with a commitment amount which is some fraction of its
preferred amount. The amount in which each participant executes the loan is called
its allocated or allotted commitment amount. Invitation letters always specify that the
underwriter can allocate commitments at its sole discretion, but in practice scale-back
is almost always done on a pro-rata basis, so that each participant is scaled-back by
an amount proportional to the amount by which the loan is oversubscribed. In this
way each participant is treated equally. An underwriter that maintained its own final
hold at target level while scaling-back the other participants would risk damage to its
reputation in the market, and this is sufficiently important that it almost never occurs.
This section has described the simplest case of a single underwriter who underwrites
the borrower’s entire desired loan amount. There are, however, variations on this in
practice. Relatively rare is partial underwriting, where the underwritten amount is
less than the borrower’s desired loan amount, with the difference arranged on a best-
efforts basis only. More common is the practice of joint underwriting, where two or
more institutions team up to underwrite the entire loan amount. The reasons that
institutions may be forced to team up to underwrite the loan are explored in Section
5.3, but can be simply explained as resulting from institutions being constrained in the
maximum amount they can underwrite or a desire to reduce their own level of under-
writing risk. The joint underwriting obligations are usually several, which means that
each institution is responsible only for its own underwritten amount. In syndication,
commitments from participants are usually applied to reduce each underwriter’s com-
mitment on a pro-rata basis according to the amount of its underwriting (noting that
it is not necessary for each to underwrite the same amount).
At this point it is appropriate to refer to the work of Francois and Missonier-Piera
(2004). They specifically consider the case where a group of banks is observed to

32
jointly undertake the tasks of arranging (what they call "agenting") the syndicated
loan. As described in Section 3.2, there are a number of separate tasks in arranging a
syndicated loan, and these authors propose that such agent groups arise where a single
lead arranger originates the loan and then delegates these tasks to other institutions
on the basis of their comparative advantage in performing them. Their hypothesis is,
however, somewhat inconsistent with market practice. Groups of banks are observed
to jointly undertake the tasks of arranging only where they have jointly underwritten
the syndicated loan. Given the importance of a successful syndication outcome, each
underwriter usually insists on being involved in the process. Certainly the roles may
be delegated among the underwriters on the basis of capability, but it is not observed
that specialization in undertaking certain arranging tasks is the explanation for the
existence of arranging groups per se.
Returning to the issue of underwriting, another variation is the practice of sub-
underwriting. An institution or institutions initially underwrite the loan and another
group of institutions are subsequently invited to sub-underwrite, or share the under-
writing. General syndication then proceeds as usual. Documenting the allocation of
syndication risk between the parties is surprisingly simple, especially given the po-
tential consequences. Usually it takes little more than the form of a notation in the
mandate letter that the syndicated loan is arranged either on a best efforts or a fully
underwritten basis, and a notation in the term sheet that the loan facility amount is
best efforts or fully underwritten.

3.4 Conclusion

Once it is executed, a syndicated loan will provide a borrower with the same type of
financing as an equivalent bilateral loan. The presence of a syndicate rather than a
single lender means there are obvious practical differences between the two forms where
the borrower is in default or wishes to waive or amend the terms of the facility, but in
the absence of such circumstances the borrower may notice little difference in utilizing

33
the facilities. This is a significant conclusion because it means that borrowers should
view syndicated and bilateral loans as substitutes in terms of meeting their funding
needs.
The major differences between the two forms of loan are found in the way they are
arranged; that is, brought from initial mandate to execution. The process of arranging
syndicated loans, as well as being more complex, introduces a major element of risk to
the parties that is not present in the arrangement of bilateral loans. This is syndication
risk, which derives from the uncertainty in the amounts that will be committed to the
loan by the participants. The allocation of syndication risk between the syndicated
loan originator and borrower is a major factor in the decision to select a syndicated
loan. In particular, it impacts on the return to the originator and the way in which it
does so is a major subject of the next chapter.

34
Chapter 4

Returns from Syndicated Lending

The major contribution of this chapter is to describe the economic structure of syndi-
cated loans, ultimately by developing a new expression of the return to the institutions
that originate them. The task appears to be complicated by the fact that syndicated
loans are provided by multiple parties, which is also characteristic of the bond and note
instruments of the public capital markets, and so syndicated loans have been described
as being at the intersection of the bank and capital markets (Armstrong, 2003; Dennis
and Mullineaux, 2000). It is an important contention of this work, however, that it is
their character as commercial bank loans that, first and foremost, defines syndicated
loans in terms of their ability to meet borrowers’ financing requirements and in terms
of the returns to the lenders that provide them. It follows that any real understanding
of syndicated loans must be grounded in an understanding of loans generally.
The approach in this chapter is to first build up an expression of the return from
providing a generic bilateral, or single lender, loan. The elements of this expression are
developed by comparing and distinguishing loans from their major alternative, a bond
issued in the public capital markets.
Into this general expression of return are then incorporated the unique features of
syndicated loans and their consequences for the parties, as identified in the previous
chapter, to generate the new expression of the return from originating a syndicated
loan. The expressions of return are forms of what are known as Economic Value Added

35
(EVA) models in which the required return to the investors who provide the capital
with which an investment is funded is treated as a cost of that investment. The mix of
the firm’s debt and equity capital which is assumed to fund each individual loan in this
model is determined by the incremental risk of the loan to the bank’s portfolio and an
objective of maintaining this overall portfolio risk at a given level. This treatment of
risk and capital is the same as that in the RAROC (Risk-Adjusted Return on Capital)
models which are being increasingly adopted by banks. The difference between EVA
and RAROC models, however, is that the latter does not treat the return on capital as
a cost, instead generating an internal rate of return measure which is then compared
with the investors’ required return on capital. EVA models, by contrast, generate a
direct measure of the value by which the firm is increased due to undertaking the new
investment.
It should be noted here that the expressions of return developed in this chapter
have one non-traditional element. They include not just the contractual revenue and
direct costs of meeting the contractual obligations, which are usually accepted as the
major elements of return, but also the opportunity cost of the return from alternative
investments that must be foregone, which is not. To this extent, therefore, the ex-
pressions differ from the traditional EVA model as the measure generated is not the
value added to the firm per se, but rather the marginal value added to the firm over
that of alternative investments. Opportunity cost is important in the context of this
work because it is a significant element of the new model and explanation for the use
of syndicated loans that is one of its major subjects.
The chapter is structured as follows. Section 1 undertakes a comprehensive analysis
of loans generally, comparing them to bonds, and develops the expression of return
from providing a bilateral loan. Section 2 then compares the economics of bilateral
with syndicated loans, concluding with the complete new expression of return to the
originator of a syndicated loan.

36
4.1 Loan Returns

In this section loans are compared with their major financing alternative, bonds issued
in the public capital markets. Bonds are well-understood, as much because of their
relative simplicity as their usage. The major theme of this section is that loans are
more complex than bonds, but it is because of this complexity that they are able to
meet a range of financing requirements that are beyond the scope of other debt capital
markets instruments. Ultimately, the differences between bonds and loans flow from
differences in the nature of their providers.
Bonds are structured on the assumption that they are fixed debt claims purchased
by capital markets investors with surplus funds. In terms of elementary finance theory
investment in a bond is a mechanism for deferring consumption. By contrast loans are
structured on the assumption that they are provided by commercial banks. Banks are
not assumed to lend surplus funds. Instead they are the classic financial intermediaries
that raise the funds they lend by selling fixed debt claims, traditionally by accepting
deposits from investors or by drawing on surplus liquidity in the interbank market.
Today there is a large and growing universe of finance providers, with all manner of
funds and non-bank financial institutions blurring the distinction between investor and
lender that drove the historical development of the distinct bond and loan products.
This periodically incites commentators to forecast the demise of commercial banks and
their staple product, loans, in the face of increasing disintermediation in the capital
markets. Yet the loan in traditional form continues to go from strength to strength, as
the statistics on syndicated loans attest. It is true that there is a retreat of the loan
product from areas where the financing requirement can be more efficiently met in the
capital markets, most notably for core debt funding of investment-grade corporates.
This is more than offset, however, by the use of loans to enable transactions that would
otherwise be impossible using capital markets funding (Fuchs, 2004). There is also an
increasing use of loans and capital markets instruments as complements rather than
substitutes. The classic example is the complementary use of commercial paper and
standby loan commitments, described in Chapter 2.

37
 So what is it about a loan, structured on the assumption that it is provided by a
true financial intermediary, which distinguishes it in its capacity to meet a firm’s debt
financing requirements? Foremost is in the way in which the funds are available to and
utilized by the borrower.

4.1.1 Loan Availability and Utilization

A bond issue is a series of identical debt claims that are initially sold by the firm to
investors, and the purchase price paid by the initial investors generates the required
funding to the issuer. The issuing firm will, therefore, receive its funding in one lump
sum on the payment date of the bonds. After issuance the bonds may be freely traded
so that, when they mature and the debt becomes due, the issuer pays out to the parties
that hold the bonds at that time. Prepayment prior to the maturity date is not allowed
or, if it is allowed, the issuer must compensate the then bondholders for the opportunity
cost of the cash flows they will forego over the remaining original life of the bond. This
is necessary because the bondholders will have purchased the bonds, and determined
the price for them, in expectation that their cash flows will be received as scheduled.
When a loan is executed and becomes binding on the parties it does not create
an immediate debt claim. Instead a loan gives the borrower the right, subject to
conditions, to require the lender to make cash advances to it upon request. So loans
are more accurately described as loan facilities that set out the conditions on which
the borrower may draw advances and the terms of those advances. This is possible
because the lender does not raise its funding for an advance until it is required; it
does not have surplus funds sitting idle on which it requires an immediate return. In
the academic literature a distinction is often made between what are called spot loans
and loan commitments (Saunders and Lange, 1996). Loan commitments are those loan
facilities where the borrower’s options to draw and repay advances exist throughout
the life of the facility, provided only that the total of advances outstanding do not
exceed the maximum facility amount. Where it is expected that the borrower will
utilize a loan commitment regularly it is usually described as a revolving loan facility.

38
Standby facilities, such as those backing commercial paper programmes or for credit
enhancement, are also loan commitments but are usually expected to be drawn only in
specific, rare circumstances.
There are equivalents to loan commitments in the capital markets, namely commer-
cial paper (CP) and medium term note (MTN) programmes. Under these programmes
an issuer may, from time to time at its option, offer to sell CP or notes to a tender panel
of institutions who will bid to purchase them for trading or on-sale to investors. There
is, however, no obligation on the tender panellists to do so and even should they wish to
purchase paper or notes, the price at which they are issued depends on the price offered
by tender panellists at the time of the request. This lack of obligation, and thus lack
of certainty of funding for the borrower, is a very important difference between these
programmes and loan commitments. Under a loan commitment the lender is obliged
to provide the advances upon request, at the pricing and on the terms agreed at the
time the facility is entered into.
While a loan commitment allows the borrower to request and maintain advances
throughout the often lengthy life of the facility, each individual advance is actually
repayable within a relatively short period; 1, 3 or 6 months being usual. These periods
are called funding periods or interest periods. Loan commitments are structured in this
way because of the underlying assumption that lenders are intermediaries that raise
short-term funding to meet loan advances. The typical 1,3 or 6 month advance periods
are the most common periods for banks to raise funding in the deposit or interbank
markets, but longer or shorter periods may be agreed between borrower and lender.
If it wishes to keep the funds from an advance outstanding beyond the term of the
current funding period the borrower simply redraws the advance for a further period
and the lender matches this by refinancing its own funding for the same period. It is
important to note that advances cannot be prepaid during a funding period, or at least
without penalty, as this would not correspond with the underlying match funding of
the advance by the lender.
The other type of loan facility described in the academic literature is the spot

39
loan. This is typically distinguished from the loan commitment on the basis that
it is a kind of bond equivalent, in the sense that all the loan funds are fully drawn
upon the execution of the loan and then repaid in full on some agreed maturity date.
In reality, however, spot loans are not at all equivalent to bonds. All bank loans,
including what have been described as spot loans, provide their borrowers with options
in utilization and repayment of loan funds. The spot loans of the academic literature
are more accurately called term loans and are distinguished from loan commitments
only by certain limitations on, but not the extinguishment of, the options available to
the borrower.
The borrower under a term loan can only request advances during an initial availabil-
ity period, although this may be many months or even years long. Those commitment
amounts not drawn at the end of the availability period are automatically cancelled,
and once repaid advances cannot be reborrowed. Term loans usually have a defined
repayment or amortisation schedule, and provide for advances of often lengthy periods.
These long advances are, however, still assumed to be funded by a succession of short-
term fund raisings by the lender, each new one effectively refinancing the previous one.
Consequently, term loan advances are also segmented into consecutive shorter funding
or interest periods the length of each being, again, typically 1,3, or 6 months long.
When the term loan is repaid then the lender uses the proceeds to repay the current
funding and does not refinance it. This assumption that the loan is match funded for
short funding periods allows the borrower the right to prepay the term loan prior to its
scheduled maturity without cost or penalty, provided only that the prepayment occurs
at the end of a funding period. This right to prepay is a valuable option to the borrower
that is not available in the capital markets. Any partial repayment or prepayment by
the borrower of outstanding advances again occurs only at the end of a funding period.
In this case the lender is assumed to refinance its funding for the next funding period
in the amount of the remaining outstanding advances1 .

1
It should be noted that match funding does not necessarily reflect the actual way that banks
fund their loan advances. In practice, funding is the responsibility of a bank’s treasury department
which provides advances to meet the bank’s obligations under the loan agreement. Match funding is a

40
 So a major advantage of loans over bonds is that loans grant borrowers options
in both the drawing and repayment of advances. A loan can provide a borrower with
certainty in meeting an uncertain future funding requirement, whether the uncertainty
is in the amount that will be required or its timing. Furthermore, the borrower can
repay or prepay as cash flows or more attractive alternative funding becomes available
or funding is no longer required, avoiding the carrying cost of maintaining a sinking
fund to meet future bond maturities.
At this stage it is possible to start setting out the basic framework for an expression
of loan return by describing the amount of the loan that is outstanding at any given
time. In this chapter the specific steps in the development of the new expression are
distinguished from the general analysis by placing them within a delineated section as
follows.

Loan Return: Funding Periods and Advances

The loan facility is segmented into n consecutive funding periods t = 1...n. The
amount of loan advances actually drawn and outstanding in each period t is defined as
V.αt where V is the total initial facility amount and αt is the proportion of the initial
facility amount outstanding in period t.

Advances in period t = V.αt αt ∈ [0, 1] , (4.1)

where αt is the product of: (i) the proportion of the total initial facility amount
that is available to be drawn in period t, and (ii) the proportion of the available facility
amount in period t that is actually drawn as advances. The available facility amount
in any period is equal to the total initial facility amount less any amount by which the
loan has been amortized as scheduled, prepaid and/or cancelled by the borrower.

riskless strategy but banks also operate their treasury departments as profit centres and they may take
exposure on future funding requirements and interest rate movements by deliberately mismatching the
maturities of their assets and liabilities. Nevertheless the consequences of such treasury activity are
not usually attributed to the loan or to the loan managers, and so the assumption of match funding is
valid from the perspective of this work and is reflected in standard loan documentation.

41
4.1.2 Net Interest

The next feature of loans to be considered is the way the lender is compensated. The
interest rate on loan advances is almost always defined to be the sum of a base rate and
margin 2 applicable to each funding period. The base rate reflects the lender’s cost of
raising funds; that is, it is the assumed interest rate on the debt claim it sells to raise
the amount of the advances. In accordance with the assumption of match-funding the
base rate is reset at the beginning of each funding period to the rate applicable for that
period, and so an important feature of loans is that they provide a variable or floating
interest rate for the borrower.
There is a capital markets product that also offers floating rate term financing,
called a floating rate note (FRN). As with all term capital markets instruments it does
not allow the issuer flexibility in utilization. Furthermore the length of the interest
periods is always defined and fixed in advance, usually being 6 months. This again
contrasts with loans where the borrower can usually select the length of each funding
period at the start of each one.
In competitive lending markets the base rate on a loan does not reflect the lender’s
own actual cost of funding. An external reference is usually used, typical of which is
the use of Libor as a standard reference rate for US dollar loans. Libor, the London
Interbank Offered Rate, is the rate at which international banks trade US dollar deposits
in the London market, and the assumption underlying its use as a base rate is that
the lender could match-fund the loan advances in this market. Clearly the use of an
external reference rate provides the borrower with protection against arbitrary rate
setting by the lender. Common reference rates are independently determined each day,
by the British Banker’s Association in the case of Libor, for periods of standard length.
Sometimes an individual institution cannot raise funding at the market base rate. In
this case it will be said to be paying a funding premium. Obviously a negative funding
premium would represent the case where an institution is able to raise funding at a

2
Also known as the spread or credit spread.

42
rate below the market benchmark.
The interest payable on a loan in a given funding period is calculated as the product
of the defined interest rate and the amount of the loan advances outstanding. As
described, a part of each interest payment is simply passed through to cover the lender’s
cost of funding the loan. The amount retained by the lender, which will be called the
net interest, therefore equals the interest margin less the funding premium.
The next step in developing the new loan expression of loan return, identifying the
expression for net interest, can now be taken. Recall that, so far, the loan has been
segmented into consecutive funding periods and the amount of advances outstanding in
each period denoted V.αt . The net interest in each period will therefore be equal to the
product of the advances outstanding and the rate of net interest. In this work, rates
are denoted by the symbol ρ with subscripts denoting the item to which the rate relates
and the relevant time period. Net interest is denoted N , so the rate of net interest in
a given funding period t is denoted ρN,t . In relation to loans, as with most financial
instruments, rates are usually specified as annualized rates, and this convention is also
followed.

Loan Return: Net Interest

The net interest on a loan is equal to the sum, for all funding periods, of the product
of the rate of net interest and the loan advances outstanding in each period, and is given
by

n
X dt
Net Interest = V.αt .ρN,t . . (4.2)
t=1
360

where dt = the actual number of days in each period3 .

3
The assumed number of days in a year, the denominator of the expression, is given by financial
market convention. A 360 day year is conventional for US$ advances, and will be used throughout this
work. However payments on advances in other currencies, such as the GBP and A$, are calculated on
the basis of a 365 day year and this should be substituted into the expression where appropriate.

43
4.1.3 Credit Costs

Net interest does not, itself, represent the lender’s return from providing loan advances
as it does not capture all the costs of lending. Some of the most important of these other
costs of lending are what will be called credit costs. They are most simply understood by
considering what happens if a borrower fails to repay amounts of principal and interest
when due, which is called a default. If there is a default then the lender is still obliged to
repay its own funding and the interest thereon. Any shortfall in the payments it receives
from the borrower must therefore be made up by the lender from its own capital. Such
a shortfall is described as a credit loss. Lenders with large portfolios always expect that
some of their loans will default and so they treat credit losses as a cost of undertaking
a lending business. More specifically, bank lenders make a provision for the expected
credit loss across their portfolio in each period. This provision represents a cost to be
set off against the net interest earned on the loans in the portfolio.
As it is an expected value, the total portfolio provision is simply the sum of the
expected credit loss for each loan in the portfolio over a given time horizon. In an
international survey of bank practice in this area, the Bank for International Settlements
(2000) noted that the share of the total credit loss provision attributed to an individual
loan is usually calculated as the product of three factors. These are:

1. The probability of default: The probability that the borrower will fail to meet its
payment obligations in full and on time.

2. The expected loss given default. The proportion of the outstanding loan advances
that the borrower ultimately fails to repay.

3. The expected credit exposure: The loan advances outstanding at the time of de-
fault.

Clearly the major task in determining the provision for credit loss is estimating the
probability of default. It is reasonable to generalize that banks, the lenders contem-
plated by loan agreements, have capabilities in this area that are superior to those of

44
public investors. Banks are professional financial intermediaries who do not require
an external credit rating to validate the credit risk of the firm, as in necessary in the
capital markets. Not only are banks better placed to assess risk, the flexible nature of
bank loans and the lending relationship means that they are often able to structurally
mitigate it. This means that loans, compared with bonds, often have a greater range of
covenants, conditions precedent and other controls over the activities of the borrower,
more sophisticated security arrangements and the presence of a wider range of remedies
in the case of borrower default.
The complex structural features of loans are often regarded as a disadvantage of
loans compared with bonds that have traditionally had far simpler structures that
are less onerous for the firm, but this misses the point entirely. The superior ability of
banks to analyse and then manage the risks of lending by structural means and ongoing
monitoring allows them to accept risks that may be unacceptable in the capital markets.
Loans are used widely for complex transactions and for borrowers without credit ratings,
and it is well-accepted that bank lenders tend to lead the way into emerging markets
ahead of the capital markets. Even where capital market investors are willing to accept
certain risks, the ability of banks to mitigate those risks with covenants or other loan
structural features often allows the financing costs to be lower under a bank loan.
Returning to the costs of lending, it is expected that over the long term a bank’s
accumulated actual credit loss should converge to its accumulated provision for expected
credit loss4 . In any short period, however, the provision may be inadequate to cover
actual credit loss. In response to this bank regulators in most developed economies re-
quire financial institutions to set aside capital specifically to absorb what are commonly
described as unexpected credit losses; the actual credit losses in excess of the provision
amount (Jones and Mingo, 1998). This regulatory capital must be freely available to
absorb credit losses; that is, it must not represent a fixed claim on the assets of the
bank (see, for example, Australian Prudential Standard 111). Equity, which is only a
residual claim on the bank’s assets and so which does not need to be repaid if the bank

4
Presuming, of course, that the expected credit loss is an unbiased estimate.

45
has insufficient assets, is the definitive form of capital.
Most national prudential regulations are based on the international Basel Capital
Accord and specify the amount of capital to be held against each individual loan as a
proportion of the loan advances outstanding. The capital requirements differ according
to the type of loan and borrower according to a published schedule, but the current de-
fault for corporate loans is 8% (Basel Committee on Banking Supervision, 1988). The
rather simplistic approach of the Accord has been criticized for failing to reflect the
actual credit risk of an institution’s loans, both on a stand-alone basis and as part of its
loan portfolio. In particular it fails to capture portfolio effects (Hawke, 1999; Interna-
tional Swaps and Derivatives Association, 1998). Furthermore the relationship between
capital and loan assets is indicative of the institution’s own probability of insolvency,
and some institutions may desire to hold a level of capital sufficient to maintain their
probability of insolvency at a lower level than that implicit in the regulatory capital
regime5 .
For these reasons, many institutions also calculate an economic capital requirement
using more sophisticated portfolio modelling techniques. The modelling process is
aimed at generating a distribution of portfolio credit losses of the type shown in Figure
4.1, which shows a probability density function for aggregate portfolio credit losses.
This approach is essentially one of determining Value-at-Risk and, as can be seen in
the figure, the form of the probability density function and the target probability of
insolvency, the latter being the probability that aggregate portfolio credit losses exceed
the bank’s economic capital, together determine the amount of economic capital to be
held against the portfolio over any given time horizon (Jones and Mingo, 1998; Boot
and Schmeits, 1997).

5
It is observed that the majority of large international banks maintain regulatory capital ratios well
above the required 8% minimum. See Section 5.2 for some examples.

46
 Probability Density Function

Provision
for Target
Expected Economic Probability of
Credit Loss Capital Insolvency

Portfolio Credit Loss

Figure 4.1: Portfolio credit loss, provisioning and economic capital.

The economic capital requirement attributable to any individual loan is then de-
termined as the difference between the total economic capital requirement calculated
without and then with the particular loan in the portfolio. (For an excellent description
of the way banks allocate economic capital among their different activities see James,
1996).
Notwithstanding criticisms of them, however, regulatory capital requirements are
compulsory and regulators do not yet allow institutions to calculate credit risk capital
for regulatory purposes using their own internal economic models. So even if an insti-
tution determines and maintains its own internal economic capital requirement it will
still be required to hold the regulatory capital requirement if that is greater in amount
(see International Swaps and Derivatives Association, 1998).
Whether it is regulatory or economic, raising and holding capital against its loan
advances has a cost to the lender. Recall that the interest rate on a loan advance
includes a base rate which is designed to reimburse the lender for its costs of funding
the loan with fixed debt claims in the interbank markets. The funding of a loan asset
with equity capital rather than debt is accepted as being more costly for financial

47
institutions6 . It follows, then, that the loan base rate will not fully compensate the
lender for the funding costs on that proportion of the advance that is effectively funded
with capital. In this work the difference between the base rate and the cost of capital
is described as the net carrying cost of capital, and the product of the net carrying cost
and the capital requirement is called the net capital charge.
It is useful to demonstrate the concept of net capital charge with a very a simple
example.

Assume that a bank lender is required under the regulations to hold a

minimum 4% Tier 1 Capital and 4% Tier 2 Capital against a particular
loan7 .

Also assume that the bank’s required return on equity (which is the defini-
tive form of Tier 1 Capital) is 15%p.a., the average cost of Tier 2 Capital is
10%p.a., and the base rate on the loan is 5%p.a. The rate of net regulatory
capital charge on this loan will therefore be

4%(15% − 5%) + 4%(10% − 5%) = 0.60%p.a.

Further assume that the bank calculates an internal economic capital re-
quirement of 6%p.a. of the loan amount. The rate of net capital charge for
this loan will therefore be

max(4%, 6%)(15% − 5%) + 4%(10% − 5%) = 0.80%p.a.

6
Under the basic M&M propositions, the replacement of debt with equity capital should not lead
to an increase in the firm’s cost of capital as the cost of the remaining debt should fall to reflect its
now lower risk. However it is widely accepted that, for financial institutions, information asymmetries
and the opacity of their operations to investors, the costs of new equity issuance, the fixed price of
pre-existing debt, and express or implied government insurance of debt obligations, represent deviations
from the frictionless world of the the M&M propositions and mean that raising new equity to replace
debt will represent a cost to a bank. See Miller (1995) and Berger, Herring & Szego (1995, 1995).
7
Under the Basel Capital Accord, Tier 1 Capital is equity or its close equivalents, while Tier 2
Capital comprises such things as deeply subordinated debt which are not of the same quality as equity
in absorbing credit losses but which are still subordinate to senior claims against the bank, and so can
be counted for up to 50% of regulatory capital.

48
 To summarize, the rate of credit costs on a loan comprises the rate of credit loss
provision and the rate of net capital charge, where the rate expresses the costs as a
percentage of the loan advances outstanding. They represent the first two major costs
of lending.

4.1.4 Opportunity Cost

The third of three major costs of lending is the opportunity cost represented by the
return on alternative investments that must be foregone because of entry into the loan.
The reason that a lender may be required to forego alternative investments is because of
the presence of credit exposure limits, often also called lending limits. Credit exposure
limits are explained in more detail in Section 5.3, but for the moment it is sufficient
to note that all financial institutions are subject to effective limits on the amount they
can lend to individual borrowers, industries and countries.
The purpose of such limits is to prevent excessive concentrations of portfolio credit
risk and an associated increase in the probability of insolvency of the institution. In
this they are a crude precursor to the capital requirements described in the previous
subsection but, nevertheless, exposure limits still remain in use. They have the effect of
hard rationing the amount of loan advances and other credit exposures8 for any given
borrower or class of borrower. It follows that an institution that enters into a new
loan commitment is necessarily precluding itself from entering into, during the life of
the loan commitment, some of the alternative loans or financial exposures that would
also be subject to the same limit. Any positive return that the institution would have
earned on the alternative exposures foregone thus comes within the classic definition
of opportunity cost.
It is important to note that opportunity cost can be realized over the life of a
loan even though the loan does not fully utilize a bank’s credit limit at the time it

8
A credit exposure is any commitment or obligation that carries the risk of loss due to the failure
of another party to fulfil its obligations. While a loan is the commonest example, there are a range of
other banking products and activities that are classified as credit exposures. For example, a derivatives
contract carries the risk that the counterparty will not meet its payment obligations.

49
is entered into. Banks are dynamic institutions that are continually trying to exploit
their relationships to undertake new transactions with their clients. A loan commitment
extends over a period of time and its use of scarce limits may preclude the bank from
undertaking some of these future transaction opportunities.
Having identified the three major costs of lending, it is now possible to identify an
expression of what will be called the net return on loan advances.

Loan Return: Net Return on Loan Advances

Net return on loan advances is defined as the net interest income less the costs of
lending. Letting the costs of lending - the sum of the credit loss provision, capital
charge and opportunity cost - be denoted C, then the net return on loan advances is
expressed as

n
X dt
Net Return on Loan Advances = V.αt (ρN,t − ρC,t ) (4.3)
t=1
360

Equation (4.3) shows that there is an obvious relationship between the interest
margin, which is the major element of net interest, and the costs of lending, including
the provision for credit loss. It is generally accepted that there is, all else being equal, a
positive relationship between the margin and the maturity of all debt instruments. The
more time passes, the more chance that the borrower’s credit status will deteriorate
requiring greater credit loss provision, and so the margin over the life of the loan must
be sufficient to reflect this. This is described as the term structure of credit risk. It
has been suggested that in some cases there may actually be a negative relationship
between maturity and margin. A very risky firm would be expected to either default
or recover over time, and so the margin for longer maturities for these borrowers would
reflect a "survivorship bias" (that is, if it defaults in the early years then the margin
payable in later years will be irrelevant anyway). For a description of this literature see
Sorge and Gadanecz (2004).
Some loans do not, however, specify a fixed rate of margin for the full term of the
loan. Instead they allow for the margin to vary according to some objective measure

50
of the borrower’s credit risk. This is commonly described as grid pricing and common
references, against which the margin is adjusted, include the borrower’s credit rating or
financial leverage. The advantage of grid pricing is that it enables the margin to remain
low if the borrower’s credit risk remains low, but increase to compensate the lender for
higher credit costs should the borrower’s position deteriorate. For the borrower the
advantage is that it need not be penalized with high margins should it be performing
well, and it is fair to say that most managers are willing to not contemplate that their
firm’s financial condition may deteriorate in the future.
Another feature of loans is that the borrower must, in certain circumstances, protect
the lender against any increase in its costs of lending from the time the loan is entered
into. It is assumed that the costs of then applicable or anticipated capital regulations
and taxes are built into the margin by the lender at loan signing. If these change
after loan signing, however, then it may be that the agreed margin may no longer be
sufficient to cover them. A standard provision in loan contracts requires the borrower
to gross-up the lender for increased taxes and indemnify it against the increased costs
of lending represented by unexpectedly increased regulatory capital requirements.

4.1.5 Other Major Income and Costs

A commitment fee is usually charged on the available but undrawn loan facility amount.
The rate is usually set at, or slightly under, 50% of the margin on drawn advances. This
is usually attributed to the fact that the regulatory capital regime also requires banks
to hold capital against the undrawn but available loan commitment at a rate of 50% of
that to be held against advances, with commensurate capital charge. Regulators require
capital to be held against commitments, even though there is no actual credit exposure
and risk of credit loss, because they only test regulatory capital ratios periodically and
wish to ensure capital is in place for loan drawdowns that occur between the regulatory
capital reporting dates. For this reason it is not expected that banks would hold
internal economic capital against undrawn loan commitments. In the new expression
of return the difference between the commitment fee and the regulatory capital charge

51
on undrawn commitment will be described as the net commitment fee.
The final income element of a lender’s return is the up-front fee, a fee payable by
the borrower to the lender upon signing of the loan, equal to an agreed percentage of
the loan facility amount. In the new expression of return the net commitment fee and
up-front fee are expressed as follows.

Loan Return: Net Commitment Fee

The available but undrawn commitment in each funding period t is expressed as
a percentage, denoted β t , of the total initial facility amount, V . Note that β is not
equal to 1-α (where α has been previously defined as the proportion of the initial
facility amount drawn as advances in any period t) because some of the initial facility
amount may have been previously cancelled (either because of repayment in the case of
a term loan or the borrower choosing to cancel part of the commitment), in which case
it will not be subject to a commitment fee or regulatory capital charge on undrawn
commitments. Where the net commitment fee is denoted the total net commitment
fee is therefore expressed as

n
X dt
Net Commitment Fee = V.β t .ρ ,t (4.4)
t=1
360

Loan Return: Up-front Fee

Where the up-front fee is denoted δ, and recalling that the initial loan facility
amount is denoted V , then the up-front fee is expressed

V.ρδ (4.5)

4.1.6 Return from a Bilateral Loan

The three major elements of lender’s return have now been identified; net return on
loan advances, net commitment fee and up-front fee. It is now possible to combine
them to identify a complete expression of the return from a bilateral loan.

52
 Provisional Loan Return
Letting loan return be denoted R, a provisional expression is as follows

n
X X n
dt dt
R = V.ρδ + V.αt (ρN,t − ρC,t ) + V.β t (ρ ,t ) (4.6)
t=1
360 t=1 360

It will be observed that this expression sums returns generated at different periods,
which suggests that the returns must be converted to present values in order that they
can be summed on the same basis. For a standard cash flow model the discount rate
used usually reflects the firm’s cost of funds, which in turn reflects the time value of
money and compensation for risk of the firm’s investors. This model, however, is not
a cash flow model but is a form of economic value added model in which the required
return to investors are already captured and deducted as costs (namely as the capital
charge and the base rate on the loan). The return in each period therefore represents
the economic value added, or the return to the bank’s investors in excess of required
return in each period.
It also, however, represents the profit generated by the loan relationship manager
after meeting the costs of getting loan funding allocated by the bank’s treasury depart-
ment and credit risk capital allocated from the bank’s portfolio management group. So
while, strictly speaking, these periodic returns should be converted to present values
that reflect the bank shareholders’ time value of money, in practice the decision to
proceed with the loan is made by the loan relationship manager within the bank. It is
certainly not practice within banks to charge relationship managers for shareholder’s
time value of money on their profits. For this reason the periodic returns in this model
are discounted at the time value of returns as perceived by the decision maker, the loan
relationship manager, which is denoted r.

53
 The final expression of loan return is, therefore, as follows.
Loan Return

n
X dt Xn dt
V.αt (ρN,t − ρC,t ) 360 V.β t (ρ ,t ) 360
R = V.ρδ + + (4.7)
t=1
(1 + r)t t=1
(1 + r)t

4.2 Syndicated Loan Return

It is already a major contention of this work that syndicated loans closely resemble the
standard bilateral loans in most ways, with major differences reflecting the way they
are arranged. This very short section, which expands the basic expression of return
from the bilateral to the syndicated loan case, shows exactly how similar they are.
There are, in fact, only two, albeit important, amendments or additions to the basic
expression of return to move from the bilateral to the syndicated loan case. The first
is that the originator’s own commitment to the loan is now in the smaller amount of
its final hold. The total initial facility amount V is replaced with the originator’s final
hold amount H in the elements for net return on loan advances and net commitment
fee. The second is an addition. The arranger of a syndicated loan pays a participation
fee to participants from its own account, as described in Section 3.2. So there is a new
element in the expression, representing total participation fees, equal to the product of
the average rate of participation fee ρφ , and the amount syndicated V − H. This can
be viewed as an effective reduction in the up-front fee paid to it by the borrower on
the entire loan amount.
Syndicated Loan Return
The new expression of the return to the originator of a syndicated loan is denoted
S and is set out below in (4.8).

n
X dt Xn dt
H.αt (ρN,t − ρC,t ) 360 H.β t (ρ ,t ) 360
S = V.ρδ − ρφ (V − H) + + (4.8)
t=1
(1 + r)t t=1
(1 + r)t

54
4.3 Conclusion

Syndicated loans differ from bilateral loans relatively little in terms of their utilization
by the borrower. In fact there should be no practical difference provided the loan is
not in default or the borrower seeks to waive or amend its conditions. An important
contribution of this chapter has therefore been to develop a new expression of the
return from providing a loan in standard bilateral form, which because of the essential
similarity between bilateral and syndicated loans, provides the basis for an expression
of the return to the syndicated loan originator.
The major difference between syndicated and bilateral loans is the manner in which
they are arranged, in both the process and the risk to the parties. For the loan originator
its own lending amount, a major determinant of its return on advances and return on
undrawn commitment, and the up-front fees it retains for itself, can differ significantly
from the bilateral to the syndicated loan case. These are reflected in the final expression
of return to the originator of a syndicated loan. That the difference between the return
from bilateral and syndicated lending can be so easily identified leads on to the obvious,
and important, question of why certain loans are syndicated rather than provided
bilaterally. This question is taken up in the next chapter.

55
56
Chapter 5

Why Are Loans Syndicated?

The question of why loans are syndicated or, more specifically, why parties select syn-
dicated loans in preference to the financing alternatives, is a very significant one. It
is possible to identify three widely-accepted explanations in the existing literature and
these are described and analysed in this chapter. It is concluded, however, that there
are sufficient, and sufficiently important, aspects of the syndicated loan markets that
cannot be explained by these to allow room for an alternative hypothesis.
Before proceeding to the detailed analysis in this chapter it is useful to set out the
major arguments. Of the three existing explanations, the first is found in a small but
growing group of recent academic works that view syndicated loans as hybrids of private
bank loans and public debt instruments. In this context syndicated loans are explained
in terms of a life cycle theory of firms, in which firms move from private borrowing,
provided by financial intermediaries such as banks, into the public capital markets
as they become more able to overcome investors’ adverse selection problems arising
under conditions of asymmetric information. Syndicated loans therefore represent an
intermediate stage of this cycle. Consistent with this theme, the major findings of these
works are that loans are more likely to be syndicated as better information about the
borrower becomes available and/or the reputation of the loan originator is such that it
signals the acceptability of the borrower. Syndication of a loan is, therefore, a function
of its "saleability", and unsaleable loans are held by their originator as bilateral loans.

57
 There appear to be a number of important aspects of the syndicated loan mar-
kets that this hypothesis cannot explain. The overwhelming majority of participants
in syndicated loans are not end investors but the same banks that also originate syn-
dicated loans and provide loans bilaterally. Syndicated loans with such participants
could offer none of the benefits of disintermediation that might make capital markets
financing more attractive than bilateral loans in some circumstances. Furthermore, this
hypothesis cannot explain the very significant volume of syndicated loans for borrow-
ers who clearly do not provide adverse selection problems to investors, as evidenced
by investment grade credit ratings and an ability to simultaneously raise funds in the
capital markets, nor the many syndicated loans for borrowers who would appear to
provide such severe adverse selection problems as to preclude any "sale" of the loans to
investors. In these cases the use of syndicated loans appears to be due to the fact that
they are loans, and so able to meet financing requirements that cannot be met in the
capital markets, as described at length in Chapter 4. The empirical evidence provided
in support of this explanation is also considered, and it is suggested that it may also
be consistent with other explanations for the use of syndicated loans or result from the
nature of the data.
The second existing explanation says that syndication of a loan effectively transfers
loan assets from the originator to other institutions, the syndicate participants, and so
it is a form of loan portfolio management having functionally the same purpose and
effect as secondary loan sales. In this context it is proposed that loan originators might
syndicate their loans where they have difficulties in providing the loans themselves, for
example because of difficulty in meeting portfolio capital requirements or high funding
costs. It is suggested, however, that this cannot explain two important features of the
loan markets. The first is that syndicated loans are distinct financing products that are
mandated, documented and executed as such: they are alternatives to bilateral loans
and not a way for a bank to transfer or sell all or part of its existing bilateral loans.
Second, it cannot explain syndication in a competitive loan market, and it is reasonable
to suggest that most of the largest markets for syndicated loans are highly competitive.

58
A bank that offers a syndicated loan to meet a firm’s financing requirement because
it is an inefficient lender should be unable, in a competitive loan market, to win the
mandate to originate the loan, in any form, against its more efficient competitors.
The third existing explanation is that borrowers and lenders prefer bilateral loans,
but are forced to use syndicated loans where the loan requirement is too large to be
provided by a single lender. It is clearly motivated by the observation that syndicated
loans are, on average, larger than bilateral loans, and the presence of credit exposure
limits that constrain the amount a bank can lend to individual borrowers, countries
and industries. It is suggested, however, that it cannot explain the large proportion of
syndicated loans that are underwritten by their originators, which is a legally binding
obligation to provide the full amount of the loan irrespective of the outcome of syndica-
tion. Nor can it explain those syndicated loans that could have been provided by their
originators on a bilateral basis, at least to the extent that the originator would not
have been prohibited from doing so purely because of size considerations (as distinct
from the originator having a preference for a lower loan amount, which would require
a further explanation as to how optimum loan commitment amount is identified).

5.1 Syndicated Loans as Hybrid Debt Securities

The syndicated loan market has many of the superficial characteristics of the public
debt markets. Syndicated loans are provided by multiple parties on common terms;
the underwriting and syndication process resembles, and even adopts the jargon of,
bond underwriting and distribution; and there is now a segment of the market, the US
HLT loan market, in which non-bank institutional investors, with their very specific
requirements for debt ratings and secondary market liquidity, often outnumber banks
as participants.
Presumably this is why a great deal of financial market commentary and the recent
academic research into syndicated loans has taken, as its starting point, a basic as-
sumption that syndicated loans represent some form of hybrid private and public debt

59
instrument (Armstrong, 2003; Jones, Lang and Nigro, 2000; Dennis and Mullineaux,
2000; Preece and Mullineaux, 1996; Panyagometh and Roberts, 2003; Zhang, 2003).
The adoption of this assumption has seen the recent research move in a particular, and
quite narrow, direction. The use of syndicated loans is considered in terms of the rela-
tionship between the loan originator and the other syndicate participants. The focus is
on the "saleability" of syndicated loans by the originator to participants as investors,
and empirical findings support the researchers’ expected result that syndication of a
loan is more likely if it is validated by a credit rating, public listing or the reputation
of the originator.
This focus is reflected in the theoretical framework within which the basic assump-
tion and the empirical results most readily fit. The use of syndicated loans is explained
as an intermediate stage in the life cycle of firms that move from private to public
sources of debt capital as they become better able to overcome adverse selection prob-
lems, according to the model of Diamond (1991).
An explanation of syndicated loan activity utilizing this theoretical framework has
two clear implications. The first is that firms’ preferences for financing should generally
be in the order of public debt first, syndicated loans second, and bilateral loans third.
Those firms who are able to access public capital markets should tend not to use
syndicated loans, which still contain elements of unattractive private debt, and those
firms who pose severe adverse selection problems should generally be limited only to
bilateral loans, unable to use syndicated loans which have some elements of public debt.
The second implication is that syndicated loans should be able to provide financing of a
kind closer to that of the public capital markets than pure bilateral loans. Underpinning
this is an implicit distinction between public and private financing on the basis that
the latter is shorter-term, more costly and with more onerous covenants and controls
over the borrower because it is provided by financial intermediaries. The public capital
markets provide a more attractive source of finance because of disintermediation, with
firms dealing directly with end investors with surplus funds to invest. It follows that
syndication of a loan should therefore involve some aspect of disintermediation.

60
 In the next two subsections these implications are considered and it is concluded
that they are inconsistent with, and so this hypothesis is unable to explain, important
aspects of observed syndicated loan market practice. The third subsection deals with
the HLT syndicated loan market which does have characteristics of public debt markets.
It is proposed that these transactions still represent a relatively small proportion of total
syndicated loan volume, and are not representative of the majority of syndicated loans
in terms of their structures. The fourth and final subsection recognizes that the authors
in this area have presented empirical support for their propositions, but shows how this
might either be consistent with alternative explanations or result from the nature of
the data.

5.1.1 Preference Ranking of Debt Financing Alternatives

In Chapter 4 the new expression of loan return was developed by comparing a loan with
its alternative, a bond in the capital markets. It was shown that a loan is able to provide
financing of a type that cannot be provided by capital markets debt instruments, and
there is ample evidence that loan financing is as much in demand by firms that do not
pose any adverse selection problems as those that do. It is useful here to cite a number
of different examples in support of the contention that there is little evidence of a strict
preference ranking of debt instruments, at least in the context of syndicated loans.
The largest use for syndicated loans is as standby facilities that provide liquidity
back-up for firms that desire to issue into the capital markets. In fact a syndicated
standby facility is a pre-requisite to securing the required investment-grade credit rating
for the issuance of short-term debt securities such as commercial paper. Importantly,
the standby facilities do not provide credit enhancement to these firms who would be,
and are able to, achieve investment grade ratings for long term debt issues without them.
Rather, they provide liquidity to support the roll-over of short-term debt securities in
the event of capital markets disruption. So the largest use for syndicated loan facilities
is actually for firms that are, by definition, the least information problematic of all
firms.

61
 An excellent example is that of General Electric Capital Corporation which was,
in 2001, a AAA-rated corporation that was one of the heaviest and most sophisticated
users of the capital markets of any entity. In that year, and in one of the most notable
series of transactions ever attempted by a private firm, it issued over US$40 billion of
new public securities into the global capital markets. Yet, as an integral part of this
capital raising programme, GECC also raised a new US$18 billion syndicated standby
facility that had the same unsecured senior debt ranking as the issues into the capital
markets.
At the other end of the credit risk spectrum, the loan product is also able to provide
financing where capital markets investors would face severe adverse selection problems.
As also described in Chapter 4, it is the ability of banks to assess risk and mitigate
it with structural means that enables them to do so. The argument for preference
ranking of debt instruments suggests, however, that such firms should tend not to
utilize syndicated loans but bilateral loans instead. Yet one of the best examples of a
class of borrower posing adverse selection problems are the special purpose vehicles set
up to raise funding for major infrastructure, power, water, mining and other projects,
and it has already been observed that by far the major source of project financing
is the syndicated loan market. Very few if any significant projects are financed on a
bilateral loan basis. For example, 2001 also saw the completion of a US$1bn syndicated
loan to finance the construction of new units in a liquefied natural gas project in
Nigeria. The borrower in this case was a special purpose vehicle set up to build, own
and operate the specific assets. The eight syndicate participants that joined the five
underwriters accepted uncovered Nigerian country risk and significant project risk, in a
loan that tested the limits of their tolerance for exotic credit risk. By any definition this
transaction required the syndicate participants to overcome serious adverse selection
problems that would never have been acceptable in any public debt market. This
strongly supports the contention that syndicated loans are available for even the most
"difficult" of borrowers, who are not limited only to pure "private" bilateral loans.

62
5.1.2 Syndication as Disintermediation

The second implication of this explanation is that syndicated loans provide at least some
of the benefits of capital markets issuance. The implicit argument is that, by issuing
securities direct to end investors, firms that raise financing in the capital markets are
benefiting from disintermediation, by which financial intermediaries such as banks are
bypassed. The question, then, is do syndicated loans provide borrowers with any of the
benefits of disintermediation, and the obvious place to search for this is in the nature
of the syndicated loan participants themselves.
To begin it is instructive to consider the views of earlier authors, recalling that
syndicated loans have been a major part of the financing landscape now for over 30
years. What is striking is that up until the mid/late 1990s, syndicated loans were
viewed as loans, first and foremost, with the major relationship between the borrower
and bank participants as lenders. No real distinction was made between the loan
originator and the other participants, who were assumed to be banks of the same
kind. For example Allen (1990) specifically distinguished syndicated loans from capital
markets instruments such as bonds and commercial paper on the basis of the unique
financing capabilities of the banks that provide them, such as the capacity to provide
the borrower with a stable source of committed funds, quickly, but with the option to be
prepaid or cancelled by the borrower prior to maturity. Clark, Levassuer and Rousseau
(1993) explicitly cited the willingness of the bank lenders to accept credit risks that
institutional investors are unable or unwilling to, as an explanation for the existence
of the eurocurrency syndicated loan market. Megginson, Poulsen and Sinkey (1995)
studied, inter alia, the responsiveness of bank’s stock prices to the announcement of
their participation in syndicated loans to US corporate borrowers in the 1980s. They
explained their positive results in terms of the banks being rewarded with excess returns
from syndicated loan participation because of their ability to provide funding quickly
and as a signal of future growth opportunities.
Has the syndicated loan market changed so dramatically in the last 10 years that
participants are no longer financial intermediaries but investors? It is submitted that

63
it has not. The participants to whom syndicated loans are distributed are still, over-
whelmingly, not capital markets investors but financial institutions of exactly the same
type as those that originate them. In fact they are usually the same institutions, as the
universe of syndicated loan originators is simply a subset of the universe of syndicated
loan participants and bank lenders generally. It is not uncommon, for example, for an
institution to bid to originate a syndicated loan, fail, and then participate in the loan
when it is subsequently syndicated by the successful bidder.
Over the 5 years from 1996 to 2001 there were 3,396 different institutions that
participated in syndicated loans, although perhaps some more useful statistics are that
there were 1,320 institutions that participated with non-trivial total commitments of
more than $100 million1 over the period and 455 institutions that could, arbitrarily,
be defined as active participants, with total commitments of $1 billion or more. Of
the latter group only 37 (8%) were non-banks. In terms of volume the leading non-
bank institutional investor was the Metropolitan Life Insurance Company of the US,
but it was ranked only 139th with $9.3 billion in commitments. By contrast, the most
active participants were JP Morgan and Bank of America each with over $500 billion
of commitments in, respectively, 7,627 and 10,128 separate syndicated loan tranches2 .
There were 44 banks that participated in syndicated loans with over $100 billion of
commitments each during that 5 year period. Clearly non-banks comprise a relatively
insignificant part of the overall syndicated loan participation market.
Once this is recognized then the fundamental differences between syndicated loans
and securities issues become apparent. Loan syndicates are very small, on average less
than ten participants, and the identity of each lender is publicly disclosed at the com-
pletion of each transaction. Unlike the relationship between the issuer of a security and
its usually anonymous investors, there is a direct relationship between each syndicated
loan participant and the borrower, which imposes obligations on each, and which makes
the identity of participants important. It is very common for the borrower to have a

1
These statistics were drawn from the Dealogic Loanware database, which is the source of the data
used in the major empirical work in Chapter 9.
2
Note that a syndicated loan may be divided into a number of tranches, each with different terms.

64
Rank Institution Nationality # Tranches US$ million

1 JP Morgan USA 7,627 552,013

2 Bank of America USA 10,128 515,676
3 Citigroup USA 5,545 452,453
4 Mizuho Japan 5,664 402,448
5 Deutsche Bank Germany 4,591 375,168
6 BNP Paribas France 5,141 370,676
7 Mitsubishi-Tokyo Japan 4,983 367,587
8 ABN-Amro Netherlands 5,267 350,519
9 Bank One USA 5,346 314,481
10 Scotia Capital Canada 4,079 295,818
11 Wachovia USA 5,145 285,558
12 Barclays UK 2,935 280,377
13 FleetBoston USA 5,959 279,768
14 Sumitomo Mitsui Japan 3,706 275,727
15 Bank of New York USA 3,104 269,997
16 Societe Generale France 3,685 261,071
17 Credit Lyonnais France 3,920 257,137
18 WestLB Germany 2,679 248,983
19 HSBC UK/Hong Kong 2,729 237,951
20 Credit Suisse First Boston Switzerland 2,450 236,356
21 RBC Dominion Canada 2,189 228,875
22 Commerzbank Germany 2,815 227,646
23 Royal Bank of Scotland UK 2,758 220,960
24 Dresdner Kleinwert Wasserstein Germany 2,975 218,087
25 Toronto-Dominion Canada 1,991 211,165
26 Hypovereinsbank Germany 3,106 199,345
27 UFJ Group Japan 2,584 195,333
28 ING Barings Netherlands 3,093 195,102
29 IntesaBci Italy 1,885 192,479
30 BayernLB Germany 2,262 189,683

Table 5.1: Top 30 Syndicated Loan Participants, 1996-2001. Source: Loanware.

65
veto over which institutions are invited to participate and/or to whom participations
in the loan can be subsequently transferred. Finally, the originator of the loan also acts
as a syndicate participant, and usually with a loan commitment which is at least as
great as any other participant3 .
It is also significant that most participants, being banks, join syndicated loans with
a reasonable expectation that they will hold their share of the loan to maturity. In other
words, banks treat participations in syndicated loans as loans for the banking book and
not trading assets. This is difficult to reconcile with a view of the syndicated loan as
a form of public debt instrument, and it is useful to elaborate a little on this point.
While banks are happy to take advantage of opportunities to increase the liquidity of
their loans and actively manage their loan portfolios, the industry has strongly rejected
any change to accounting standards that would require them to value their loans on
a mark-to-market, or "fair value" basis, which is the norm for traded securities. The
response to such a proposal by the Financial Accounting Standards Board (2000) by the
Chairman of the British Bankers’ Association, on behalf of the industry, in December
2000 is especially instructive in demonstrating the difference between banks, and their
staple product - loans, and investment in traded securities (Chisnall, 2000).

(Fair value measurement of loans) ... would bear no resemblance to the

fundamentals of the business objectives of transactions entered into within
the banking book. ... (banks’ lending business is) ... driven principally by
longer-term decisions about credit quality and concentration and revolves
around the fostering of customer relationships. Transactions are entered
into over the longer term and the value to the bank is achieved over the life
of the contract and not by reference to short-term changes, though naturally
these are monitored and have a bearing on management decisions. (p.147).

This view has now been reflected in the new International Financial Reporting

3
It is significant that the three banks that dominate the market for arranging syndicated loans, JP
Morgan, Bank of America and Citibank, are also the leading three syndicated loan participants by
volume and number of transactions.

66
Standard, under which most financial assets are required to be reported at fair value
(that is, marked-to-market) at each balance sheet date, but which provides a major
exception for what are called "originated loans" (see PriceWaterhouseCoopers, 2004).
Originated loans are to be reported at amortised cost (subject to a reduction for actual
impairment), as is the existing practice of banks, and not on a marked-to-market basis.
Participation in a typical syndicated loan, where the originator and other participants
all execute the loan together, would appear to fall clearly within this definition of an
originated loan4 .
The conclusion that syndicated loans generally lack the fundamental features of
disintermediation which are characteristic of traded debt securities is also indirectly
confirmed by the structure of the market for arranging syndicated loans. Investment
banks are noted for their unparalleled access to public investors and superior distribu-
tion capabilities in the capital markets. They also have relatively low levels of capital
and lack of natural funding base which means they have a clear disinclination for lend-
ing. These facts, together with the potential earnings in the sizeable syndicated loan
market, might be expected to provide them with a strong incentive to seek mandates to
arrange syndicate loans. Yet attempts by these institutions to enter this market have
been singularly unsuccessful, and they are notably absent from the rankings of leading
originators of syndicated loans in Table 2.4.
This question was specifically addressed by Harjoto, Mullineaux and Yi (2004).
They found that investment banks arranged 7.3% of syndicated loans during their
sample period 1996 to 2002. They did, however, include Credit Suisse First Boston
(CSFB) as an investment bank although it is more properly characterized as a com-
mercial bank. With CSFB removed, true investment banks arranged less than 5% of
total syndicated loan volume. These authors found that investment banks were signif-
icantly more likely to arrange HLT (Highly-leveraged Transaction) syndicated loans,

4
Participation in a bought syndicated loan, where the loan is funded first by the arranger from
whom participants take a subsequent assignment, would appear to be more problematic. This is very
significant for project finance where bought syndicated loans are the norm. It is expected that bank
participants in these cases will argue that the fair value of such loans cannot be reliably measured,
which is another exception to the requirement for fair value accounting for financial assets.

67
which is to be expected given their capabilities. This is consistent with the argument
that HLT syndicated loans are not typical of the wider class of syndicated loans, as is
outlined in the next subsection.

5.1.3 HLT Syndicated Loans

There is a high profile class of syndicated loans which, on the face of it, do appear to have
the characteristics of debt securities, and which are probably responsible for the breadth
of the view that syndicated loans represent a convergence of bank loan and securities
markets. These are the syndicated loans for highly-leveraged borrowers (called HLT
loans) in the United States. It has been widely noted that a significant group of non-
bank investors now participate in HLT loan syndicates, in many cases exclusively, and
that there is an active secondary market for participations in these loans which has
all the characteristics of a traded debt market. It is contended, however, that HLT
syndicated loans are not typical of the vast majority of syndicated loans. A major
contention of this work is that loans are distinguished from bonds on the basis that
they are structured to be provided by a financial intermediary, and that this enables
them to provide financing of a type not available in the capital markets. The major
features of loans are flexibility in utilization by the borrower and the fact that their
lenders are able to accept and manage risks (through monitoring and covenants) that
cannot be accepted in the public capital markets.
How do HLT syndicated loans fit within this profile? Many HLT syndicated loans
are, in fact, structured to separate the lending commitments of the institutional in-
vestors and banks into separate tranches with different terms. The borrower retains
some of its usual flexibility through the tranche which is provided by a syndicate of
banks. The non-bank tranches, by contrast, are fully-drawn at the time they are syn-
dicated and often do not allow the borrower the right of prepayment. This ensures
that these tranches of the loan are always outstanding in their full amount, which is
important for non-bank investors who have surplus funds that must be invested and is
a necessary pre-condition to determining mark-to-market values and active secondary

68
market trading, but which eliminates one of the defining features of loans.
HLT syndicated loans are usually rated, also to enable benchmark pricing and
marketability of the loans for institutional investors, but again this removes one of the
major features of loans that makes them flexible for borrowers. For this reason HLT
syndicated loans are often executed as bought deals, with all of the loan initially funded
by bank underwriters. It is usually only after the underlying transaction is completed,
and at which point most of the uncertainty relating to the purpose of the financing
is resolved and the loan utilization options no longer so important, that the loan is
syndicated and non-bank investors join as participants.
Where institutional investors do participate in HLT syndicated loans on equal terms
with bank lenders, it has been noted that they have been forced to adopt to the require-
ments of the banking market, for which it is reasonable to say that they must therefore
be compensated on the same basis as banks (Schmelkin, 2001). HLT syndicated loans
are certainly not a retail investment product. It has been shown that the pricing on
HLT syndicated loans does differ from the pricing of equivalent transactions in the
capital markets (Abgbazo, Mei and Saunders, 1998). In the end, and despite the high
profile of HLT syndicated loans, over 75% of syndicated loans in the United States in
2001 were for general corporate purposes, a market in which institutional investors do
not participate at all (Armstrong, 2003).

5.1.4 Empirical Findings

Dennis and Mullineaux (2000) and the other authors in this stream (such as Jones,
Lang and Nigro, 2000) do offer empirical support for their proposition that loans are
more likely to be syndicated as information about the borrower becomes more readily
available, for example due to the presence of a credit rating or listing. If the explanation
of syndicated loans as hybrid debt securities is unable to explain significant aspects
of syndicated loan activity, then these findings must be explained. There are two
possibilities. The first is that the results are due to nature of the data. The second is
that these findings may be explained by the well-known relationship between loan size

69
and syndication, which is not an implication of the explanation that syndicated loans
are hybrid debt securities.
Dealing with the data first, these authors draw observations of syndicated and
bilateral loans from commercial databases of completed loans. These generally do a
good job in capturing information on syndicated loans: the arrangers of syndicated
loans have great incentive to publicize them to maximize their rankings on league
tables, and the process of syndication inevitably ensures that details of the loan make
their way into the public domain. Loans are, however, private contracts and there is
no such incentive or mechanism for the existence, let alone details, of the majority of
bilateral loans to be disclosed. Megginson, Poulsen and Sinkey (1995) observed that
syndicated loans are the only form of loan that is regularly disclosed by commercial
bank lenders.
It is possible that those bilateral loans that are disclosed, and thus captured in the
data, would tend to be notable or significant or unique in some way. For example,
syndicated loans that are arranged as bought deals, that is they are signed and funded
by their originator prior to syndication, often appear in the databases initially as single
lender loans. Bought deals are used almost exclusively for complex transactions such
as project finance and usually for unrated borrowers. It is possible, therefore, that an
unrepresentative proportion of those bilateral loans that are reported and captured in
the data are "difficult" (that is, information problematic).
There is another potential issue with the data in this area. It has also been noted
that one of the major uses of syndicated loans is as a standby for commercial paper
facilities, enabling firms to achieve the investment grade credit rating required to access
this market. The huge volume of syndicated loans raised for this purpose has already
been noted in Chapter 2, and so this might result in a strong correlation between credit
rating and syndication.
The second possibility is that the empirical findings do not require that syndicated
loans are hybrid debt securities. It is generally accepted that, all else being equal,
loans are more likely to be syndicated as they increase in size. It is a feature of firms

70
that are rated or have a public listing that they tend to be larger than firms that are
not. It follows that rated or listed firms therefore have larger financing requirements
than those that are not, and so their loans might be more likely to be syndicated
for this reason. An apparent relationship between rating or public listing, or more
generally, the availability of information about a firm, and syndication of their loans,
might reasonably be explained as a relationship between borrower, and therefore loan,
size and syndication. The explanation of syndicated loans as hybrid debt securities
does not explain the relationship between loan size and syndication.
Dennis and Mullineaux (2000) also found empirical support for their contention that
loans are more likely to be syndicated if the arranger has a strong reputation. This is
cited as support for their agency cost argument, as described in Chapter 3, in which they
suggest that reputation can overcome an adverse selection problem where arrangers
of syndicated loans are presumed to be exploiting their superior information about
borrowers, and a moral hazard problem in which they are presumed not to monitor
syndicated loans adequately. Clearly reputation is a difficult concept to quantify and
so the authors used several proxies for it in their analysis, the major one being what
they call "repeat business", which reflects the number of syndicated loans arranged by
an institution previously. And they do find that this variable is significant.
They do, however, recognize a potential problem with such a variable, in that it
may capture serial correlation rather than being a true explanatory variable. In this
context they explain possible serial correlation as the possibility than institutions have
a general strategy to syndicate their loans. They therefore test an alternative proxy for
reputation as well, being the arranger’s credit rating. They do not, however, find that
the credit rating is significant at the .01 or .05 level of their "all variables included"
model specification (page 420).
It is suggested that there might be a very plausible alternative explanation for the
significance found for the "repeat business" variable. Syndicated loans are mandated
to their arrangers in a competitive bidding process and so the repeat business variable
might in fact be capturing serial correlation, but serial correlation in the sense that

71
certain institutions are more successful than others in winning syndicated loan man-
dates and that this advantage persists over time. Observation of the arranger League
Tables in Table 2.4 shows that certain institutions are dominant and, while it is not
shown, other data shows that this dominance has extended over time. In this sense,
then, testing the alternative proxy variable of arranger credit rating could be seen as
testing a possible source of such a competitive advantage.

5.2 Active Portfolio Management

This section considers the second existing explanation for the use of syndicated loans.
It is that syndication of a loan is a form of portfolio management by the bank that
originates it. Banks actively manage their portfolios both to transfer the risk of loans
to other parties who are able to bear them at lower cost, thus enhancing the returns
or minimizing losses on the transferor’s portfolio, and to create room within portfolio
lending limits for more lucrative new business.
There is a classic example of the use of such techniques. In the mid/late 1990s
nearly all Japanese banks became unable to raise funding at the interbank base rate
because of the banking system crisis in that country. At its worst, Japanese banks were
paying as much as 0.90% over the base rate for their funding (Federal Reserve Bank
of San Francisco, 2001; Hanajiri 1999). While it was not widely reported, this Japan
Premium led almost directly to the creation of the secondary loan market in Asia as the
Japanese banks offered for sale what had become, for them, uneconomic loans (those
on which the interest margin could not now cover their costs of funding, let alone the
other costs of lending). For institutions that did not suffer this relative disadvantage
in funding, however, the Japanese banks’ loans were attractive investments, and they
were willing purchasers.
The function of syndication in effectively transferring loan obligations from the
originator to other institutions, the participants, had led many to suggest that it is
driven by a similar motivation (Hall and Stuart, 2003). There has even been some

72
empirical work on this theme. Simons (1993) hypothesized that capital-constraints,
the difficulty faced by some banks in raising additional capital to support new loans,
motivates them to syndicate their loans to other banks that are not so constrained.
Her major empirical result was that, in a sample drawn in 1993, banks’ capital/asset
ratios were positively associated with the share of syndicated loans they retained in
their own book. She proposed that as a bank’s capital position deteriorates it becomes
less able to raise the capital to support its loans and thus holds smaller proportions of
the syndicated loans that it originates.
The difficulty with this explanation is that syndicated loans cannot be, and are
not, used as portfolio management tools. They are structurally different from bilateral
loans, must be mandated and executed initially as syndicated loans, and the process of
syndication in most cases takes place before the loan is executed. An existing bilateral
loan cannot be subsequently syndicated and it is not market practice to execute a loan
in syndicated form simply to give the lender the free option to syndicate in the future5 .
Syndication is not a tool with which to manage an institution’s existing loan portfolio
in response to changing conditions.
The case of the Japan Premium has already been noted as an example of the
value of active portfolio management. It is very instructive, however, that what the
Japan Premium did not lead to was any increase in origination of syndicated loans
by the Japanese banks, as would be expected if this explanation were valid. In fact
the opposite was emphatically the case and Japanese banks fell dramatically down the
rankings of syndicated loan arrangers at the same time as they substantially withdrew
from the lending markets (Peek and Rosengren, 1999).
The contended difficulties with this explanation are also supported by the observed
structure of the syndicated loan market. Those institutions that do arrange signifi-
cant volumes of syndicated loans are actually among the world’s largest and strongest
commercial banks. Far from being disadvantaged, they appear to be among those

5
Bought deals, while executed by the originator as sole lender prior to syndication, are specifically
contemplated to be syndicated loans and are structured as such.

73
institutions most capable of lending. Table 5.2 confirms that the top arrangers of syn-
dicated loans also lead the rankings by total loan assets and capitalization. The three
institutions that dominated the syndicated loan markets in 2000, Bank of America, JP
Morgan Chase and Citibank/SSB had regulatory capital ratios in that year of 11%, 12%
and 11.3% respectively, well above the required minimum of 8%, demonstrating very
strong lending capability. These statistics are not cited to support a direct correlation
between capital ranking and the origination of syndicated loans, but rather to demon-
strate that the leading originators are certainly not among those institutions that are
constrained in their lending activities. As there are several thousands of institutions
active in the lending markets worldwide, the ranking of these institutions near the top
by capital adequacy supports this contention.
It should also be noted that the banking environment in 1993, when Simons’ re-
search was undertaken, was one where most leading US institutions had recently faced
serious capitalization problems due to substantial credit losses in the late 1980s and
new minimum regulatory capital requirements had just been introduced, to substantial
speculation about their effect on banks’ willingness to hold loan assets. Her hypothesis
and observed correlation between low capitalization and arranging syndicated loans at
this time should not be unexpected. Subsequently, however, the syndication market
has grown dramatically notwithstanding that these same leading arrangers have long
since built very strong capital positions.

5.3 Loan Size

One of the most popular explanations of syndication is that it enables an institution

to still originate a loan that is too large for it to provide on a bilateral basis. Moosa
(1998) is one of a number of authors who actually define syndicated loans as loans that
are so large that it is necessary to form syndicates to provide them. It is important
to distinguish between an explanation that loan originators are forced to syndicate
because of loan size and an explanation that they would prefer lower loan commitment

74
 Bank Syndicated Loans Total Assets Total Capital
Volume / Rank Volume / Rank Rank

JP Morgan Chase 305,202 1 693,600 4 4

Bank of America 299,576 2 621,800 5 3
Citibank/SSB 225,730 3 1,051,500 2 1
Barclays 115,782 4 505,400 18 23
Deutsche 87,994 5 809,200 3 8
BancOne 81,617 6 269,000 37 11
ABN-Amro 76,381 7 526,500 13 17
Mizuho FG 70,731 8 1,178,300 1 2
Credit Suisse 51,708 9 609,600 11 19
HSBC 46,433 10 696,400 6 5
FleetBoston 44,929 11
BNP Paribas 41,427 12 727,300 9 14
Societe Generale 41,424 13 451,700 22 30
First Union 34,655 14
Commerzbank 32,921 15 441,800 20 35
Mitsubishi Tokyo 32,130 16 751,500
Royal Bank of Scotland 31,798 17 520,000 17 16
Dresdner KB 30,379 18 446,500 19 37
Scotia Bank 27,083 19
WestLB 26,317 20 371,200 26 46

Table 5.2: Descriptive Statistics for Leading Syndicated Loan Arrangers. All figures
for 2000 except Total Assets which is for 2001. Source: Loanware, The Banker.

75
amounts. The latter would require a mechanism or theory to explain how originators
select the optimum loan commitment amount, which the relatively simple assertions in
the literature that loan size is the reason for syndication do not attempt to provide.
For this reason the power of this explanation is considered here in the simple terms in
which it is usually framed.
The constraint on the amount that an individual institution can lend is usually
attributed to the presence of credit exposure limits that constrain the total amount it
is able to lend to a particular borrower, industry or country (Thomas and Wang, 2004).
All regulated banking institutions are subject to fixed limits on the amount of exposure
they can have to a particular borrower. The regulations of the Australian banking regu-
lator, the Australian Prudential Regulation Authority (APRA), are typical. Australian
Prudential Standard 221 prohibits financial institutions under its supervision from hav-
ing aggregate exposure to an unrelated corporate counterparty (or counterparty group)
of greater than 25% of its capital base. These institutions are also required to have a
policy for managing what are defined as large exposures, those greater than 10% of the
bank’s capital base. The latter is not a prohibition per se, but it is reasonable to say
that most institutions will not maintain such large exposures as a matter of course.
Now consider a borrower with a funding requirement which would, if provided as
a bilateral loan, cause the bank to exceed its credit exposure limits, whether they are
fixed regulatory limits or those imposed internally. The question, then, is whether
syndication of the loan can overcome the prohibition. Where the syndicated loan is
arranged on a best efforts basis, with the originator committing only to its desired
final hold amount, then there is no difficulty with the explanation that syndication
can avoid the prohibition of credit exposure limits. It is contended, however, that this
hypothesis is unable to explain the majority of syndicated loans that are not arranged
on a best efforts basis, but are underwritten6 . An underwriting commitment is a legally

6
The loan markets are highly competitive and there is very strong anecdotal evidence that, except
where there are extreme or unusual circumstances, it is necessary for institutions to commit to deliver
the whole loan amount, whether bilaterally or by underwriting a syndicated loan, in order to win
loan origination mandates. While the terms of mandates are private between the parties and rarely

76
binding obligation to provide the loan facility in the full underwritten amount. While
the intention of the underwriter is to successfully syndicate the loan so that it provides
only part of the facility itself, the actual amount of the commitment it will have to
provide - its final hold - is uncertain, but may be up to the full underwritten amount
(Fight, 2000).
There are many examples of banks that have been forced to provide the loan in
its full underwritten amount following compete failure of syndication. For example,
Citibank was reputed to have been left with almost all of the approximately $1bn
syndicated loan that it solely underwrote to finance the acquisition of the Loy Yang
B power station in Victoria, Australia, in 1997 after the loan pricing was rejected by
potential participants as inadequate.
What is at issue, then, is whether the syndicated loan underwriting commitment
would also be subject to credit exposure limits. Unfortunately it is one that does not
appear to be addressed directly in the banking regulations or in the literature. The reg-
ulations are, however, highly suggestive that a binding underwriting commitment will
fall within the definition of exposure. Australian Prudential Regulation 221 broadly de-
fines exposure to include on- and off-balance sheet claims, commitments and contingent
obligations in the banking and trading books (trading book exposures are distinguished
from banking book exposures as they are intended to be sold in a short time frame).
A non-inclusive list of examples in Australian Guidance Note 112.2 includes com-
mitments which share the essential features of syndicated loan underwriting. They
include note issuance and revolving underwritten facilities, where the bank is obliged
to take up any issues of notes that the issuer is unable to place into the capital mar-
kets. They even include commitments which are clearly less onerous on the bank than

disclosed, one of the leading loan originators was willing to provide the author with statistics relating
to its operations in Asia, Australasia and India over the period 1996 to 2000. Of the 208 syndicated
loans it arranged in that region, 141 (almost 70%) were underwritten with only the standard material
adverse change and clear-market conditions described in Chapter 3. This is a very significant finding
given that this period included the Asian financial crisis, a time of severe and unprecedented uncertainty
in the loan markets that made institutions much less willing to underwrite syndicated loans and bear
syndication risk (see Wild 1998).

77
a syndicated loan underwriting commitment, for example a commitment which can be
unconditionally revoked at any time without notice. If it is difficult to confirm whether
syndicated loan underwriting falls explicitly within the definition of exposure, it is rea-
sonable to say that in practice it is generally treated so by banks. Seeking and gaining
approval for an underwriting commitment that would cause the bank to exceed its
limits is, in practice, the exception rather than the rule.
It is possible to identify examples of large syndicated loans that would obviously
have been too large to be provided bilaterally due to the presence of credit exposure
limits. It would not have been reasonable to expect that any single institution could
have provided the entire Euro30 billion France Telecom loan described in Chapter 2, and
in that case the loan was, in fact, jointly underwritten by six institutions. After it was
underwritten, however, the France Telecom loan was still taken to general syndication
where a further 54 banks committed Euro71.8 billion to substantially oversubscribe it.
These commitments were substantially scaled-back, but the original underwriters were
still each left with a loan commitment that was only a small fraction of the amount it
originally underwrote.
So while the practice of joint underwriting large syndicated loans might support
the contention that banks syndicate because they are constrained by lending limits,
the fact that these loans are then subsequently taken to general syndication in order to
further reduce each joint underwriters’ own loan commitment shows that syndication
of these loans must have another motivation and another explanation is required.

5.4 Conclusion

In this chapter the major contemporary explanations for syndication were considered
and it was concluded that they are unable to explain many significant features of the
observed syndicated loan market. This suggests that there is room for an alternative
explanation for the use of syndicated loans that can do so, and this is the subject of
the next chapters.

78
Chapter 6

Syndication and the Costs of

Lending

In this chapter the basis for a new hypothesis for the use of syndicated loans is set
out, and the line of reasoning that is pursued is as follows. Banks and firms are both
motivated by the profit incentive, and so it is reasonable to suggest that a syndicated
loan might be selected in preference the alternative bilateral loan where it generates
greater return to the originator and/or has lower cost to the borrower. The source of
such differentiation might reasonably be expected to found in the costs of lending, of
which three are identified in the new expressions of bilateral and syndicated loan return
developed in Chapter 4; credit loss provision, capital charge and opportunity costs.
In this chapter the effect on each of these costs of syndication of a loan, compared
with its provision on a bilateral basis, is explored. And it is found that, given certain
reasonable assumptions, syndication of a loan reduces a lender’s rates of credit loss
provision, capital charge, and opportunity costs. These findings do not, in themselves,
provide the complete explanation for syndication. It is necessary to identify exactly how
the lower costs of lending might manifest in lower costs of financing for a borrower in
realistic market conditions and so in Chapter 7 the expressions of return from bilateral
and syndicated loans are developed into a new model of the expected marginal return

79
from syndication which does just this, and provides a rigorous new explanation for
syndication.

6.1 Credit Risk

This section considers the effect of syndication on the first of the major costs of lending,
the provision for expected credit loss. It is shown that syndication of a loan should, all
else being equal, at least maintain and in many cases reduce the rate of the provision
for expected credit loss on a loan. In this sense the term rate refers to the provision
expressed as a percentage of the loan advances, which is the form in which it is incor-
porated in the expressions of the return from bilateral or syndicated loans proposed in
Chapter 4.
It has been previously observed that there are two main drivers of the rate of credit
loss provision held against any loan advance; the probability of default and the expected
loss given default. There are potentially serious consequences for any firm that defaults
on a debt obligation. Loans and debt securities typically contain, as standard, what are
known as cross-default provisions, which allow the lenders or security holders to call
their debt into default and demand immediate repayment, irrespective of scheduled
repayment, if the firm defaults upon any of its other debt obligations. The intention
is to ensure that these creditors are able to participate immediately in negotiations for
a restructuring of the firm’s obligations or, in the worst case scenario, its winding up
and distribution of its assets among its creditors.
This suggests that a firm will not voluntarily default on a debt obligation, and
so the probability of default for a firm should be independent of the structure of its
loan obligations. However the consequences of default may be different for non-firm
borrowers or borrower firms who rely on the support of non-firm entities, and in these
cases the presence of a lending syndicate may reduce the probability of default on a
loan compared with its provision on a bilateral basis.
Goodman (1980) and Chowdry (1991) proposed separately that syndication of sov-

80
ereign loans can reduce the risk of voluntary default by these borrowers. Their reasoning
is that the only real sanction on sovereign borrowers1 that voluntarily default on their
loans is the withdrawal of future lending by the defaulted lender. Where there is only
a single lender, and particularly in a competitive lending market, there is no incentive
for other lenders to withhold future new lending to the sovereign borrower. Chowdry
(1991) suggests that, while there are many ways for such borrowers to re-enter the
market with new bilateral lenders, this can be prevented by the creation of lending
syndicates. A borrower who voluntarily defaults on a syndicated loan will quickly use
up the available lender market, providing a strong incentive for it not to do so. In this
specific case, then, syndication reduces the probability of default of a loan.
Sovereign lending is, relatively, not as significant as it was in the early days of the
syndicated loan product, but it does still take place today in reasonable volume. The
more recent development of international project finance could provide another area
in which syndication may reduce the probability of default of a loan. Infrastructure
projects often rely on undertakings by government or government-owned organisations
to purchase the future output from the project to underpin their creditworthiness and
make them financable. For example, a power generation project may have an electricity
offtake agreement with a public sector electricity distribution utility. The presence of a
syndicate of international lenders to the project may reduce the incentive of the national
government to default, or allow its utility to default, on this offtake obligation.
In fact this idea lies behind the co-financing schemes offered by the multilateral
institutions such the IFC and the various regional development banks to encourage
international lending to projects in developing countries. Commonly known as B-
Loans, these are actually participation loans in which the IFC or development bank
acts as lender of record to the project with a syndicate of participants indemnifying
it against losses caused by project default. The expectation is that a government will
be reluctant to voluntarily default, or allow voluntary default by a government entity,

1
These borrowers are not subject to any binding external jurisdiction in accordance with the principle
of permanent sovereignty.

81
on its obligations to the project where one of its major creditors to that project is a
multilateral agency that the same government may be relying on for other direct loans
or financial aid (see International Finance Corporation, 2001).
If the probability of default by an independent private firm should be insensitive
to syndication, it is suggested that the second element in estimating the credit loss
provision, the loss given default, may not be. Given a default has occurred there is
a strong incentive for its creditors not to force a borrower into formal administration
or bankruptcy proceedings without first attempting to reach a mutually agreeable re-
structuring of its obligations. Often this requires creditors to accept some initial loss in
expectation of either recovering it later, if the firms trades its way out of difficulty, or
the avoidance of even larger losses if the firm is wound up. In this process creditors will
also be bargaining against each other for the available assets of the firm or a share of
future assets, as well as with the firm’s management and shareholders, in their attempt
to get the most favourable terms in the restructuring. It is entirely reasonable, then, to
suggest that a lender may have a significantly stronger bargaining position and so be
expected to minimize its credit losses given default if it is part of a syndicate of lenders
competing with other creditors and the firm’s existing shareholders in a restructuring
scenario2 . There may even be more tangible benefits from syndication in the event of
formal administration proceedings in some jurisdictions, where rules as to the voting
rights of different creditors may favour large blocks of creditors with common interests.

6.2 Capital Charge

The net capital charge, which is the carrying cost of holding capital against the loan, is
another major component of an institution’s costs of lending. In this section it is shown

2
It is important to note that, although each syndicate lender has a distinct legal claim against the
borrower, they do not compete against each other. A fundamental provision of the standard form of
syndicated loan agreement provides that any payment received by a syndicate lender from the borrower
which is in excess of the amount it would have received had that payment been made to the agent on
behalf of the syndicate, and then been distributed pro-rata among all syndicate lenders, must be paid
by that syndicate lender to the agent for distribution among all the syndicate lenders. This is known
as a "claw-back" provision.

82
that, given certain reasonable assumptions, the loan originator’s rate of net capital
charge is also reduced by syndication of a loan. This is because syndication reduces
the amount of the originator’s own lending obligation, which has the effect of reducing
the relative amount of economic capital it must hold against it. The major assumption
behind this conclusion is that the credit risk of the new loan is either uncorrelated or
partially positively correlated with the credit risk of the bank’s existing portfolio. This
seems to be a reasonable assumption given the nature of firms and observations of the
correlation of equity returns, which have claims on the same firm cash flows as debt, of
firms in the economy.
Unless the reader is already familiar with the concept and terminology of capital
charges it can very difficult to appreciate the general result, and its derivation, in
abstract terms. For this reason it will be demonstrated first in a worked example, and
then the specific result from that example will be generalized.

WORKED EXAMPLE

This worked example has three parts. The first describes a hypothetical
bank’s pre-existing portfolio. The second considers the impact of adding a
hypothetical new bilateral loan to the portfolio in terms of the rate of net
capital charge on that new loan. The third shows the effect of syndicating
the new loan, thereby reducing the amount the bank has to provide itself,
on its rate of net capital charge.

Capital Charge on Pre-Existing Portfolio

The worked example starts with the following basic assumptions about a
given bank:

It has loan advances under its existing portfolio of $10, 000.

It has calculated that the one-year distribution of credit losses associated

with this portfolio is approximately normal with an expected value of $100
and a standard deviation of $20.

83
 It has a policy of holding sufficient economic capital such that its probability
of insolvency due to credit loss is no greater than 0.03%p.a.3 .

Its cost of equity capital is 15%p.a. and the loan base rate is 5%p.a..

The first observation to be made is that the bank will make a provision for
expected credit losses of $100.

The second is that, in accordance with its policy, it will hold economic cap-
ital of $68.63. This economic capital requirement is equal to 3.43 standard
deviations of credit losses from the expected value, which is only exceeded
with a 0.03% probability.

There will, therefore, be only a 0.03% probability that actual credit losses
in the next year will exceed the $168.63 of combined provision and economic
capital.

This economic capital requirement can also be expressed as a percentage

of the outstanding portfolio loan advances, so that in this case economic
$68.63
capital must be held at a rate of $10,000 or 0.6863%.

The net carrying cost of economic capital is 10%, being the 15% cost of
economic capital less the 5% base rate on the loan that the lender receives
as compensation through the interest rate on its loan advances.

The net economic capital charge on this portfolio is, therefore, $6.863, being
the product of the $68.63 economic capital requirement and the 10% net
carrying cost of economic capital. This can also be expressed as a rate,
$6.863
being 0.06863% which can either be generated as $10,000 or 0.6863% ∗ 10%.

3
Such an annualized probability is consistent with the institution having a AA credit rating from
Standard & Poor’s, or equivalent from some other agency.

84
New Bilateral Loan

To consider the capital charge on an individual loan, assume that:

The bank wishes to add a new bilateral loan to its portfolio with loan
advances in the amount of $1, 000.

It estimates that the distribution of credit loss associated with the new loan
advances has an expected value of $20 and a standard deviation of $5 and
that these are uncorrelated with credit losses on the institution’s existing
portfolio.

With the addition of the new loan the bank’s portfolio would have the
following characteristics.

The loan advances under the portfolio would now be in the amount of
$11, 000.

The distribution of credit losses associated with the new portfolio would
have an expected value of $120, being the expected credit loss on the pre-
existing portfolio plus the expected credit loss on the new loan.

The distribution of credit losses associated with the new portfolio would
√
have a standard deviation of $20.616, being $202 + $52 .

The new portfolio would therefore be subject to an economic capital re-

quirement of $70.75, being the 3.43 standard deviations of credit losses.

How much of this economic capital requirement is attributable to the new

loan? As the economic capital requirement is determined on a portfolio
basis, the share allocated to an individual loan is calculated as the differ-
ence between the economic capital requirement determined for the portfolio
which includes that loan and then determined for the same portfolio but
with that loan excluded.

The new loan would therefore have a marginal economic capital requirement
$2.11
of $70.75−$68.63 = $2.11. This can be expressed as a rate of $1000 = 0.211%

85
which translates into a rate of economic capital charge on the new loan of
0.0211%, being the product of the rate of economic capital requirement and
the 10% net carrying cost of economic capital.

New Syndicated Loan

Now consider the effect of loan size on the capital charge. Assume that
instead of providing the entire new loan itself on a bilateral basis, the in-
stitution syndicates it so that it only has to provide 10% of the new loan
itself, with advances of $100.

The distribution of credit losses associated with the new loan now has an ex-
pected value of $20∗10% = $2 and a standard deviation of $5∗ 10% = $0.50
and these remain uncorrelated with the credit losses on the institution’s cur-
rent portfolio.

If the institution were to add this new loan its portfolio would have the
following characteristics.

The loan advances under the portfolio would be in the amount of $10, 100
and the distribution of credit losses associated with the new portfolio would
have an expected value of $102.

The distribution of credit losses would now have a standard deviation of

√
$20.00625, being $202 + $0.502 , and so the portfolio would be subject
to an economic capital requirement of $68.66 (again being 3.43 standard
deviations of credit losses).

The new loan would therefore have a marginal economic capital requirement
of $68.66 − $68.63 = $0.03. This can be expressed as a rate of 0.03% which
translates into a rate of net economic capital charge on the new loan (given
the 10% net carrying cost of economic capital) of 0.003%.

86
 Result

So the rates of net economic capital charge incurred by the loan originator
in this example, under the bilateral and syndicated loan alternatives, can
now be compared; 0.0211% if the loan is not syndicated and 0.003% if it is.
Clearly the rate is lower for the syndicated loan, where the only difference
between the bilateral and syndicated loans is that the banks has a smaller
loan commitment under the later.

Now this result is generalized to show that it applies in all cases. This is done
by showing that the rate of the economic capital requirement to be held against any
loan is positively related to the loan amount, given the correlation assumptions noted
previously. In other words, as the loan amount decreases the bank must hold a propor-
tionally lesser amount of economic capital against it, and vice versa. It is reasonable
to assume that the net carrying cost of economic capital is constant irrespective of the
loan amount, and so it follows that the rate of net economic capital charge, the prod-
uct of the economic capital requirement and net carrying cost, will also be positively
related to the loan amount.
The first step is to identify a general expression for the rate of economic capital
requirement for a loan. Let the standard deviation of credit loss on a bank’s pre-
existing portfolio be denoted σ E , the standard deviation of credit loss on the new loan
be denoted σ N for each dollar of advances under the new loan, and the new loan have
advances in an amount $γ. For convenience assume this bank holds economic capital
equal to one standard deviation of credit losses. Letting the rate of any item x be
denoted ρx , the rate of economic capital requirement of any new loan, where the credit
risk is uncorrelated with the existing portfolio, is therefore given by

(σ 2E + γ 2 σ 2N )0.5 − σ E
ρeconomic capital on new loan = (6.1)
γ

A positive relationship between the dependent variable, ρeconomic capital on new loan ,
and the independent variable, the loan amount γ, can be shown by differentiating the

87
expression with respect to γ and showing that the result is greater than zero. For
convenience, but without affecting the generality of the result, let σ E = 1. Therefore

(1 + γ 2 σ 2N )0.5 − 1
ρeconomic capital on new loan = (6.2)
γ

It is differentiated with respect to γ, and the expected result is found, as follows:

∂ (1 + γ 2 σ 2N )0.5 − 1 σ 2N 1 ³¡ 2 2 ¢0.5 ´
{ } = ¡ ¢ 0.5 − γ σ N + 1 − 1 (6.3)
∂.γ γ γ 2 σ 2N + 1 γ2
¡ ¢0.5 ³¡ 2 2 ¢0.5 ´
γ 2 σ 2N − γ 2 σ 2N + 1 γ σN + 1 −1
= ¡ ¢0.5
γ 2 γ 2 σ 2N + 1
¡ ¢ ¡ ¢0.5
γ 2 σ 2N − γ 2 σ 2N + 1 + γ 2 σ 2N + 1
= ¡ ¢0.5
γ 2 γ 2 σ 2N + 1
¡ ¢0.5
−1 + γ 2 σ 2N + 1 2
= ¡ ¢0.5 > 0 where γ > 0, σ N > 0
2 2
γ γ σN + 1 2

For convenience this proof assumes that the credit risk of the new loan is uncor-
related with the credit risk of the existing portfolio. If partial positive correlation is
assumed then the same result is found but the effect is magnified. It is not demon-
strated here in the interests of keeping the computations simple. So it has now been
shown that the rate of economic capital requirement for any loan, and thus the rate of
net economic capital charge on it, is positively related to the loan amount given these
assumptions. Syndication of loan, which reduces the amount of the loan commitment
the originator must make itself, may therefore lower the rate of economic capital charge
it incurs on the loan commitment.
There is a final observation to be made about the technique of calculating the
marginal portfolio economic capital requirement attributable to a particular loan. It is
correct that the marginal portfolio capital requirement could theoretically be attributed
to the pre-existing portfolio instead of the new loan. Nevertheless it is always, in
practice, treated as being attributable to the new loan because the loans in the pre-

88
existing portfolio will have been previously priced to cover the then capital charges
associated with that portfolio, and there is no scope in a competitive market to reset
their pricing to cover the incremental capital requirement of a new loan. By contrast,
a new loan is able to be priced to cover its marginal cost, which should include the
marginal portfolio capital charge.

6.3 Opportunity Cost

The existence of a positive relationship between the amount of a loan commitment and
the rate of opportunity cost is one that every bank relationship manager is intuitively
aware of but, paradoxically, is one that is almost impossible to quantify. As has been
noted previously, banks are not investors but intermediaries or, more specifically in
this context, providers of financial services. As such a bank loan can be viewed as one
of a suite of products that banks sell to their customers, albeit one that places heavy
demands on their scarce resources of credit limit availability. Loans are not, however,
the only products that demand these scarce resources and so the provision of a loan
commitment will not only limit the ability of a bank to sell other loans but also other
credit intensive financial products. Derivatives with counterparty risk, letters of credit
and payments services are just a few common examples.
There are two main reasons that these opportunity costs are so difficult to quantify.
The first is the obvious difficulty in identifying and estimating the returns from the sales
of the other financial products that might have to be foregone. The second is that there
is usually uncertainty as to whether these alternatives would be available in any event.
For example, the bank will usually have to compete against other financial institutions
for the sale of a product or the customer may eventually decide not to proceed. In this
sense the lending decision of a bank differs dramatically from the investment choice
of an investor who simply considers the offered price and structure of the alternatives
available in the market for immediate investment.
Nevertheless, it is clear that increasing the amount of any loan commitment is

89
viewed by bankers as having an increasing rate of cost in terms of having to forego more
and more lucrative alternative business either now or in the future. In the remainder
of this section an attempt is made to rationally explain this intuition and demonstrate
it with a highly stylised example.
As has already been noted in Section 5.3, banks are subject to limits on the amount
of credit exposure they can take for given borrowers, industries and countries. Of the
set of alternative exposures a rational bank would forego, if forced to ration, those
with the lowest rate of return, allowing it to undertake those with the highest rate
of return. In this sense the rate of return is the return expressed as a proportion of
the exposure amount. The rate of return on the alternative exposures that have to be
foregone because of entry into the new loan represents the rate of opportunity cost of
the new loan.
Now if the amount of the new loan were increased then further alternative exposures
will have to be foregone. For the rational institution these will be exposures that offer a
higher rate of return than those previously foregone. It therefore follows that the rate of
opportunity cost of the new loan is positively related to the loan commitment amount.
So, as syndication reduces the amount of the originator’s own loan commitment, the rate
of opportunity cost is lower if it syndicates the loan rather than provides it bilaterally.
This is demonstrated with the following, highly stylised, example.

Assume that a given bank has the opportunity to originate a $100, 000, 000
loan for a given borrower and that, by coincidence, it has an available credit
exposure limit for that borrower of $100, 000, 000.

It believes it has future opportunities to provide the same borrower with

derivatives contracts that have counterparty exposure of up to $50, 000, 000,
with trade letters of credit that have counterparty exposure of up to $35, 000, 000
and/or payments facilities with counterparty exposure of up to $15, 000, 000.

The rates of return on these alternative exposures are estimated at 5%,

0.5% and 3% respectively.

90
 New Loan Alternative Exposures Foregone Rate of
Commitment Derivatives Letters of Payments Opportunity
Amount Contracts Credit Facilities Cost

$100,000 $50,000 $35,000 $15,000 2.93%

90,000 40,000 35,000 15,000 2.92%
80,000 30,000 35,000 15,000 2.66%
70,000 20,000 35,000 15,000 2.32%
60,000 10,000 35,000 15,000 1.88%
50,000 0 35,000 15,000 1.25%
40,000 0 35,000 5,000 0.81%
30,000 0 30,000 0 0.50%
20,000 0 20,000 0 0.50%
10,000 0 10,000 0 0.50%
Rates of return on alternative exposures are: derivatives, 5%;
letters of credit, 0.5%; payments facilities, 3%.

Table 6.1: Rate of opportunity cost at different loan commitment amounts.

Table 6.1 shows that the rate of opportunity cost at different amounts for
the new loan. The obvious result is that as the amount of its own loan
obligation falls, as with syndication of a loan, the bank has to forego less or
fewer of the more lucrative alternative exposures, thus reducing its rate of
opportunity costs.

6.4 Conclusion

The major contribution of this chapter is to lay out the basis for the new hypothesis
that syndication may be motivated by an economic incentive. The major economic
advantages of loan syndication were shown to be in reducing the loan originator’s rates
of the costs of lending compared with the provision of a loan on a bilateral basis. These
flow both from the presence of the lending syndicate per se and from the effect of
syndication in reducing the loan amount to be provided by the originator. The work in
this chapter is important because the economic advantages of syndication for lenders

91
are taken up in the next chapter where they form the basis of a rigorous new economic
model and hypothesis for syndication.

92
Chapter 7

New Loan Syndication Model

and Hypothesis

The existing explanations for loan syndication were analysed in the Chapter 5 and
it was suggested that they cannot explain many important features of the syndicated
loan market. It was, therefore, concluded that there is room for a new, alternative
hypothesis. In Chapter 6 the consequences of syndication were considered and an
important finding was made that could reasonably form the basis of a new explanation.
It was shown that syndication of a loan may, under reasonable assumptions, reduce
the loan originator’s rate of lending costs. It was proposed that this might enable the
originator to offer a syndicated loan with lower pricing, and thus cost to the borrower,
than the alternative bilateral loan. In this chapter the idea is developed into a formal
model of the marginal return from syndication that demonstrates how a syndicated
loan might, again under reasonable assumptions, provide both greater returns to the
originator and lower costs to the borrower.
The new model and hypothesis can be simply summarized as follows.
Consider a borrower that is seeking a loan to meet its funding requirement and a
bank, the originator, which desires to provide it. The originator can provide the loan
either entirely by itself as a bilateral loan, or by arranging it as a syndicated loan.

93
The cost of a loan to the borrower comprises the interest and fees, the rates of which
are usually described as the loan pricing. The new model developed in this chapter
shows that if the pricing to the borrower is identical, then a lower rate of lending
costs (being those identified in Chapter 4; credit loss provision, capital charge and
opportunity cost) means that the expected return to the originator will be greater if
it provides the loan as an underwritten syndicated loan than if it provides the loan
bilaterally. The originator can share this expected marginal return from syndication
with the borrower by reducing the pricing on the syndicated loan to below that it
would be willing to accept in providing the loan on a bilateral basis. This provides an
incentive for both the originator and the borrower to select the syndicated loan over
the alternative bilateral loan.
The full expression of the new hypothesis is, unsurprisingly, a little more complex
than suggested by this brief outline, and its most important elements are those that
address a number of major complications. These are somewhat detailed, and so before
beginning it is useful to sketch them out first.
The outline refers to the originator’s expected marginal return from syndication,
where the term expected is used in its statistical sense of the probability weighted
average. This is necessary because the originator’s return from a syndicated loan is
sensitive to its final hold, and final hold is a random variable. It follows, therefore, that
the marginal return from syndication is also a random variable and so the expected
marginal return from syndication will depend on both the sensitivity of return to final
hold and the distribution of final hold itself. How, then, is it possible to generalize that
the expected marginal return from syndication is always positive where the syndicated
and bilateral loans have the same pricing? Simply, the new model demonstrates that,
where the pricing of the syndicated and bilateral loans are identical, the marginal return
from syndication is positive for all possible levels of final hold.
Another complication is that the originator’s return from a syndicated loan, and
thus its marginal return from syndication, is also a function of the participation fees
it pays away. It is not sufficient, however, to simply assume that the originator will

94
set the rates of participation fee at a level at which it generates a positive marginal
return from syndication. The participation fee must be set at a level sufficient that
potential participants will actually join the loan so that it is, in fact, syndicated. There
is a universe of potential participants that may each, for any given loan, have different
minimum required rates of participation fee.
One of the most important elements of the new model is, therefore, to show that
there does exist a threshold rate of participation fee for any syndicated loan at which
the originator continues to generate a positive marginal return from syndication but
at which those participants, who are no more efficient than the originator in lending,
will also generate positive return. These participants would thus have incentive to
participate in the loan and so the loan would be expected to be syndicated. The fact
that this is shown to hold where participants are no more efficient than the originator
in lending is very significant. It is observed that syndicated loans are originated by
institutions who are among the most efficient lenders, as would be expected in any
competitive market.
Another major contribution of the chapter is to show that the originator’s return
from a syndicated loan, and the expected marginal return from syndication, is positively
related to the size of the loan. It follows that, all else being equal, a larger loan is more
likely to be syndicated as its pricing can be lower than its equivalent bilateral loan.
This provides a viable explanation for the observed fact that syndicated loans are, on
average, larger than non-syndicated loans.
There is one final complication. When the originator shares the expected marginal
return from syndication with the borrower by reducing the pricing on the syndicated
loan below the minimum pricing on the bilateral loan, the marginal return from syn-
dication may now be negative at some levels of final hold. This does not invalidate
the explanation because it will still be positive at the other levels of final hold and so
the expected marginal return from syndication may still be positive. It does mean,
however, that the amount by which the originator will be willing to reduce the pricing
on the syndicated loan depends sensitively on the distribution of final hold and its own

95
risk tolerance. This is an important observation because it explains the relationship
between risk and return in syndicated lending, and shows how a competitive advantage
in winning mandates could accrue to a loan originator that is willing to accept greater
risk.
The chapter is structured as follows. Section 1 develops the new expression of the
marginal return from syndication. Section 2 demonstrates that there can always be a
positive marginal return from syndication even where the originator of the syndicated
loan is equally as efficient in lending as the participants to whom the loan is syndicated.
Section 3 shows how the marginal return from syndication is positively related to the
loan amount. Section 4 makes explicit the relationship between the risk and expected
return to the originator from providing a syndicated loan at pricing lower than its
alternative bilateral loan equivalent.

7.1 Marginal Return from Syndication

The first task in developing the new model is to identify the expression of the difference
between the return to the originator if the loan is syndicated and if it is provided
bilaterally, where the loan pricing is the same in both cases. This is the expression of
the marginal return from syndication. In Chapter 4 general expressions were developed
of the return to the lender of a bilateral loan, B, and the originator of a syndicated loan,
S. In the simplest terms, the new expression of marginal return from syndication is
generated by subtracting B from S. Clearly the expressions of S and B are fundamental,
and so it is necessary to restate them first. Recall the following.
The loan is segmented into n funding periods each of length dt days
V = the total initial loan amount
H = the originator’s final hold in the syndicated form of the loan
ρδ = the rate of up-front fee paid by the borrower to the originator
ρφ = the average rate of participation fee paid by the originator to participants in
the syndicated form of the loan

96
 αt = the proportion of the total initial loan amount that is drawn as advances in
any period t
β t = the proportion of the total initial loan amount that is available but undrawn
in any period t
ρN,t = the annualized rate of net interest to the originator in any period t
ρC,t = the annualized rate of lending costs of the originator in any period t (these
being the rates of credit loss provision, capital charge and opportunity cost)
ρ ,t = the annualized rate of net commitment fee to the originator in any period t
r = the time value of return for the originator’s delegated loan relationship manager
The return from providing a bilateral loan is

n
X dt Xn dt
V.αt (ρN,t − ρC,t ) 360 V.β t (ρ ,t ) 360
B = V.ρδ + + (7.1)
t=1
(1 + r)t t=1
(1 + r)t

and the return from originating an underwritten syndicated loan is

n
X dt n
X dt
H.αt (ρN,t − ρC,t ) 360 H.β t (ρ ,t ) 360
S = V.ρδ − ρφ (V − H) + + (7.2)
(1 + r)t (1 + r)t
t=1 t=1

These two expressions, although appearing complex, are in fact quite straightforward.
In essence the originator’s return from a loan, whether bilateral or syndicated, comprises
two major elements; net up-front return, generated upon execution of the loan, and net
ongoing return, generated over the life of loan. The former, the first term in equation
(7.1) and the first two terms in equation (7.2), consists of up-front fees and, in the
case of the syndicated loan, up-front fees less participation fees. The latter, the final
two terms in equations (7.1) and (7.2), consist of the net return on loan advances
and the net return on the undrawn loan commitment respectively. The return on
advances depends crucially on αt , described already as the proportion of the initial
loan commitment actually drawn as advances in period t. Similarly, the return on the
undrawn commitment depends on β t , the proportion of the initial loan commitment
that is available but undrawn in period t.
Before continuing with development of the model it is important to make an obser-

97
vation about the relationship between the net up-front return, which is driven by the
rate of up-front fees, and the net ongoing return, which is a function mainly of interest
income and costs of lending. It is observed in the market that up-front fees to lenders
(including participation fees under a syndicated loan) are positive. This suggests that,
in any highly competitive market where institutions must accept low overall returns in
order to win lending opportunities, the net ongoing return may in fact be negative. And
it certainly is common for institutions to reject lending opportunities notwithstanding
that the offered up-front fee is positive.
Returning to the new model, the marginal return from syndication can now be
expressed as the difference between the two expressions of return, that is S − B. In
their current form, equations (7.1) and (7.2) contain multiple parameters with time
subscript t. In order to make it tractable the expression is modified in two ways. First,
the time value of return for the loan relationship manager is assumed to be zero. It
is suggested that this is a reasonable assumption that is not inconsistent with market
practice. For example, the pricing of a loan is always given by practitioners and in
the trade press as the annual rate of interest margin plus the annualized rate of up-
front fees, with no discounting for time. Second, the parameters of the expressions are
re-expressed as weighted averages taken over the period of the loan. Therefore:
The average length of each funding period is given by

Xn
d=( dt )/n (7.3)
t=1

and the weighted average value of αt is written as

à n ! n
X X
α= αt dt / dt (7.4)
t=1 t=1

where the weights are the length of each funding period. Similarly, the weighted average
value of β t , is given à n !
X n
X
β= β t dt / dt . (7.5)
t=1 t=1

98
The weighted average rate of net interest, ρN,t , weighted by the product of the length
of each funding period and the value αt , is given by
à n ! n
X X
ρN = αt dt ρN,t / αt dt . (7.6)
t=1 t=1

and similarly for the rate of the costs of lending

à n ! n
X X
ρC = αt dt ρC,t / αt dt . (7.7)
t=1 t=1

Finally, the weighted average rate of net commitment fee, ρ ,t , is given by

Xn n
X
ρ =( β t dt ρ ,t )/ β t dt . (7.8)
t=1 t=1

Using these definitions, equation (7.1) can be restated as

d d
B = V.ρδ + V.n.α (ρN − ρC ) + V.n.β ρ (7.9)
360 360

Recall the important finding in the previous chapter that the rates of the costs
of lending, now denoted ρC , are lower where the loan is syndicated than where it is
provided on a bilateral basis. Syndication of the loan reduces its credit risk, and thus
the rate of any lender’s credit loss provision, as well as reducing the originator’s own
commitment amount, thus reducing its rates of capital charge and opportunity cost. To
reflect this, the weighted average rate of the costs of lending under the syndicated loan
is now denoted ρC − ∆ρC , where ∆ρC > 0, and the function for return on a syndicated
loan is restated as follows

d d
S = V.ρδ − ρφ (V − H) + H.n.α (ρN − ρC + ∆ρC ) + H.n.β ρ (7.10)
360 360

The expression of the marginal return from syndication, where the rates of up-front
fee ρδ , net interest income ρN , and net commitment fee ρ are the same under both the

99
syndicated and bilateral loans, can now be stated as follows

d d d
S − B = (H − V )(ρφ + n.α (ρN − ρC ) + n.β ρ ) + H.n.α .∆ρC (7.11)
360 360 360

The derivation of this expression is provided in Appendix 7.1.

This important new expression can be explained as follows. By syndicating the
loan, the originator reduces its own lending amount from the initial total loan amount
V to the lesser final hold amount H. It is clear, therefore, that the first part of this
expression
d d
(H − V )(ρφ + n.α (ρN − ρC ) + n.β ρ) (7.12)
360 360

represents the lost return to the loan originator from foregoing lending in the amount
V − H. This includes the participation fee it pays away that it would otherwise have
retained for itself,
(V − H)ρφ (7.13)

the net interest income,

d
(V − H).n.α ρ (7.14)
360 N

and the net commitment fee,

d
(V − H).n.β ρ. (7.15)
360

It does, however, save itself the costs of lending

d
−(V − H).n.α ρ (7.16)
360 C

on the lending amount foregone, which includes the opportunity cost of other invest-
ments that must have been otherwise foregone.
The second part of the expression

d
H.n.α .∆ρC (7.17)
360

100
represents the amount by which the loan originator is better off because the costs of
lending the final hold amount, H, are reduced by the change in rate ∆ρC where the
loan is syndicated rather than provided bilaterally.

7.2 Efficient Loan Originator

With the expression of the marginal return from syndication identified, the next step
is to demonstrate that it will be positive even where the originator is a lender that
is equally as efficient as the participants to whom it syndicates the loan. This is
undertaken in two steps, as follows.
The first step is to identify a general function of the threshold rate of participation
fee by solving equation (7.11) for the rate of participation fee, ρφ , when the terms
representing the marginal return from syndication, S − B, and change in the rate of
lending costs, ∆ρC , are allocated values of zero. The result is as follows

d d
ρφ = −n.α (ρ − ρC ) − n.β ρ (7.18)
360 N 360

The derivation of this expression is shown in Appendix 7.1.

This threshold rate is significant because it is the rate of participation fee at or
below which the marginal return from syndication is always positive. The reasoning is
as follows. Equation (7.17) showed that the marginal return from syndication, S − B,
is a positive function of ∆ρC . So if S − B = 0 where the rate of participation fee is
the threshold rate and ∆ρC = 0, then S − B must be positive at the threshold rate
of participation fee because, as is the major finding of this work, the rate of change in
lending costs from syndication is actually positive, that is ∆ρC > 0.
The second step is to show that potential participants, who are no more efficient
than the originator in lending, will be willing to join the loan syndicate if they receive
the threshold rate of participation fee so that the loan is, in fact, syndicated. This
is done by showing that the return to a participant, who is otherwise identical to
the originator, is positive if it receives the threshold rate of participation fee. Let L

101
represent the return to this institution from participating in the syndicated loan in an
amount l < V . The return to the participant will be the same as the return would have
been to the originator had it provided the loan bilaterally, but with three important
differences.
First, the commitment amount of the participant is obviously lower, being l < V .
Second, the participant will now have a lower rate of the costs of lending. Even though
the participant and the originator are assumed to be equally efficient in providing
loan commitments, the fact that the loan is syndicated will reduce the participant’s
credit risk, and thus its rate of credit loss provision, compared with the same loan
provided by the originator on a bilateral basis. Further, the smaller lending amount
of the participant in the syndicated loan will attract lower rates of capital charge and
opportunity cost. And, third, the rate of up-front fee to the originator is replaced with
the rate of participation fee.
The function for L is therefore expressed as follows.

d d
L = l.ρφ + l.n.α (ρN − ρC + ∆ρC ) + l.n.β ρ (7.19)
360 360

When the rate of participation fee is then set at the threshold level, that is

d d
ρφ = −n.α (ρN − ρC ) − n.β ρ (7.20)
360 360

then the return to the participant solves to

d
L = l.n.α (∆ρC ). (7.21)
360

The derivation of this result is provided in Appendix 7.1.

It follows that as ∆ρC > 0 (and by definition, l, n, α, d > 0) then the return to this
participant is positive. Such institutions therefore have an incentive to participate in
the loan, notwithstanding that they can lend no more efficiently than the originator who
is offering them, effectively, lower pricing than it receives itself. This is an important

102
finding because, in competitive loan markets, mandates to originate loans are only
going to be won by efficient lenders. Any defensible explanation of syndication must
explain, as this one does, why efficient lenders who are in a position to win mandates
to originate loans also have an incentive to syndicate.
At this stage it is useful to demonstrate the model and explanation graphically. The
basic graphic used in this and subsequent sections plots the originator’s return from a
syndicated loan, and the two components of that return, net up-front return and net
ongoing return, against its final hold. The cases demonstrated are all variations on the
same worked example, the assumptions of which are set out in Appendix 7.2.
In the first case, shown in Figure 7.1, the rate of participation fee is set to the
threshold rate and the change in the rates of lending costs, ∆ρC , is set to zero, indicating
no benefit from syndication. The loan is also assumed to be priced such that the
originator’s return, if it were provided bilaterally, would be zero. This case, called
the no advantage case, shows clearly that any advantage from syndication must flow
from the reduction in rate of the costs of lending. Where there is no such reduction,
and the rate of participation fee is set at the threshold rate, then the no advantage
case shows that the net up-front return and net ongoing return exactly offset each
other, the marginal return from syndication is always zero, and there is no incentive
for the originator to syndicate the loan. Effectively the no advantage case confirms the
validity of the expressions underlying the new model and the relationship between the
two elements of return and final hold.

103
 $800,000
$600,000
$400,000
$200,000
Return
$0
-$200,000
-$400,000
-$600,000
-$800,000
5 $0
0 00
5 00
0 00
5 00
0 00

$1 500 0
$1 000 0
$1 500 0
$1 000 0
$1 500 0
$1 000 0
$1 500 0
$1 000 0
$2 500 0
00 0
00
0
00 ,00
12 ,00
25 ,00
37 ,00
50 ,00
62 ,00
75 ,00
87 ,00
00 ,00
$2 00,0
$3 00,0
$5 00,0
$6 00,0
$7 00,0
$8 00,0

,0
,0
2,
5,
7,
0,
2,
5,
7,

,
,
,
,
,
,
,
,
$1

Final Hold

Net Up-Front Return Net Ongoing Return Return

Figure 7.1: No Advantage Case

The second case is called the base syndication case, Figure 7.2. It varies the no
advantage case in two ways to reflect the actual effect of syndication; the originator’s
rate of costs of lending are reduced where the loan is syndicated and the rate of partic-
ipation fee is set to a level below the threshold rate. As expected it is observed that, at
all levels of final hold less than the full loan amount, the net up-front return and the
net ongoing return are greater than under the no advantage case, there is a positive
marginal return from syndication, and so there is an incentive for the originator to
syndicate the loan. Again the assumptions are set out in Appendix 7.2.

104
 $800,000
$600,000
$400,000
Return $200,000
$0
-$200,000
-$400,000
-$600,000
-$800,000
00 0

50 0
0, 000

50 0
5, 000

00

0
00
2, $0

00 00

12 00

25 ,00

37 00

50 00

62 ,00

75 00

87 ,00

00 00
$2 0, 0

$3 0, 0

$6 0, 0

$8 0, 0

,0
,

$1 00,

$1 00 ,

$1 00 ,

$1 00 ,

$1 00 ,

$2 00 ,
0

$1 00

$1 00

$1 00

00
50

00

00

,0

,5

,0

,5

,0

,5

,0

,5

,0
5,

7,

2,

7,
$1

$5

$7
Final Hold

Net Up-Front Return Net Ongoing Return Return

Figure 7.2: Base Syndication Case

7.3 Loan Size

In this section it is shown that, all else being equal, the marginal return from syndication
is positively related to the total loan amount. This is significant because the amount
of marginal return will determine how much the pricing on the syndicated loan can be
reduced below that of the alternative bilateral loan. The larger the reduction in pricing,
the more likely that the borrower will agree to syndication. The finding therefore
provides an explanation for the observation that loans are more likely to be syndicated
where, all else being equal, they are larger.
Recall the expression of the marginal return from syndication, equation (7.11)

d d d
S − B = (H − V )(ρφ + n.α (ρN − ρC ) + n.β ρ ) + H.n.α .∆ρC
360 360 360

Now let final hold equal the underwritten loan amount, V , less a constant θ, so that
H = V − θ where 0 < θ < V . The marginal return from syndication can therefore be

105
restated

d d d
S − B = −θ(ρφ + n.α (ρN − ρC ) + n.β ρ ) + (V − θ).n.α .∆ρC (7.22)
360 360 360

This expression can be interpreted in terms of the total loan amount, V , as follows.
The first part of the expression,

d d
−θ(ρφ + n.α (ρN − ρC ) + n.β ρ) (7.23)
360 360

describes the originator’s loss of the participation fee it pays away, and its loss of net
ongoing return, because of syndication which results in the originator giving up lending
in the amount θ. Note that this part of the expression is independent of, and thus
insensitive to, the total loan amount, V . However the second part of the expression,

d
(V − θ).n.α .∆ρC (7.24)
360

describes the benefit to the originator from the reduction in the rate of the costs of
lending from syndication applied to all of the loan amount that it retains, its final hold.
Clearly there will be greater benefit to the originator in terms of increased marginal
return where, all else being equal, the loan amount, V , and thus its final hold, V − θ,
is greater.
Again this is simply demonstrated in a graphical example. Figure 7.3 takes the
base syndication case from the previous section and then overlays on it the returns
to the originator if the loan amount is reduced. The latter case is described as the
small loan case. For the same amount of loan commitments from the participants, θ,
which is assumed to occur with given probability irrespective of the total loan amount,
the return to the originator is greater where the loan amount is greater. This is more
clearly demonstrated in Figure 7.4 where the returns from the loan under the base
syndication case and the returns from the small loan are directly compared for equal

106
 Return Return
$2
00
,
$1 000

-$800,000
-$600,000
-$400,000
-$200,000
$0
$200,000
$400,000
$600,000
$800,000

87 ,00 $1

-$800,000
-$600,000
-$400,000
-$200,000
$0
$200,000
$400,000
$600,000
$800,000
, 0 2, $0
50
$1 500
75 ,00 $ 2 0, 0
, 0 5, 0
$1 000 00 0
62 ,00 $ 3 0, 0
,5 0 7, 0
$1 00 50 0
50 ,00 $ 5 0, 0
, 0 0

Return - Base
0,
$1 000 00 0
37 ,00 $6 0,
,

Net Up-Front - Base

0 2 , 00 0

Net Up-Front - Small

50
$1 500 0
syndicate commitment amounts.

$7 ,0
25 ,00
, 0 5, 0
$1 000 00 0
12 ,00 $ 8 0, 0
,5 0 7,
5
00
$1 00 $ 1 0 0,
00 ,00 0 0 00
,0 0 ,0 0
$8 00,0 $ 1 00 ,

107
7, 12 00
5
00 ,5 0
$7 00,0 $ 1 00 ,
5, 25 00
0 00 ,0 0
$6 00,0 $ 1 00 ,
2, 37 00
5 00 ,5 0

Return - Small
Net Ongoing - Base
Net Ongoing - Small

$5 00,0 $ 1 00 ,
0, 0 50 00
0
00 0 ,0
Figure 7.3: Small Loan Case

$3 0,0 $ 1 00 ,
7, 00 62 00
5 ,5 0
$2 00,0 $ 1 00 ,
5, 75 0 00
0 00 ,0
$1 00,0 $ 1 00 ,
2, 87 00
50 0 0 ,5 0

Figure 7.4: Base Loan and Small Loan Comparison

0, $ 2 00 ,
00 00 00
0 ,0 0
00
Return - Base

,0
Return - Small

$0 00
Final Hold

Syndicate Commitments
7.4 Risk, Return and Sharing of Marginal Return with
the Borrower

So far it has been shown that there is, at any possible level of final hold, a positive
marginal return to the loan originator from syndication where the loan has the same
pricing to the borrower under both the syndicated and bilateral alternatives. This does
not, in itself, provide any incentive for the borrower to agree to syndication. In this
section the mechanism is identified by which the loan originator can share this marginal
return with the borrower, by reducing the loan pricing and thus its cost of borrowing,
and so provide it with the required incentive to syndicate.
Consider a bilateral loan where the loan is priced such that the return to the origi-
nator is zero, as was assumed in the demonstration cases in the previous sections. The
rate of up-front fee associated with this loan can be described as the bilateral break-even
rate of up-front fee, ρbδ . That is

d d
B = V.ρbδ + V.n.α (ρ − ρC ) + V.n.β ρ =0 (7.25)
360 N 360

It has been shown, however, that syndication of the same loan with the same pricing,
including the same upfront fee, will generate a positive expected return to the institution
that originates it. Therefore

d d
S = V.ρbδ − ρφ (V − H) + H.n.α (ρ − ρC + ∆ρC ) + H.n.β ρ >0 (7.26)
360 N 360

S is clearly sensitive to the loan originator’s final hold H. H is random at the time the
originator commits to provide the syndicated loan and so S will also be random at this
time. Nevertheless it was demonstrated in Section 6.1 that, where the loan pricing is
the same, then S > B for all possible values of H. It follows that the expected value
of S, S, must always be greater than B, irrespective of the distribution of final hold,
where the cost of borrowing is the same under both alternatives.

108
 Now consider the case where the pricing on the syndicated loan is reduced below
that of the alternative bilateral loan, by reducing the rate of up-front fee. There will
be a rate of up-front fee on the syndicated loan at which the expected return on the
syndicated loan will be equal to zero. So what can be called the syndicated break-even
rate of up-front fee, ρeδ , the rate of up-front fee at which the expected return from the
syndicated loan is equal to zero, will be less than its bilateral equivalent. That is,
ρbδ > ρeδ .
It follows that where the rate of participation fee is less than the bilateral break-
even rate but greater than the syndication break-even rate, that is ρbδ > ρδ > ρeδ , then
both the expected return to the originator will be greater, and the borrowing cost will
be lower, where the loan is syndicated rather than provided bilaterally. So both the
borrower and the loan originator will have an incentive to select the syndicated loan
instead of the bilateral loan.
Recall, however, that the return from the syndicated loan, S, is sensitive to the final
hold, H. It also follows that the amount by which the underwriter is willing to reduce
the rate of underwriting fee on the syndicated loan below the bilateral breakeven rate of
up-front fee must depend on the distribution of H and therefore S, and the originating
institution’s tolerance for risk, as there may now be levels of final hold at which the
originator’s return is lower where the loan is syndicated.
This idea is also simply demonstrated with a graphical example. Figure 7.5 shows
the returns from the base syndication case compared with returns from what is called
the reduced pricing case. In this case the loan originator’s up-front fee, and thus its
up-front return, is reduced while the net ongoing return is held constant. Note that
at certain levels of final hold close to the underwritten loan amount the return is now
negative although it remains positive at other levels of final hold. It is also clearly
demonstrated that whether the syndicated loan with the reduced pricing still has a
positive expected return, and the probability that the originator’s return will be nega-
tive, depends on the distribution of final hold.

109
 $800,000
$600,000
$400,000
$200,000

Return
$0
-$200,000
-$400,000
-$600,000
-$800,000
5 $0
0 00
5 00
00

5 00
0 00
00

$1 500 0
$1 000 0
$1 500 0
0
0

$1 000 0
$2 500 0
00 0
00
00 ,00
12 ,00

25 ,00
37 ,00
50 ,00

62 ,00
75 ,00
87 ,00
00 ,00
$2 00,0
$3 00,0

$5 00,0
$6 00,0
$7 00,0

$8 00,0

,0
$1 500
$1 000

$1 000
$1 500
0

,0
2,
5,
7,

0,
2,
5,
7,

,
,
,
,
,

,
,
,
$1

Final Hold
Net Up-Front - Base Net Ongoing - Base Return - Base
Net Up-Front - Price Net Ongoing - Price Return - Price

Figure 7.5: Reduced Pricing Case

7.5 Conclusion

This chapter has developed a new explanation for syndication that is based on the un-
derlying economics of the syndicated loan product. It is consistent with market practice
in that it provides for a benefit from syndication for all loan originators and borrow-
ers, irrespective of the former’s lending efficiency in a competitive lending market. It
explains the observation that syndicated loans are larger than other loans. Together
these findings demonstrate that there is, given reasonable assumptions, a competitive
advantage in securing syndicated loan mandates for loan originators that are more ef-
ficient lenders, have superior ability to forecast final hold and/or are willing to accept
lower expected return and greater risk of negative return. This final conclusion leads
directly to the next chapter where the tools are developed to enable an institution to
quantify the distribution of its final hold in a syndicated loan, and thus its risk and
return from committing to provide it.

110
 Appendix 7.1
The derivation of the marginal return from syndication, equation (7.11), is as fol-
lows.

d
S − B = ρφ (H − V ) + H.n.α (ρ − ρC + ∆ρC ) (7.27)
360 N
d d
−V.n.α (ρ − ρC ) + (H − V )n.β ρ
360 N 360
d
= ρφ (H − V ) + n.α (H(ρN − ρC + ∆ρC )
360
d
−V (ρN − ρC )) + (H − V )n.β ρ
360
d
= ρφ (H − V ) + n.α (HρN − HρC + H∆ρC
360
d
−V ρN + iρC ) + (H − V )n.β ρ
360
d
= ρφ (H − V ) + n.α (HρN − V ρN − HρC + V ρC
360
d
+H∆ρC ) + (H − V )n.β ρ
360
d
= ρφ (H − V ) + n.α ((H − V )ρN − (H − V )ρC
360
d
+H∆ρC ) + (H − V )n.β ρ
360
d
= ρφ (H − V ) + n.α ((H − V )(ρN − ρC )
360
d
+H∆ρC ) + (H − V )n.β ρ
360
d
= ρφ (H − V ) + n.α (H − V )(ρN − ρC )
360
d d
+n.α (H∆ρC ) + (H − V )n.β ρ
360 360
d d
= (H − V )(ρφ + n.α (ρ − ρC ) + n.β ρ)
360 N 360
d
+n.α (H∆ρC )
360

111
 The derivation of the threshold rate of participation fee, equation (7.18), is as
follows.

d d
0 = (H − V )(ρφ + n.α (ρ − ρC ) + n.β ρ) (7.28)
360 N 360
d
+n.α H(0)
360
d d
0 = ρφ + n.α (ρN − ρC ) + n.β ρ
360 360

The derivation of the return to the participant, equation (7.21), is as follows.

d d
L = l.(−n.α (ρN − ρC ) − n.β ρ) (7.29)
360 360
d d
+l.n.α (ρN − ρC + ∆ρC ) + l.n.β ρ
360 360
d d
= −l.n.α (ρ − ρC ) − l.n.β ρ
360 N 360
d d
+l.n.α (ρ − ρC + ∆ρC ) + l.n.β ρ
360 N 360
d
= l.n.α (∆ρC )
360

112
 Appendix 7.2
The assumptions underlying the base syndication case example are as follows. The
assumptions are the same for all other example cases except where stated in the text.
Total initial loan amount;

V = $200, 000, 000.

Small loan amount (Figure 7.3),

$150, 000, 000

Loan maturity = 1 year.

Rate of up-front fee paid by the borrower to the originator;

ρδ = 0.40%.

Average rate of participation fee;

ρφ = 0.30%.

Average proportion of the total initial loan amount that is drawn as advances;

α = 100%.

Average proportion of the total initial loan amount that is available but undrawn;

β = 0%.

Average annualized rate of net interest income;

ρN = 0.40%

113
Average annualized rate of credit loss provision at final hold H;

V −H
ρCL,H = 0.40% − 0.001%( )
$2, 500, 000

Average annualized rate of capital charge at final hold H;

V −H
ρCC,H = 0.20% − 0.0015%( )
$2, 500, 000

Average annualized rate of opportunity cost at final hold H;

V −H
ρOC,H = 0.20% − 0.0025%( )
$2, 500, 000

114
Chapter 8

Final Hold

The term final hold describes the share of a syndicated loan that must be provided
by the originator of the loan itself. Where the syndicated loan is underwritten, as the
majority are, final hold is a random variable. This is because the amount that will be
contributed to the loan by other participants is uncertain and the loan originator, as
underwriter, is obliged to provide the difference between this and the total underwritten
loan amount, thus ensuring the borrower receives its full desired loan amount.
It was shown in the previous chapter that the distribution of final hold determines
the loan originator’s expected return and risk of realizing negative return, and so is
vital to the decision to underwrite and the terms (including pricing) on which it is done.
The major contribution of this chapter is in developing new algorithms for determining
the distribution of final hold. It is explicitly recognized that the probability that any
given institution will participate in a given syndicated loan is uncertain, and so the
algorithms are, essentially, methods for transforming the participation probabilities for
all potential participants into a distribution of final hold. Two major methods are
proposed, an efficient algebraic method and a conceptually simpler numerical method.
As well as providing a method for estimation the algorithms also enable the general
form of the distributions of final hold to be considered, and this is another important
contribution of the chapter.
Before moving on to the new algorithms, however, the chapter commences with an

115
overview of how final hold is currently assessed in the industry and the small amount
of research on the subject. After the new algorithms are developed they are also used
to explore the general structure of the distribution of final hold. It is shown that
the general form of the distribution of final hold is a truncated normal distribution
with the risk for the underwriter in the direction of higher final hold. It is noted that
an asymmetrical distribution of this type is also the general form of the returns to the
writer of an option, which suggests a new interpretation of syndicated loan underwriting
as a form of option. The underwriter writes an option which allows the borrower to
put to it any shortfall in loan commitments after the completion of syndication.
The chapter is structured as follows. Section 1 provides an overview of the existing
approaches to final hold, both in the industry and academia. Section 2 develops the
new final hold algorithms. Section 3 considers the general form of the distribution
of final hold and proposes the new interpretation of syndicated loan underwriting as
a form of option sold by the underwriter to the borrower. The chapter also has two
appendices. Appendix 8.1 demonstrates how the new final hold algorithms developed
in the chapter can be used to more accurately calculate the total participation fees in
the expression of return to the syndicated loan originator. Appendix 8.2 sets out the
assumptions for the worked examples.

8.1 Overview of Final Hold

8.1.1 Industry Practice

The typical industry approach to the assessment of final hold can be characterized
as follows. The originator first identifies its optimum or preferred level of final hold,
called its target final hold. This is usually a decision of the relevant client relationship
management group, subject to the approval of portfolio management units within the
institution. It is reasonable to suggest that this is the level of final hold at which the
institution believes it will maximize its return, although in practice this is usually not
specifically quantified.

116
 A separate and dedicated syndications group, usually the same one that will be
responsible for conducting syndication of the loan, is then asked to provide an assess-
ment of the likelihood that the target final hold will be realized. In practical terms
the role of the syndications group usually extends to providing input on the loan struc-
ture or pricing that will enable them to make the required positive assessment of the
underwriting risk. This assessment of final hold is qualitative; that is, it is based on
the expert judgement of those in the syndications group. It is usually expressed in
subjective terms only, such as a high or low degree of confidence that the target final
hold will be realized. In some institutions the decision to proceed with an underwriting
commitment requires the syndications group to find that the target final hold will be
realized with some minimum numerical probability, for example an undertaking that
they are 95% confident it will be achieved. Even in this case, however, the assessment
process remains qualitative and the final numerical specification of the confidence level
does not reflect any underlying quantitative process.

8.1.2 Research

Interestingly, the proportion of syndicated loans that are held by their originators
has been the subject of more empirical work than any other issue associated with
syndicated loans. It is suggested that this reflects the ready availability of data in the
form of commercial databases that compile information about completed syndicated
loans, including the loan amount and the arrangers’ own commitment amounts.
There are three major papers on the subject: Jones, Lang and Nigro (2000), Dennis
and Mullineaux (2000) and Esty and Megginson (2000). In all of these works the
authors treat each syndicated loan in their sample as a discrete observation, with the
proportion of the loan retained by the originator as final hold (or some equivalent
measure) as the dependent variable. They then attempt to draw conclusions about the
factors that drive the observed level of final hold. Their underlying assumption is that
the lower the proportion of the loan retained by the originator, and thus the larger the
proportion of the loan "sold" in syndication, the more attractive the loan must have

117
been to participants. Independent variables which described the loan characteristics
are tested for significance in explaining the attractiveness of the loan to participants.
The approach is part of the recent theme in the literature, considered as a potential
explanation of syndication in Chapter 5, that syndicated loans are hybrids of bank loans
and debt securities. It is suggested here, as it was in that chapter, that this approach
is unable to significantly explain syndicated loan market practice. The reasoning is as
follows.
The majority of syndicated loans are underwritten, and there are a vast number
of institutions that have participated in syndicated loans. Over 3,000 participated in
syndicated loans globally during the 5 year period from 1996-2001. Yet the average
number of participants in any individual syndicated loan over the same period is less
than ten. This reflects the fact that the originator of a syndicated loan has a target final
hold at which it presumably maximizes its return, and so it will only desire to attract
sufficient participants to the loan to achieve this target. It was shown in Chapter 7
that any institution’s return from participating in a syndicated loan is sensitive to the
rate of participation fee paid to it by the loan originator, and the minimum required
rate of participation fee in any case may differ between potential participants. It is
reasonable to suggest, therefore, that the originator will set the rate of participation
fee at the minimum level necessary to secure the necessary number of participants to
achieve its final hold target.
It follows that the level of the originator’s actual final hold will reflect either, or a
combination of, the following. First, the relative aggressiveness with which the origi-
nator sets the rate of participation fee. Second, the accuracy with which it estimates
the rate of participation fee necessary to secure the required number of participants.
Third, as will be shown later in this chapter, random variation of the total commitments
actually received from participants.
This logical assumption is not, however, reflected in the methodology or findings
of the previous papers on this subject. Esty and Megginson (2000) considered the
syndicate structure of project finance loans, exploring the relationship between the

118
syndicate of participants and the political risk of the country in which the project
is being developed. They found, inter alia, that syndicate size does initially increase
with increasing political risk, but then declines for the most risky countries. No clear
explanation is provided for this finding.
Dennis and Mullineaux (2000) considered the proportion of the syndicated loan
retained by the originators in a sample of transactions, and found that availability of
information about the borrower was significant. They concluded that the originator’s
final hold falls as a percentage of the loan amount as the information about the borrower
becomes more transparent. They cited the presence of a debt rating or public listing
as providing transparency. The clear implication was that more "difficult" loans are
less attractive to participants which is reflected in smaller syndicate size and relatively
larger final hold.
A difficulty with this approach is that it takes no account of the pricing of the
loans to reflect risk and the originator’s target final hold. It is also difficult to reconcile
this with work by Megginson, Poulsen and Sinkey (1995). Based on an assessment of
the share market response to announcements of participation in syndicated loans by a
number of US banks they found that significantly positive abnormal returns followed the
announcements by banks of syndicated loans to US corporate borrowers in the 1980s.
A sample of syndicated loans used to finance takeovers also generated strong positive
returns following their announcement. In both cases the authors attributed the results
to their return-to-liquidity hypothesis, whereby a borrower needing large sums of money
quickly will pay a premium for it. The obvious implication is that lenders are rewarded
with high returns to providing more "difficult" loans, supporting the argument that
the price of syndicated loans is set to manage demand from participants.
Further evidence for this is found in the strong appetite of non-bank financial insti-
tution for participation in risky HLT loans but not in investment grade facilities, and
the well-documented fact that banks are increasingly unwilling to compete with the
capital markets in providing low-priced term loan facilities to their large and highly-
rated corporate customers in the absence of severe relationship pressure. Jones, Lang

119
and Nigro (2000) considered the same question as Dennis and Mullineaux (2000) and
found that bank capital, loan seasoning and maturity were significant to the loan share
retained by the arranger, and that arrangers retained larger proportions of their lower
quality loans. Similar criticism applies to their work.
The number of lenders in a loan syndicate was also considered by Hallak (2002) in
a study of loans to sovereign borrowers. He related the level of participation fees to the
size of the syndicate; that is, syndicated loan pricing is used to ration participation.
He attributed the desire to ration participation to the borrower, who attempts to
minimize syndicate size to limit renegotiation costs, or maximize it where the loan
amount is large. In practice, however, it is the arranger of a syndicated loan that
pays participation fees from its own account, and thus sets the fee level. In a typical
underwritten syndicated loan, the borrower pays an agreed up-front underwriting fee
to the arranger who accepts the risk on the number of participants that join the loan,
and who in turn sets the rate of participation fee accordingly to manage this risk and
achieve its own desired final hold target.

8.2 Final Hold Algorithms

In the remainder of this chapter the new algorithms for determining the distribution
of final hold are developed. It is fundamental to the new approach that final hold is a
random variable with a distribution over the full range zero to the underwritten loan
amount. This is not obvious in the current industry approach where the reliance on
undertakings that final hold targets will be realized often leads to misapprehension as
to the nature of the underwriting commitment among decision-makers.
The algorithms are developed as follows.
Let C denote the sum of amounts committed to the loan by invited institutions
during syndication. This amount is called the total initial commitments. Let there be
m potential participants B1 , · · · , Bm to be invited by the originator to join the loan
syndicate, and each may offer any one of n possible initial commitments. Each possible

120
initial commitment amount is an integer multiple of a minimum commitment amount,
c. A commitment of zero means the institution does not join the loan.
Each potential participant Bk will provide an initial commitment to the loan in
amount Dk . The total initial commitments from the m invited institutions is therefore
a discrete random variable which takes values from 0, when none join, to nmc when
every invited lender makes the maximum initial commitment, and

Xm
C= Dk (8.1)
k=1

Consider a syndicated loan, unconditionally underwritten in an amount V , for which

the loan originator (hereafter called the underwriter) receives total initial commitments
C. Assume that the borrower cannot increase the total loan amount in the event of
oversubscription, that if there is oversubscription then each lender is allotted a final
loan commitment amount less than its initial commitment amount, and that this scale-
back of the lender’s initial commitments and the underwriter’s final hold are made on
a pro-rata basis.
The underwriter’s final hold, H, is determined as follows. There are two scenarios
to consider.

1. The loan is under-subscribed because C + T ≤ V , where T is the underwriter’s

target final hold1 . In this case, each lender will be allotted their initial commit-
ment and the underwriter’s actual final hold, H, will be

H =V −C >T (8.2)

2. The loan is over-subscribed because C + T > V . In this case, the final allotted
commitment of each lender and the final hold of the underwriter are determined
by scaling their initial commitment and target final hold, respectively, by the

1
It is very common for participants to insist that the underwriter holds at least an equal amount in
the loan as they do. In such a case the underwriter’s target final hold is effectively imposed on it, and
is equal to nc.

121
 factor V /(C + T ).

In summary
⎡
V −C V −C ≥T
⎢
H=⎣ T.V (8.3)
V −C <T
(C + T )
As the underwritten loan amount V and the target final hold T are defined by the
parties at the time of mandate, the determination of total initial commitments C is the
central factor in forecasting the underwriter’s final hold H. The basic form of the new
algorithms proposed in this section determine the distribution of C which can then be
translated into a distribution of H using equation (8.3).
Two general methods are proposed; a computationally efficient algebraic method2
and a numerical simulation method. However the fundamental independent variables
under both methods are the same; the probabilities that each potential lender will join
the loan and the amount it will commit.
(k)
Let Pj be the probability that the k−th potential lender makes an initial com-
mitment in amount j c, where j takes all integer values between 0 and n, as specified
(k)
above. Clearly P0 is the probability that the k−th potential lender does not join the
(k)
loan. The values of Pj clearly describe the distributions of Dk .
The algebraic method requires that the lenders’ random commitment amounts Dk
are independent. In general, numerical simulation methods can accommodate corre-
lation between independent variables. However the numerical simulation algorithm
proposed in this model will also assume the independence of Dk . This is because the
participation probabilities represent the originator’s best estimate of the probabilities
that each bank will participate, given the information available to it, and accounting for
any systematic factors. Assuming dependence in the participation probabilities would
imply that the originator systematically under- or over-estimates the participation prob-
abilities. It is suggested, however, that it is more reasonable to assume that deviation
of the actual participation probabilities from the originator’s estimates of them are

2
The algebraic method was proposed by Ken Lindsay of Glasgow University.

122
unbiased, from which follows that the participation probabilities are independent.

8.2.1 Algebraic Method

(k)
Based on the fundamental probabilities P j the computation of the distribution of C
(k)
is made in a recursive fashion. At the k − th step of the recursion, let pi be the
probability that potential lenders B1 , · · · , Bk have made a total initial commitment of
(k+1)
i c, where i = 0, . . . , mn. The task is now to compute the probabilities pi recursively
(k)
from pi and this is achieved by combining the commitment of lender Bk+1 with the
total commitments already received from lenders B1 , · · · , Bk .
(k)
The updating procedure for pi is

min(i ,n)
(k+1)
X (k)
pi = pi−r Pr(k+1) (8.4)
r=0

where the index i is taken to run from 0 to mn at each iteration.

(1)
The initial conditions pi for the recursions summarized by equation (8.4) are
obtained from the fundamental properties of the potential lender B1 . These conditions
are given by ⎡
(1)
(1) ⎢ Pi 0≤i≤n
pi =⎣ (8.5)
0 n < i ≤ mn

Equation (8.4) is now used to update the respective probabilities, the calculation
(m)
terminating when pi is known for i = 0, · · · , nm. The total initial loan commitment,
(m)
C, corresponding to each probability pi , is Ci = ic.

8.2.2 Numerical Method

The numerical method is best explained as a sequence of steps, as follows:

(k)
1. Pj is the probability that the k−th potential lender makes an initial commitment
in amount j c, where j takes all integer values between 0 and n.

123
 2. To obtain the commitment of the k−th potential lender, the interval (0, 1) is first
dissected by the points zr where z0 = 0 and

r
X (k)
zr+1 = Pj r = 0 . . . n. (8.6)
j=0

Clearly the properties of the discrete probabilities ensure that zn+1 = 1.

3. A uniform deviate U (0, 1) is drawn. Suppose this deviate falls in the interval
[zr , zr+1 ], then the initial commitment of the k−th lender is Dk = rc. Self
evidently, if r = 0, the k−th lender does not participate in the loan.

4. Steps 2 and 3 are undertaken for each lender k = 1...m, and together these
comprise a single trial. The total initial commitments received from the potential
lenders in each trial is thus
m
X
C= Dk (8.7)
k=1

5. The distribution of C is obtained by undertaking a prescribed number of trials,

and the probability associated with each value for C is its relative frequency in
all trials.

8.3 Distribution of Final Hold

What can be said about the expected shape of the distribution of total initial commit-
ments?
Pm
Recall that C = k=1 Dk and that Dk is a discrete random variable which can take
any one of n values. Thus Dk = j (k) .c where c is the defined minimum commitment
amount, a constant, and j (k) is a discrete random variable taking integer values 0...n.
It follows that
Xm
C=( j (k) ).c (8.8)
k=1

(k)
The probabilities of realizing each value of j (k) are denoted Pj . In practice each
these probabilities must be estimated by the underwriter. For the purposes of de-

124
scribing the general form of the total initial commitments, however, assume that each
is generated by a Poisson distribution. The Poisson distribution is a general form of
discrete distribution with the probability mass function

λx e−λ
P (y = x) = (8.9)
x!

Let the discrete random variable j (k) be a Poisson variable with a unique intensity
(k)
parameter λ(k) that satisfies the condition Pj>n = 0. That is

(k)
(k) (λ(k) )x .e−λ
P (j = x) = (8.10)
x!

Now the sum of independent Poisson variables is also a Poisson variable with an
intensity parameter equal to the sum of the independent intensity parameters. It follows
that

Xm x
(k) λ .e−λ
P (( j ) = x) = (8.11)
Xm x!
k=1

where λ = λ(k)
k=1

Recalling that
Xm
C=( j (k) ).c (8.12)
k=1

the probability of realizing total initial commitments C is also a Poisson vari-

able as follows

x
λ .e−λ
P (C = x.c) = (8.13)
x!

It is also known that as the intensity parameter λ gets larger, the Poisson distrib-
ution can be approximated by a normal distribution with mean λ and variance λ.
It follows that as the number of lenders invited to join the loan m becomes large,
then the total initial commitments C is approximately normal.

125
 This expectation is confirmed by numerical testing. By way of example, Figure
8.1 shows the approximately normal distribution of final hold based on the assumed
participation probabilities set out in Appendix 8.2.

0.07

0.06

0.05

0.04

0.03

0.02

0.01

0
0 100 200 300 400 500 600 700 800 900
C

Figure 8.1: Distribution of Total Initial Commitments.

Once the distribution of C is determined, the procedure for determining the distrib-
ution of H is straightforward. Where the algebraic method is used for calculating total
(m)
initial commitments, the calculated values for Ci corresponding to pi are translated
into Hi using equation (8.3) to create a distribution Hi . Where the numerical method
is used, each value for C in the distribution is translated in a value for H using equation
(8.3) to create the distribution of H.
Equation (8.3) will therefore determine the nature of the distribution of H and
clearly the discontinuity in the equation at the point of oversubscription will be reflected
in the transformation of the distribution of C into the distribution of H. This can be

126
observed in the example in Figure 8.2, which generates the distribution of final hold
given the distribution of total commitments from Figure 8.1.
At levels of final hold above target final hold, the distribution maintains the same
shape as the distribution of total initial commitments with which they are associated.
This reflects that at these levels, H is a simple linear function of C. At level of final
hold below target, however, the distribution is truncated compared with the equivalent
values on the distribution of C, reflecting that in this range H is a geometric function
of C. The significant skewness of the distribution towards higher level of final hold
means that, all else being equal, the underwriter faces greater risk in this direction

0.07

0.06

0.05

0.04

0.03

0.02

0.01

0
0 50 100 150 200 250 300 350 400
H

Figure 8.2: Distribution of Final Hold.

The general form of the distribution of final hold, being highly asymmetrical, is
very suggestive of the distribution of returns to the writer of an option, and it is
possible to interpret syndicated loan underwriting in these terms. Final hold in excess
of its target represents a cost to the originator; the cost being a lower return from the
transaction. The reasons for this have been exhaustively explored in Chapters 4 and

127
7 but, simply, higher final hold represents higher rates of credit loss provision, capital
charge and opportunity cost. Accepting that it only desires to hold its target amount,
the underwriter effectively writes an option under which it is obliged to take up the
commitments in excess of its final hold target if the total commitments raised in general
syndication are insufficient. This interpretation is significant because it clearly shows
that syndicated loan underwriting is a risky activity in its own right, separate from the
risks of providing the loan commitment itself. It demonstrates the importance of this
work in developing new tools for quantifying the risk of underwriting.

8.4 Conclusion

The return to the originator of a syndicated loan is sensitive to its final hold, and so
identifying the distribution of final hold enables it to determine its expected return and
its risk. This would be expected to be important for decision making in a competitive
loan market, in particular in determining the price at which it is willing to offer a
syndicated loan, as well as for accurate management of its lending business.
This chapter has proposed two alternative new algorithms for determining the dis-
tribution of final hold in a particular case, each based on the fundamental probabilities
that institutions will participate in the loan. The algebraic method is an efficient al-
ternative to the numerical method, but both are consistent and tractable. The general
form of the distribution of final hold is shown to be a truncated form of normal dis-
tribution, with the discontinuity at the point of the loan being oversubscribed and the
scaling back of commitments. The risk to the originator, in terms of variance from its
target final hold, is shown to be in the direction of higher final hold. This suggests
a new interpretation of syndicated loan underwriting as an option under which the
underwriter gives the borrower the right to put to it any shortfall in loan commitments
after completion of syndication.

128
 Appendix 8.1
The participation fees paid by the loan originator to the syndicate participants are
a vital element of the return to the originator of a syndicated loan. The new final hold
algorithms can be extended to enable more accurate calculation of total participation
fees and thus return to the originator. The extended expressions are described in this
appendix.
Recall that, where the average rate of participation fee is denoted ρφ , the expression
of originator’s return is

d d
S = V.ρδ − ρφ (V − H) + H.n.α (ρN − ρC + ∆ρC ) + H.n.β ρ (8.14)
360 360

This assumption that all participants receive an average rate of participation fee is,
however, a simplifying assumption and in practice the rate of participation fee usually
varies with the amount of initial commitment offered by the lender. An example is
given in Table 8.1. It follows that institutions tend to commit the minimum amount
necessary to be eligible for a next higher rate of participation fee. This is why it is
assumed in this chapter that participants make initial commitments in amounts which
are discrete multiples of a minimum commitment amount. In the example in Table 8.1,
it would be expected that institutions would commit either $0, $10 million, $20 million
or $30 million.
The final allotted commitment of each participant will be less than its initial com-
mitment where the arranger has scaled-back the commitments. The rate of partic-
ipation fee, however, depends on the amount of initial commitment. So the actual
participation fee paid by the arranger to a participant is the product of the offered per-
centage rate of participation fee, which is based on the amount of initial commitment,
and the amount of final allotted commitment.
The average rate of participation fee is, therefore, dependent on the composition
of the commitments that make up the total commitments, and so in practice it is
necessary to determine φ simultaneously with C and H. In this section both algebraic

129
 Lender’s Initial Participation Fee on
Commitment Final Allotted Commitment

$30 million or above 0.75% flat

$20 million - $29 million 0.65% flat
$10 million - $19 million 0.50% flat

Table 8.1: Participation Fee Grid.

and numerical approaches are considered.

Algebraic Method
The algebraic method determines the expected total up-front fees, φi , corresponding
to each level of total initial commitments Ci and final hold Hi again where i is the index
i = 0, . . . , mn representing the number of units of the minimum commitment amount
c. The reason that φi is an expected value is that the total commitments Ci for any
value i may be realized with a number of different combinations of initial commitments
by lenders and different initial commitments may have different rates of participation
fee. For example, i = 2 may be realized with an initial commitment of 2 units by one
lender, or by an initial commitment of 1 unit each by two lenders. The full algorithm
is as follows.
Let sj be the participation fee that would be payable to any individual lender with
an initial commitment, j c, assuming there is no over-subscription.
(k)
Again at the k − th step of the recursion, let pi be the probability that potential
lenders B1 , · · · , Bk have made a total initial commitment of i c, where i = 0, . . . , mn.
(k)
Now additionally let g i be the expected total participation fees that would be payable
to these lenders assuming, again, no over-subscription. The task is now to compute the
(k+1) (k)
probabilities pi recursively from pi and similarly the expected total participation
(k+1) (k)
fees g i from the expected total participation fees g i . This is achieved by combining
the commitment of lender Bk+1 with the total commitments already received from

130
 (k)
lenders B1 , · · · , Bk . The updating procedure for pi is

min(i ,n)
(k+1)
X (k)
pi = pi−r Pr(k+1) (8.15)
r=0

where the index i is taken to run from 0 to mn at each iteration. The same argu-
ment leads to the result that the expected total participation fees (again assuming no
oversubscription) satisfy the formula

min(i ,n)
(k+1) 1 X (k) (k)
gi = (k+1)
(g i−r + sr ) pi−r Pr(k+1) . (8.16)
pi r=0

(1) (1)
The initial conditions, pi and g i , for the recursions summarized by equations
(8.15) and (8.16) are obtained from the fundamental properties of the potential lender
B1 . These conditions are given by
⎡ ⎡
(1)
(1) ⎢ Pi 0≤i≤n
(1) ⎢ si 0 ≤ i ≤ n
pi =⎣ gi =⎣ (8.17)
0 n < i ≤ an 0 n < i ≤ an .

Equations (8.15) and (8.16) are now used to update the respective probabilities and
(a) (a)
expected total participation fees, the calculation terminating when pi and fi are
known for i = 0, · · · , na.
Recall that equation (8.3) sets out the rule for scaling final hold in the event of over-
subscription. This equation may now be used to compute the probability distribution
of final hold as follows
⎡
V − ic V > T +ic
⎢
Hi = ⎣ (8.18)
TV
V ≤ T +ic
T + ic

To this point determination of expected total participation fees has assumed no over-
subscription. The final step adjusts for this case, and the expected total participation

131
fees paid to the lenders is
⎡
(a)
gi V > T + ic
⎢
φi = ⎢
⎣ g (a) V (8.19)
i
V ≤ T + i c.
T + ic

Numerical Method
The numerical approach generates a unique value for φ in each trial. It is determined
by the way in which the total initial commitments C is realized in the particular trial.
A distribution of φ can, as usual, be generated by assessing the relative frequency of
each value across all trials. However each of the discrete values in the distribution of
φ do not correspond exactly with the discrete values in the distribution of C and thus
H generated by the same trials. In fact the distribution of φ will have more discrete
values than the distribution of C and H as, again, each of the latter may be realized
with a number of different combinations of individual lenders commitments.
(k)
The algorithm is as follows. Recall that Pj is the probability that the k−th
potential lender makes an initial commitment in amount j c, where j takes all integer
values between 0 and n.

1. To obtain the commitment of the k−th potential lender, the interval (0, 1) is first
dissected by the points zr where z0 = 0 and

r
X (k)
zr+1 = Pj r = 0 . . . n. (8.20)
j=0

Clearly the properties of the discrete probabilities ensure that zn+1 = 1.

2. A uniform deviate U (0, 1) is drawn. Suppose this deviate falls in the interval
[zr , zr+1 ], then the commitment of the k−th lender is Dk = rc. Self evidently, if
r = 0, the k−th lender does not join the syndicate.

3. The corresponding participation fee payable to this lender, assuming no oversub-

(k)
scription, is sr .

132
4. The total initial commitments received from the potential lenders is thus

m
X
C= Dk . (8.21)
k=1

5. The unscaled participation fees payable by the underwriter are

m
X
g= sr(k) (8.22)
k=1

6. For each trial, g is translated into φ using equation (8.23).

⎡
g V −C ≥T
⎢
φ=⎣ g.V (8.23)
V −C <T
(C + T )

133
 Appendix 8.2

This appendix contains, in Table 8.2, the assumed participation probabilities on

which the worked examples in this chapter are based. These were randomly generated
and then re-ordered according to the probability that the institution will provide a
commitment of $0, that is it will not participate in the loan. A participant wishing to
join the loan is assumed to do so in one of three possible commitment amounts, $10,
$20 and $30 million. There is assumed to be a universe of 40 potential participants, A
to AN.

134
 Potential Participant $0 $10 $20 $30
A 8.21 64.01 15.62 12.16
B 9.24 88.07 2.17 0.52
C 10.20 11.39 65.92 12.49
D 13.06 51.88 24.28 10.78
E 17.23 6.40 40.58 35.79
F 17.69 0.78 8.76 72.77
G 21.89 26.51 43.71 7.89
H 24.75 12.98 22.38 39.89
I 33.14 5.15 60.77 0.94
J 33.56 13.54 44.98 7.92
K 34.14 15.35 48.80 1.71
L 34.22 8.32 26.43 31.03
M 34.45 44.17 14.39 6.99
N 38.38 1.88 21.82 37.92
O 42.04 17.16 30.88 9.92
P 47.81 8.31 23.65 20.23
Q 49.33 46.87 1.90 1.90
R 50.67 14.00 26.96 8.37
S 52.29 40.32 7.18 0.21
T 53.13 8.44 30.53 7.90
U 53.55 43.08 2.53 0.84
V 54.26 1.93 8.08 35.73
W 57.13 10.76 19.49 12.62
X 59.52 4.71 29.13 6.64
Y 62.04 35.07 1.85 1.04
Z 62.10 0.67 35.15 2.08
AA 62.59 14.10 14.15 9.16
AB 63.62 7.31 18.57 10.50
AC 65.18 7.34 25.31 2.17
AD 65.26 4.55 28.00 2.19
AE 75.73 11.17 9.13 3.97
AF 78.17 18.53 2.99 0.31
AG 78.93 9.89 9.55 1.63
AH 80.85 1.68 1.69 15.78
AI 85.38 0.43 4.44 9.75
AJ 86.13 1.02 9.90 2.95
AK 87.60 7.75 4.52 0.13
AL 88.21 10.35 1.11 0.33
AM 88.26 0.09 8.43 3.22
AN 92.42 7.42 0.08 0.08

Table 8.2: Randomly generated participation probabilities

135
136
Chapter 9

Syndicated Loan Participation

The defining feature of a syndicated loan is that it is provided by a syndicate of par-

ticipants on common terms. Institutions are invited to participate by the originator
who, in most cases, has already underwritten the loan, providing the borrower with
certainty as to the loan amount but thereby accepting uncertainty in its final hold.
Underwriting represents a risk for an originator because its return is sensitive to its
realized level of final hold1 . A major issue for any purported syndicated loan originator,
then, is forecasting its final hold.
In the previous chapter the current industry approach to forecasting final hold
was described as qualitative, being based on expert judgement. One of the sources of
information used by practitioners in forming these judgements is a group of commercial
databases that identify and record information on completed syndicated loans. These
are typically used to identify syndicated loans completed for the same borrower as the
borrower under a proposed new loan, or for borrowers in the same industry or country
of risk. Underlying this is the simple idea that what happened in the past (in terms, for
example, of the loan amount, pricing and maturity of previous loans) is an indication
of what might be possible in the future.
A major contribution of the previous chapter was the formalization of a rigorous

1
This is demonstrated in the new expression of return developed in Chapter 4.

137
approach to estimating final hold, which explicitly recognizes that final hold is random
and that its distribution is a function of the probabilities that each of the potential
participants will participate in the loan. So the essence of forecasting final hold is the
identification of potential participants and the determination of their respective par-
ticipation probabilities. An interesting question, therefore, is whether these syndicated
loan databases might help determine participation probabilities. They record the par-
ticipants in completed syndicated loans and so could be used to identify the extent to
which a particular institution has participated in particular, or particular classes of,
syndicated loans previously. If the past is indeed a predictor of the future in syndicated
lending, then its history of participation in syndicated loans that share the same char-
acteristics as a proposed new syndicated loan might be expected to be significant to
whether or not it will participate in the latter. This is an obvious subject for empirical
research, and one that is taken up in this chapter.
This research is significant because these databases are the major public source
of information on syndicated loans. The extent to which public information can ex-
plain syndicated loan participation will determine the extent to which acquiring further
private information will improve final hold forecasts and so generate a competitive ad-
vantage in winning mandates to originate syndicated loans. If it is able to substantially
explain participation then model-based analysis of publicly available data could replace
the expert judgement of syndicated loan practitioners. On a more prosaic level, these
databases are quite costly and it is useful to determine whether the information they
provide is valuable for the purpose to which they are put, which is forecasting final
hold.
An econometric model is proposed in which an institution’s observed choice to
participate in a syndicated loan is regressed against independent variables that quantify
its participation in prior syndicated loans for the same borrower (or a borrower in the
same corporate group), for borrowers in the same industry, and for borrowers with
the same nationality as the borrower in the new loan. The decision to participate
is also regressed against the institution’s overall rate of participation in syndicated

138
loans. The use of these particular explanatory variables is motivated in Sections 1 and
2 of this chapter. The model is set up as a binary probit model, which is a type of
model designed specifically for discrete dependent variables; in this case the dependent
variable can take only one of two values, either the potential participant did or it did
not participate in the subject loan.
The dataset for the analysis is drawn from one of the leading commercial loan
databases used in the industry; Dealogic Loanware. The compilation of the data was,
nevertheless, was a major undertaking in its own right. Loanware cannot directly
generate the specific combinations of the dependent and independent variables required
for each observation. Furthermore, all mergers and acquisitions of institutions during
the sample period had to be identified and the data manually updated to reflect it.
The chapter is structured as follows. Section 1 proposes the irrelevance of loan pric-
ing information per se to predicting syndicated loan participation. Section 2 outlines
three hypotheses as to why previous syndicated loan participation might help explain
an institution’s decision to participate in a new syndicated loan. Section 3 then de-
scribes the dataset that is compiled for the analysis, the way it is generated, and the
specific independent variables that are to be tested. Section 4 sets out the econometric
model. The general form of the binary probit model is described and then particular-
ized to the specific analysis to be undertaken in this chapter. The testing process is
described and the major results are then presented and interpreted in Section 5.

9.1 Loan Pricing

This chapter considers the extent to which an institution’s decision to participate in

a new syndicated loan is determined by its previous participation in syndicated loans
that share characteristics of the new syndicated loan. However it will be noted, and
contrary to what might be expected, that the pricing of these loans is not considered
as a relevant characteristic. The rationale for this is as follows.
It is reasonable to say that an institution will participate in a syndicated loan where

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it is sufficiently confident that its return - its loan income less its costs of lending - plus
any collateral benefit from doing so, will be positive. Clearly its income from the loan,
which is a direct function of the loan’s price (that is the rate of interest margin and
fees), is an important part of this equation. It is just as clear, however, that whether
the institution participates is not determined by the absolute level of loan income, but
by the level of loan income in relation to its costs of lending and the collateral benefits
it expects to realize.
Loans are priced by their originators in a competitive market. A rational loan
originator will price the loan to participants - recalling that it pays the participation fee
from its own account - at the minimum level necessary to secure just those participants
required to realize its own final hold target. In other words, and as described in Chapter
8, the originator uses pricing to ration participation in the loans it syndicates. Of course
the originator will always face the risk of unsuccessful syndication where the maximum
pricing it can offer - which is ultimately constrained by the mandated loan pricing - is
insufficient to secure the desired number of participants.
It follows that if an institution is observed to have participated in a syndicated loan
then its costs of lending in relation to that loan must have been among the lowest of all
potential participants, and/or the collateral benefit it expected to generate must have
been among the highest of all potential participants in that loan. In other words, the
institution must have had a competitive advantage over other institutions in relation to
that particular loan so that it could still generate positive return at the offered pricing
even though other potential participants could not. Identifying that it participated
in the particular syndicated loan is significant because it suggests that the institution
might also have a competitive advantage in relation to any new loan that shares the
characteristics of this loan, and so will be more likely to participate in it.
The characteristics by which loans should be identified in this context are, therefore,
those that might explain the existence of such a competitive advantage. It is obvious,
however, that loan pricing, which reflects the costs of lending and collateral benefit
of the marginal participant in the loan, cannot explain why any particular institution

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would have a competitive advantage in making a particular loan. In other words, there
is no reasonable basis for suggesting that the fact that an institution has previously
participated in a loan with certain pricing indicates that it has a competitive advantage
in relation to all loans with that pricing.
By way of contrast, it is shown in the next section why the fact that it has previously
participated in a loan for a particular borrower, or borrower in a particular industry
or country, might reasonably indicate it has a competitive advantage in relation to
participating in future loans for that same borrower, industry or country. That is why
these characteristics, and not loan pricing, are tested as relevant explanatory variables
in this analysis.

9.2 Theoretical Framework

This section identifies three hypotheses as to why participation in previous syndicated

loans might indicate the extent to which an institution will have a competitive advan-
tage in participating in future syndicated loans. The first two relate to loans that share
the particular characteristics, as discussed in the previous section, of having the same
borrower, industry or country of risk. The third relates to an institution’s overall level
of activity in the syndicated loan market.

9.2.1 Classic Relationship Banking Hypothesis

The first hypothesis concerns an institution’s previous participation in loans for the
same borrower as the borrower under a new syndicated loan. It is suggested that this
can evidence the existence of a banking relationship and the traditional relationship
banking model, as well as a new alternative to it, is invoked to explain why such a
relationship should make the bank more likely to participate in the new syndicated
loan.
In a review of the literature on the subject, Boot (2000) defines a banking relation-
ship as one where a bank invests in obtaining proprietary firm-specific information and

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then generates return from this investment through multiple dealings with the firm over
time. In undertaking subsequent transactions it will enjoy a competitive advantage over
non-relationship banks because it will not suffer, or will suffer less, from adverse selec-
tion problems and may have greater flexibility and capacity to exercise discretion in the
enforcement of transaction contracts. The relationship bank may also be more willing
to view the returns from each transaction in terms of the overall relationship, with a
higher expectation of collateral benefit, which can again provide it with a competitive
advantage over non-relationship banks for whom each transaction need be profitable
on a stand-alone basis.
So the basis of the hypothesis is that the relationship bank will desire to participate
in a new syndicated loan because it is obliged to recoup its initial investment in the
relationship by undertaking multiple transactions with the firm, and it is likely to be
able to do so because the new loan participation will have lower marginal costs and/or
greater collateral benefit for it than for its non-relationship competitors.
An alternative to the classic formulation of relationship banking, but which is neces-
sary to explain why some particular banks will participate in new syndicated loans for
their relationship firms, can also be identified. Some banks do not view participation
in syndicated loans, along with other forms of lending activity, as inherently attrac-
tive. Boot (2000), however, makes the point that opportunities to exploit a banking
relationship are not limited to lending, and may extend to more lucrative banking func-
tions such as brokerage and other investment banking. Firms recognize this and may
threaten the withdrawal of this lucrative other business, or at least the opportunity
to compete for it, to force their relationship banks to participate in their syndicated
loans. This practice has been well documented in the trade press (see, for example,
Segar, 2001) and in fact one of the major controversies of the late 1990s was a re-
assessment by some leading banks of the actual benefit they were generating from their
existing relationships which led, in some cases, to their refusing to participate in new
syndicated loans for some of their most important relationship clients.
It is, however, the underwriter who takes the risk on which banks will participate

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in a syndicated loan, which raises the question of why a firm would wish to force
its relationship banks to do so. There are two possible reasons. First, the success
or otherwise of syndication has an important market signalling effect, which can be
reflected in the price of a firm’s securities in the public markets. Firms therefore have a
strong interest in the outcome of syndication, and the relationship threat is often used
to encourage banks to participate where syndication is not going as well as expected.
The second reason is that where syndicated loan originators are aware that the firm has
such leverage over potential participants, and is willing to use it, they will incorporate
this into their estimation of syndication risk and will be willing to underwrite the loan
on more aggressive terms than they might otherwise have done.
The crucial assumption in this hypothesis is that previous participation in syndi-
cated loans for a firm is evidence of the existence of the banking relationship with it. It
is important, however, to recognize some limitations of the hypothesis in this respect.
Some banks may have previously participated in syndicated loans for the firm on a
purely opportunistic basis, without any strategic relationship motive. Others may have
done so at the time in pursuance of a relationship, but have since withdrawn from
it. These banks would not be the positive prospects for participation that they would
appear to be according to this model.
On the other hand, a bank that has not previously participated in syndicated loans
for a firm may, nevertheless, have a relationship with it. The relationship may have
developed since the firm last borrowed through a syndicated loan, or have been devel-
oped through other forms of contact, for example through bilateral lending, investment
banking or advisory activity, none of which will be reflected in the bank’s history of
syndicated loan participation. Furthermore, participation in syndicated loans is, for
many reasons, one of the best ways for a bank to commence a new relationship. It
gains access to the firm it might not otherwise have, the presence of other lenders
gives it confidence in the creditworthiness of the firm and the appropriateness of fa-
cility structure and documentation, and it might be able to commit a relatively small
amount to the loan, appropriate for a new relationship. None of these banks would

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be identified by the model based on previous syndicated loan participation but might,
nevertheless, be strong prospects for participation in a new syndicated loan.

9.2.2 Extended Relationship Banking Hypothesis

The second hypothesis is that if a bank has participated previously in loans for the
same borrower, or borrowers in the same industry or country, as the borrower under
a proposed new loan, then it may already have satisfied at least some of the practical
preconditions to participating in the new loan. Its marginal cost of participating in the
new loan would therefore be lower than for a bank that had not done so. In fact previous
participation may be evidence that the bank can even consider participating in the loan
at all. This second hypothesis thus extends the first hypothesis in two ways; the bank’s
investment in the relationship is not limited simply to gathering information on the
borrower but to fulfilling the practical preconditions to lending, and the relationship is
not limited to a particular borrower but extended to entire classes of borrower.
This hypothesis is now elaborated by briefly identifying the process by which banks
make their decisions to lend (in this case, to participate in a syndicated loan), the
aspects of it that represent practical preconditions to any favourable decision, and the
sources of uncertainty as to whether they have been satisfied.
It is obvious that there is uncertainty in a bank’s decision to lend right up until the
time at which the decision is actually made by those with delegated authority to do so.
The ultimate decision-maker is usually a bank’s credit committee or equivalent, and
the decision comes at the end of an often substantial process of analysis and negotia-
tion. The specific process is unique to each loan for each bank, but it is reasonable to
generalize that, at the point of decision, there are four general preconditions that must
have been satisfied in order for a new loan to have any chance of being approved.
One, that entering into the loan is in accordance with the bank’s existing strategy,
internal lending standards and governing laws, or that there is potential justification
for these to be waived or amended in the particular case. Two, that there are credit
exposure limits in place sufficient to accommodate the new loan, or that, again, there

144
is potential justification for limits to be waived or amended. Three, that there has
been a proper assessment of the credit risk of the new loan (in the sense, for example,
that sufficient and appropriate information was considered, and the assessment was
undertaken in accordance with the bank’s internal standards). Four, that there is a
reasonable basis for expecting that the loan will generate a positive return (by whichever
method the bank uses to assess return) or, if not, that there are potential collateral
benefits from entering into the loan that may justify undertaking it.
Given the nature of these preconditions it is clear why this hypothesis has strong
intuitive appeal. Previous participation in even broadly similar loans means a proposed
new loan might already be in accordance with the bank’s strategy, lending standards
and governing laws, appropriate credit exposure limits might already be in place, and
the bank might not only be capable of adequately assessing the credit risk, but also
of accepting it. Of course, where a bank has an existing lending relationship with the
borrower under a proposed new loan then it should already be entirely up-to-date in its
credit assessment of that firm. Furthermore, a previous history of lending to borrowers
in the same industry or country as the new loan not only reduces the marginal cost of
the credit assessment for the new loan, as much of the industry and country analysis
will have already been done, but makes the bank much more confident in the outcome
of the credit approval process and so more willing to incur the sunk costs of undertaking
it.
The assessment and approval process is also important on an even more mundane
level. Banks’ new loans have to be initiated and driven through this approval process by
someone. This is usually a client relationship manager who is responsible for securing
business with that borrower or class of borrower. The fact that it has previously
participated in similar loans suggests that there might be an individual in the bank
with existing responsibility and motivation to consider participation in the new loan.
A proposed new loan that is not, at the very least, in accordance with bank strategy, or
preferably part of an ongoing banking relationship, may not even be seriously considered
by the bank.

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 It is also important, however, to recognize some of the limitations of this hypothesis.
Even if it were possible to know definitively that all these preconditions were satisfied,
it does not follow the participation in the new loan is certain to be approved. Any
decision to lend is ultimately a subjective one based on the personal judgement of the
decision-maker. While reasonable analysis might suggest that participation in the new
loan has the prospect of positive return, collateral benefit and acceptable credit risk,
for example, it may be equally reasonable for the decision-maker to draw a different
conclusion.
It should also be noted that there is scope for the decision-makers to take into
account other considerations, whether legitimate or representing agency costs for the
bank. It is also necessary to recognize that circumstances inevitably change over time,
and so the fact that the bank’s preconditions to participating in a given loan would
have been satisfied previously is no guarantee that they will be satisfied now. Finally,
each loan is unique in time and place, and the fact that a bank participated in a loan
with similar characteristics in the past does not necessarily mean that it would have
been able, even then, to have participated in this particular new loan.

9.2.3 Overall Activity Hypothesis

The third hypothesis as to why its past syndicated lending activity might be significant
to its participation in new syndicated loans relates to an institution’s overall level of
activity in the syndicated loan markets, and not just its prior participation in specific
loans or classes of loans. It is that the bank’s overall level of lending will reflect its
general competitive strength in doing so, and that this will be reflected in the probability
that it will participate in any new syndicated loan.
It is easy to identify a number of reasons that one bank may have a general com-
petitive advantage over another in making loans. A bank’s ability to raise funds at the
market benchmark is one that has already been discussed in Section 5.2 in the context
of the funding premium. It credit rating, explicit or implied government support, access
to a retail deposit base, funding strategy, regulatory capital position and the absolute

146
size of its balance sheet are factors that will determine a bank’s cost of funding its loans
relative to its competitors.
These last two factors will also determine a bank’s lending capacity, reflected in
the size of the credit exposure limits that it might be able to bear for any particular
borrower, industry or country. This will determine whether and the extent to which it
is forced to ration its lending, and so be forced to reject otherwise profitable lending
opportunities that its competitors may not. Finally, a bank’s overall analytical capa-
bilities, its scope of operations and, especially, its general strategy are also significant
to its ability and willingness to undertake new loans, and it is hypothesized that these
can also be inferred from its overall level of lending activity.

9.3 Variables and Data

An important feature of the econometric model developed in this chapter is that the
dependent variable is binary, taking one of two possible values representing the choice
of a given institution to either participate or not participate in a given syndicated
loan. Three major data items are required to generate observations of this dependent
variable: completed syndicated loans, the institutions that participated in them and
the institutions that did not. In this chapter the completed syndicated loans that are
identified are described as the subject loans.
The first two items can be readily obtained from any of the commercial syndicated
loan databases used in the industry. In this work all data is sourced from the Dealogic
Loanware database and so a specific example from Loanware is used to show how these
items of information are obtained. The basic element of the Loanware product is the
Full Profile Report, which shows all publicly available information on syndicated loans
completed throughout the world. Figure 9.1 is the full profile report on one of these
loans, a £160 million syndicated loan for British textile company Coats Viyella plc
that was signed on 9th October 2001. It can be seen from Figure 9.1 that this had
seven participants: Barclays, Royal Bank of Scotland, HSBC, Standard Chartered,

147
Toronto-Dominion Bank, Northern Bank and First Union National Bank.

Loanware Reference : 01:129231

Signed : 9 Oct 2001
Coats Viyella plc
STG 160.000
( $ 235.745 Eur 256.205 m.)
Revolving credit
Borrower Type : Private corporate
Nationality : United Kingdom
Location : London
Business Area(s) : Textiles & Clothing
Specific Area(s) : Textile-Miscellaneous
US SIC coding(s) : 2259 Knitting mills
2281 Yarn spinning mills
Loan Purpose : Debt repayment
General corporate
Market type : EURO Status: Multicurrency
Transferable
Maturity : 4 years ( 2005 )
Margin : LIBOR 90.00 bp
Repayment : Bullet
Mandated Arranger s
Barclays Royal Bank of Scotland plc
Co-arranger s
HSBC Standard Chartered Bank
Toronto-Dominion Bank
Lead Manager s
Barclays(25m) Royal Bank of Scotland plc(25m)
HSBC(25m) Standard Chartered Bank(25m)
Toronto-Dominion Bank(25m) Northern Bank Ltd(20m)
Manager
First Union National Bank(15m)
Facility/administration agent : HSBC
Bookrunner/syndication agent : Barclays
Royal Bank of Scotland plc
Documentation agent : Barclays
Fee Details
Commitment fee: 40.50 bp
Participation/
upfront fee: 25.00 bp for 25.00m
20.00 bp for 20.00m
15.00 bp for 15.00m
Fee Remarks:
Commitment fee is 45% of the applicable margin.
Purpose/Remarks:
Proceeds are for refinancing and general corporate purposes. Royal Bank of Scotland is
information memorandum agent.
Borrower description:
International producer of sewing threads.

Figure 9.1: Sample Loanware Full Profile Report.

While the full profile report shows which institutions did participate in the subject
loan, more problematic is the task of identifying the institutions that did not participate
in it, the third required data item for the dependent variable. Loanware (as with all

148
these databases) does not record which institutions were invited to participate but who
chose not to do so. The problem is dealt with in this work by creating, retrospectively, a
suitable set of potential participants for the loan. A single observation of the dependent
variable is, then, whether each potential participant did or did not participate in the
subject loan.
A very simple criterion that might be used for defining the potential participants in a
subject loan is that they are those institutions that have participated in any syndicated
loan within some reasonable period prior to the signing date of the subject loan (this
period is hereafter called the reference period). The institutions that meet this criterion
can at least be said to have demonstrated a recent desire and capacity to participate in
syndicated loans. Loanware is able to identify such a set of institutions in what is called
a league table, which lists and ranks institutions according to the number of syndicated
loans, of specified type, that they participated in during any defined period.
The Coats Viyella loan described above is actually one of the subject loans used
in generating the dataset for this analysis. The universe of potential participants for
it is defined as those institutions participating in at least one syndicated loan over a 5
year period prior to October 2001, which is when this loan was signed. The loanware
generated league table with these criteria contained 3,396 separate institutions. Po-
tentially, then, this gives 3,396 observations of the dependent variable, the choices of a
potential participant to participate in the subject loan. And this universe of potential
participants does in fact contain the 7 institutions that were observed to participate in
it, so there are potentially 7 observations of a positive choice to participate and 3,389
observations of a negative choice to participate available for analysis.
One issue that does need to be addressed is that the arranger of the Coats Viyella
loan certainly could not and would not have invited all of these 3,396 institutions to
participate in the loan. This raises the question of whether an observation that a
potential participant did not participate in the subject loan is still valid even if that
institution was not actually invited to do so. There are two strong reasons why this
should not invalidate the observation. First, proposed new syndicated loans are usually

149
reported in the trade press when they are launched into syndication and it would be
rare for an institution that would otherwise be interested in participating in a particular
loan not to be aware of it. Reverse enquiry, where the lender requests an invitation to
join the loan is common in the market and is rarely refused by the arranger. Second,
the arranger has a strong incentive to invite those institutions to whom the loan is most
attractive. This enables it to minimize the amount of participation fee it has to pay
away to secure the required number of institutions to join the loan. It is reasonable to
say that an institution, that would wish to participate in the loan on the terms offered,
will generally do so.
The next step is to expand the set of observations by adding observations for other
subject loans, reducing the influence on the data of factors specific to an individual
subject loan. By choosing subject loans signed at the same time as the Coats Viyella
loan it is possible to use the same universe of potential participants for all, as well as
ensuring a random selection of subject loans (it is assumed that there is no significance
in the signing date of a syndicated loan).
So the full set of subject loans selected for this analysis is 51 syndicated loans (in-
cluding the Coats Viyella loan) each with 3 or more participants, that were signed
consecutively in the first 11 days of October 2001. It is useful to provide some descrip-
tive statistics on these loans. The average loan amount was US$535 million equivalent.
The average number of participants was approximately 9, representing 468 participa-
tions2 in the set of 51 subject loans. Borrowers represented 15 different nationalities, as
shown Table 9.1. There is a major concentration of loans for borrowers in the United
States with 35 out of the 51 (68%). This is, however, consistent with relative weightings
of syndicated loans in the global market. Recall from Section 2.1 that 54% of total new
syndicated loans in the year 2000 were for US borrowers. The 51 borrowers under the
subject loans were also from 25 different industries, a good example of the breadth of
use of the syndicated loan product. These can be seen in Table 9.2.
With 3,396 institutions already identified as potential participants, this means there

2
A participation is defined for this chapter as one institution participating in one syndicated loan.

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 Borrower Nationality # Loans
United States 35
Sweden 2
United Kingdom 2
Cameroon 1
Iceland 1
Singapore 1
Hong Kong 1
Brazil 1
Italy 1
Switzerland 1
Turkey 1
Finland 1
Canada 1
Japan 1
Chile 1

Table 9.1: Sample statistics on Subject Loans, Borrower Nationality.

are up to 173,196 observations (being the product of 51 subject loans and 3,396 potential
participants) of the dependent variable available for the analysis.
With the method for generating observations of the dependent variable described, it
is now necessary to identify appropriate independent variables that reflect the hypothe-
ses and explain how the observations of their values are generated. The independent
variables associated with the first two hypotheses must quantify an institution’s re-
lationships, whether with a particular borrower, industry or country, in terms of its
previous syndicated loan participation. For this analysis a relationship is considered
to exist where the institution has participated in at least one syndicated loan for the
relevant borrower, industry or country previously. There are two alternative ways these
variables can be expressed. The first is to express them as binary variables, which take
the value 1 if there is a previous relationship, and zero if it does not. The second
way is to express the relationships in terms of the proportion of the total loans for
the borrower, industry or country that the institution has participated in. This clearly
enables the strength of the relationship to be quantified and distinguished from other
relationships.

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 Borrower Industry # Loans

Financial Services 7
Healthcare / Pharmaceuticals 6
Commercial Bank 3
Telecommunications 3
Hotels & Leisure 3
Automotive 2
Brewing & Distilling 2
Chemicals, Plastics & Rubber 2
Computer / Software 2
Electricity / Energy Utility 2
Fertilizers & Phosphates 2
Foodstuffs, drink & tobacco 2
Forest products/packaging 2
Transportation 2
Cement, Aggregates & Building materials 1
Construction/heavy engineering 1
Electronics & electrical 1
Engineering 1
Insurance 1
Mining & natural resources 1
Oil & Gas 1
Printing/publishing/media 1
Property 1
Retailing & distribution 1
Textiles & Clothing 1

Table 9.2: Sample statistics on Subject Loans, Borrower Industry.

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 The independent variable associated with the third hypothesis, the institution’s
overall lending activity, can only be expressed in terms of the proportion of total syn-
dicated loans completed, as the universe of potential participants contains only insti-
tutions that have participated in at least one syndicated loan.
The observations of the independent variables must also be restricted to some par-
ticular time period, and it is again decided to use the 5 year period immediately prior
to signing of the subject loans, already described as the reference period. This ensures
that the data is not stale, so that an observed relationship has a reasonable likelihood
of still continuing, but long enough to actually capture any relationships that do exist.
Given these parameters, it is now possible to define and describe the independent vari-
ables. All are expected to have positive signs as they indicate the presence or strength
of a relationship or, in the case of the final independent variable, the scope of the
institution’s previous lending activity. They are as follows.
BINBORR - Binary Borrower. It takes the value 1 if the potential participant has
participated in one or more syndicated loans for the borrower under the subject loan,
or a member of the borrower group, during the reference period. Otherwise it takes
the value zero.
PERBORR - Percentage Borrower. Takes a value in the range 0 to 1. It is the
percentage of all syndicated loans completed during the reference period for the bor-
rower under the subject loan, or a member of the borrower group, that the potential
participant participated in.
BININD - Binary Industry. It takes the value 1 if the potential participant has
participated in one or more syndicated loans for a borrower in the same industry as
the borrower under the subject loan during the reference period. Otherwise it takes
the value zero.
PERIND - Percentage Industry. Takes a value in the range 0 to 1. It is the
percentage of all syndicated loans completed during the reference period for borrowers in
the same industry as the borrower under the subject loan that the potential participant
participated in.

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 Position Bank Name Nationality Loans Amount Loans Number

1 Barclays UK 333.82 2
1 Citigroup USA 333.82 2
1 HSBC UK 333.82 2
1 Royal Bank of Scotland UK 333.82 2
1 Standard Chartered Bank UK 333.82 2
1 Wachovia Corp USA 333.82 2
7 National Australia Bank Australia 237.00 1
7 Toronto-Dominion Bank Canada 237.00 1

Table 9.3: Lender League Table. Coats Viyella as Borrower. 10/96-9/01.

BINCTRY - Binary Country. It takes the value 1 if the potential participant has
participated in one or more syndicated loans for a borrower in the same country as the
borrower under the subject loan during the reference period. Otherwise it takes the
value zero.
PERCTRY - Percentage Country. Takes a value in the range 0 to 1. It is the
percentage of all syndicated loans completed during the reference period for borrowers in
the same country as the borrower under the subject loan that the potential participant
participated in.
PERLOANS - Percentage Loans. Takes a value in the range 0 to 1. It is the per-
centage of all syndicated loans completed during the reference period that the potential
participant participated in.
The way in which values for the independent variables are generated is most simply
demonstrated with a specific example. Recall that Figure 9.1 shows the syndicated loan
for textile company Coats Viyella plc, which is one of the 51 subject loans used to create
the observations of the dependent variables. To determine values for the independent
variables BINBORR and PERBORR, Loanware was used to create a league table of
lenders to Coats Viyella and its associated companies during the reference period, and
it is shown in Table 9.3.
It can be seen that Barclays Bank, which is one of the potential participants, par-
ticipated in two transactions for the borrower during the reference period out of the

154
two in total. From Figure 9.1 it can also be seen that Barclays Bank did participate in
the subject loan. So the observation of the dependent variable representing the combi-
nation of Barclays Bank as potential participant and Coats Vayella as borrower would
have a value of 1, and the associated independent variables BINBORR would take a
value of 1 and PERBORR a value of 100%.
By contrast the observation of the dependent variable for the combination of Bank
of America as potential participant and Coats Viyella as borrower would have a value
of 0 as that bank did not participate in the subject loan. The associated independent
variables BINBORR and PERBORR would also take values of zero as Table 9.3 shows
the bank did not participate in any loans for the borrower during the reference period
either.
The same process is also used to generate values for the next two classes of inde-
pendent variables, those reflecting relationships with borrowers in the same industry
and same country. Table 9.4 is an extract from the league table of lenders to borrowers
in the textile industry during the reference period (there were in fact 392 lenders in the
full league table and a total of 670 syndicated loans for textile companies during the
period). Observe that Barclays participated in 21 loans for textile companies during
the reference period out of the possible 670. The associated variable BININD would
thus take a value of 1 and PERIND a value of 3.13%. By contrast Bank of America
participated in 199 out of 670, giving values for BININD of 1 and PERIND of 29.70%.
Generation of the full dataset for the analysis required this process be undertaken
for every unique combination of subject loan and potential participant.
Data on potential participants’ overall lending activity was simpler to compile. The
league tables by which the universe of potential participants was generated shows the
institutions ranked by a number of different measures, including the total number and
volume of syndicated loans they participated in over this period.
A major complication in compiling the data was that there was significant merger
and acquisition activity in the banking industry during the 1990s and so the full pro-
file reports do not correlate directly with the league tables where an institution that

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Position Bank Name Nationality Loans Amount Loans Number

1 Bank of America USA 41,827 199

2 Wachovia Corp USA 31,978 150
3 JP Morgan USA 31,380 119
4 FleetBoston USA 31,174 162
5 Scotia Capital Canada 24,056 64
6 Mitsubish Tokyo Japan 22,232 73
7 Mizuho Japan 21,211 69
8 Citigroup USA 20,851 61
9 Bank One USA 19,148 71
10 Bank of New York USA 16,816 58
11 ABN-AMRO Netherlands 15,398 57
12 Societe Generale France 14,679 43
13 BNP Paribas France 13,508 45
14 SunTrust USA 12,914 52
15 HSBC UK 12,235 29
16 Credit Lyonnais France 11,009 38
17 UFJ Group Japan 9,817 45
18 Sumitomo Mitsui Japan 9,579 45
19 Deutsche Germany 9,131 36
20 Commerzbank Germany 8,191 22
21 PNC Bank USA 8,172 24
22 Credit Suisse First Boston Switzerland 7,866 22
23 IntesaBCI Italy 7,524 18
24 ING Barings Netherlands 7,487 33
25 National City Bank USA 7,221 30
26 CIBC Canada 6,796 17
27 Bank of Montreal Canada 6,657 27
28 Comerica USA 6,624 30
29 Standard Chartered UK 6,514 19
30 Barclays UK 6,449 21

Table 9.4: Lender League Table. Textile Company Borrowers. 10/96-9/01.

156
was reported as a participant was subsequently acquired or merged with another. It
was therefore necessary to identify all merger and acquisition activity in the banking
industry during the reference period and manually adjust the data to ensure that the
institutions are appropriately captured in the league tables.

9.4 Econometric Model

In this section the general econometric model is developed. It shows the relationship
between a potential participant’s history of participation in certain syndicated loans,
described by the independent variables identified in the previous section, and its decision
to participate in a new syndicated loan. It is not optimal to estimate this model
using standard linear regression methods because the dependent variable is binary and
therefore non-linear. There are, however, regression methods designed specifically for
the estimation of these models and one of the most widely accepted, binary probit, is
used in this analysis. As it is a standard method that is well treated in econometric
texts (for example Gujarati, 1995) the description offered here will be very brief and
specified to the particular research question being considered in this chapter.
The major feature of these binary models is that the value of the dependent variable
y is assumed to be a function of some latent index, which can be given by the value y ∗ .
In this model the index y ∗ can be interpreted as representing the utility or net benefit
of choosing to participate in the subject loan. Where the index is greater than zero
then the institution is assumed to participate and the dependent variable takes a value
of 1. In general terms this is expressed as

y = 1 where y∗ > 0 (9.1)

Conversely, where the index is negative then the dependent variable takes the value
zero. This is expressed as
y = 0 where y∗ < 0 (9.2)

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 The latent index, in this case the utility or net benefit to a potential participant
from participating in the subject loan, is, by definition, unobservable. It follows that
y∗ is a continuous random variable which can be represented in the usual way by the
function
yi∗ = x0i β + ui (9.3)

x0i β is a vector which expresses the latent index in terms of independent variables xi
and their associated coefficients β i . Recalling the independent variables proposed in
the previous section, x0i β is specified for this analysis as

x0i β = β 1 .BIN BORR + β 2 .P ERBORR + β 3 .BIN IN D + β 4 .P ERIN D +(9.4)

β 5 .BIN CT RY + β 6 .P ERCT RY + β 7 .P ERLOAN S

The probability that yi = 1 is therefore the probability that yi∗ > 0. Recalling
that yi∗ = x0i β + ui this is the same as the probability that ui is less than x0i β. This is
expressed in general terms as

Pr(yi = 1) = Pr(ui < x0i β) (9.5)

Similarly the probability that the potential participant does not join the loan is given
by the general expression

Pr(yi = 0) = Pr(ui > x0i β) (9.6)

The defining feature of the probit model is the assumption that ui has a standard
normal distribution. The distribution of Pr(yi = 1) is therefore a standard normal
cumulative density function. This can be denoted G(x0i β) where G(.) is the standard
normal cumulative density function. The assumption that ui has a standard normal
distribution has the desirable characteristic of forcing the dependent variable Pr(yi = 1)
into the range 0 to 1. That is, the probability approaches zero, G(x0i β) = 0, as the point
estimate of the index gets very small, that is x0i β −→ −∞. Conversely, the probability

158
approaches 1, G(x0i β) = 1, as the point estimate of the index gets very large, that is
x0i β −→ ∞.
How are the β parameters of the independent variables to be estimated? The
usual least squares method is unsuitable as the probit model is non-linear and so the
Maximum Likelihood (ML) method is used instead. Put as simply as possible, the
ML estimation method chooses the parameters so that the probability of observing
the particular data sample is maximized. This clearly requires specification of the
probability density (or likelihood) of the data.
For a particular observation yi the probability density given the independent vari-
ables is

fi (yi | x1i , x2i , ..., xki , β) = [G(x0i β)]yi [1 − G(x0i β)]1−yi yi = 0, 1 (9.7)

When it is observed that yi = 1 then the probability of this outcome is given by

G(x0i β) and when it is observed that yi = 0 then the probability of this outcome is
given by 1 − G(x0i β). Taking logs yields

ln fi (β) = yi ln[G(x0i β)] + (1 − yi ) ln[1 − G(x0i β)] (9.8)

and the target function which must then be maximized by the choice of parameters β
is the sum of the individual log likelihood functions for all n observations

n
X
L(β) = ln fi (β) (9.9)
i=1

This requires the use of numerical optimisation algorithms which are available in all
the major statistical software packages and so will not be discussed further here.
The next step is to interpret the model, and there are a number of tools available.
The coefficients β i in the estimated equation determine the partial effects of each vari-
able xi on the dependent variable, or more specifically the response probability of the
dependent variable.

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 The associated Z-Statistic is interpreted as indicating the probability that the null
hypothesis, that the coefficient is equal to zero, cannot be rejected, and indicates the
significance of each variable. The overall significance of the equation, that is the coef-
ficients together, is determined by the LR statistic which tests a joint null hypothesis
that all the coefficients are zero.
In addition to the significance of the variables and the model, it is also important to
consider its explanatory power. The McFadden R-squared statistic is the equivalent, for
non-linear models, of the R-squared goodness-of-fit statistic in linear models. Simply
it shows the proportion of the variation in the dependent variable that is explained by
the estimated equation. It is constrained in the range zero to one.
An important test is of the marginal effects of each variable on the response prob-
ability. This shows how much the response probability, Pi , changes for a given change
in the value of an independent variable xji . In general this is given by

∂Pi b βbj
= g(x0i β) (9.10)
∂xji

where g(·) is the pdf (which is the derivative of) the cdf G(·). In the case of the probit
model this scale factor is given by φ(·), the standard normal density. Since g(·) depends
on the values of all the independent variables it must be computed at interesting values
of these independent variables. It is common, for example, to use the sample averages of
the other variables, Xj , when calculating the marginal effect of any particular variable.
A final interesting interpretative technique is to classify the observations in the
sample on the basis of the probabilities predicted by the model. The simplest way is
to specify a cut-off value lying between 0 and 1 such that each observation is classified
according to whether its predicted probability lies above or below the cut-off. A correct
classification is then obtained where the predicted probability is below the cut-off and
the observed value of the dependent variable yi = 0, or when the predicted probability
is greater then the cut-off and yi = 1.

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9.5 Testing, Results and Interpretation

In this section the econometric model is estimated. There is, however, one major issue
that must be addressed first, and it is one that also faces syndicated loan practitioners.
It is that the size of the universe of potential participants, however defined, is usually
very large compared with the typical number of institutions that participate in any
syndicated loan. In Section 9.3 the universe of potential participants for the subject
loans in this analysis was defined very broadly to include any institution that had
participated in a syndicated loan in the previous 5 years, and this group included 3,396
names. Yet the average number of participants in these subject loans was 9, meaning
9
that the participation rate of this group in each loan was approximately 0.27% ( 3,396 ).
For practitioners it is obviously impractical to consider this many institutions as
potential participants and so they usually undertake an initial screening to identify and
deal with a smaller, tractable set. For the econometric analysis to be undertaken here,
this very low participation rate means that there would be unacceptably low variability
in the dependent variable. Reducing the size of the set of potential participants is
clearly necessary. It will only be successful, however, if the resulting sample still retains
enough of the positive observations to increase the relative variability in the dependent
variable. So determining the criteria by which to exclude institutions from the universe
of potential participants will require an assumption that the criteria selected will be
significant, thus pre-empting the analysis itself to this extent.
Nevertheless there is an obvious criterion that can be used for initial screening of po-
tential participants without too much difficulty, which is each institution’s general level
of activity in the syndication market. This has already been described as the overall
activity hypothesis in the theoretical framework in Section 9.2. It is clear that, in the
universe of potential participants already identified, the vast majority have participated
in only a trivial number of transactions. Figure 9.2 ranks and plots the percentage of
total loans undertaken by each of these institutions during the reference period. The
plot is expressed as percentages, but, for perspective, it can be noted that over 1,300 of
these institutions participated in only 1 out of the 37,198 total syndicated loan tranches

161
recorded during the reference period.

30%

% of total syndicated loans 25%

20%

15%

10%

5%

0%
1
9
7
5
3
1
9
1, 97
1, 25
1, 53
1, 81
1, 09
1, 37
1, 65
1, 93
2, 21
2, 49
2, 7
2, 05
2, 33
2, 61
2, 89
2, 17
3, 5
3, 73
3, 01
9
12
25
38
51
64
76

17

94

32
8
0
1
2
4
5
6
7
9
0

3
4
5
6
8

0
2
Participating institutions

Figure 9.2. Participation in syndicated loans by institutions 1/96 - 9/01

It is obvious from Figure 9.2 that severe culling of the universe of potential partic-
ipants is possible if overall activity is the appropriate criteria for screening potential
participants. And in fact it is found that when the sample is recompiled to include
only the top 150 ranked participants in syndicated loans during the reference period,
it still captures 415 out of the 468 (that is, 89%) of the total participations in the
subject loans. Of the 7,650 (being the product of 51 subject loans and 150 potential
participants) individual observations pairing a potential lender with a subject loan, the
415 positive observations now represent 5.42% of the total. This is a dramatic increase
from the 0.27% participation rate in the sample containing the full universe of potential
participants, with only minimal loss of positive observations.
Further varying the number of potential participants in the sample yields the follow-
ing results. If only the top 75 ranked participants are included, the dataset has 3,825

162
observations with 369 positive observations representing 9.65% of the total sample and
capturing 79% of all participations in the subject loans. The top 50 participants give
2,550 observations with 321 positive observations representing 12.6% of the total sample
and capturing 69% of all participations in the subject loans. The top 30 participants
give 1,530 observations with 256 positive observations representing 16.7% of the total
sample and capturing 54.7% of all participations in the subject loans.
As the set of potential participants becomes relatively small, there begins to be a
trade-off between increasing the proportion of positive observations in the sample and
losing positive observations overall. It follows that the institutions in all these sets
of potential participants are relatively active in the market and other factors are now
needed to distinguish between their choices to participate. It is at this point that the
econometric model containing all the independent variables can be usefully estimated,
and this is done. Results of the estimation process are now shown and discussed for
each of the three different samples comprising the top 150, top 75 and top 30 potential
participants ranked by syndicated loan activity during the reference period.
The results for the first sample, representing the top 150 potential participants
combined with the 51 subject loans for 7,650 observations, immediately provides strong
support for the three hypotheses that comprise the theoretical framework. As shown
in Table 9.5, all independent variable are significant at the 5% level except for BININD
which is significant at the 7% level, and the large LR statistic confirms that the variables
are significant in combination.
It is suggested that BININD, the variable indicating whether an institution has or
has not previously participated in at least one loan for the same industry as the new
borrower, may be susceptible to a lack of variability in values as these relatively active
institutions are likely to have participated in loans for most of the industries covered by
the subject loans. Interestingly the variable PERLOANS is significant, meaning that
even the top 150 ranked institutions globally can still be distinguished simply on the
basis of their overall syndicated lending activity. Notwithstanding the significance of
all the proposed variables, the McFadden R-Squared statistic of 34.95% shows that a

163
 Variable Coefficient Standard Error Z-Statistic Prob.

C -3.4512 0.3503 -9.8513 0.0000

BINBORR 1.0046 0.0747 13.4553 0.0000
PERBORR 2.9674 0.4603 6.4466 0.0000
BININD 0.5199 0.2829 1.8379 0.0661
PERIND 1.2146 0.2955 4.1109 0.0000
BINCTRY 0.6497 0.2170 2.9938 0.0028
PERCTRY 1.0172 0.1786 5.6968 0.0000
PERLOANS 1.6333 0.7576 2.1558 0.0311
LR statistic (7 df) 1099.822 (0.0000)
McFadden R-Squared 0.349543

Table 9.5: Top 150 participants sample. 7,650 observations.

significant proportion of the variability in the dependent variable is still unexplained

by the model. This is not unanticipated given the limitations of the three hypotheses
that were previously identified.
The next set of results are for the sample containing the top 75 institutions as
potential participants, which has 3,825 observations. These are shown in Table 9.6.
The variables BININD and PERLOANS are now not significant at the 5% level and so
are excluded. The previous suggestion that the explanatory power of BININD might
be impaired by invariance in its values is confirmed by looking at the actual sample.
Almost 99% of the observations of BININD in this sample have a value of 1, indicating
that all these potential participants have previously participated in all of the industries
represented in the sample. Given these are the top 75 ranked financial institutions
globally, this is not a surprising result. Similarly PERLOANS loses significance when
dealing with this group of leading institutions that are all relatively active in the syn-
dicated loan markets. The LR statistic remains large showing that the five variables
included are significant in combination. Again, however, the McFadden R-Squared at
28.50% shows that while the model has not insignificant explanatory power, a substan-
tial proportion of the variation in the dependent variable is still unexplained.
The final set of results is for the sample containing only the top 30 institutions as

164
 Variable Coefficient Standard Error Z-Statistic Prob.

C -2.7572 0.2949 -9.4376 0.0000

BINBORR 0.9079 0.0817 11.1162 0.0000
PERBORR 3.0398 0.4780 6.3589 0.0000
PERIND 1.3861 0.2311 5.9968 0.0000
BINCTRY 0.6782 0.2957 2.2934 0.0218
PERCTRY 0.9390 0.1783 5.2676 0.0000
LR statistic (5 df) 676.6893 (0.0000)
McFadden R-Squared 0.2850

Table 9.6: Top 75 participants sample. 3,825 observations.

Variable Coefficient Standard Error Z-Statistic Prob.

C -1.9486 0.0968 -20.1217 0.0000

BINBORR 0.9552 0.1063 8.9831 0.0000
PERBORR 2.3202 0.5339 4.3132 0.0000
PERIND 1.0880 0.2809 3.8732 0.0000
PERCTRY 0.8861 0.2186 4.0439 0.0001
LR statistic (4 df) 317.7574 (0.0000)
McFadden R-Squared 0.2354

Table 9.7: Top 30 participants sample. 1,530 observations.

potential participants. As can be seen in Table 9.7 the variable BINCTRY, the binary
indicator of whether the institution has participated in a previous syndicated loan for a
borrower in the same country, is now insignificant and is excluded. This shows, as would
be expected, that the top 30 institutions are active in almost all countries represented
in the sample. It is interesting to note, however, that this variable was still significant
in the sample containing the top 75 institutions, which suggests that the set of truly
global banking institutions is still relatively small. The LR statistic and the McFadden
R-Squared tell the same story as previously.
The next step is to consider the power of each of the variables individually by
looking at their marginal effects on the response probability (the response probability
is the probability that the dependent variable is 1; that is, the probability that the

165
 Variable BINBORR PERBORR PERIND BINCTRY PERCTRY

1 or 100% 18.35% 98.10% 34.91% 5.91% 24.08%

50% 71.05% 13.99% 12.03%
0 or 0% 3.05% 3.05% 3.80% 1.01% 1.01%

Table 9.8: Marginal Effects.

potential participant participates in the loan). The marginal effects analysis is only un-
dertaken in relation to the sample containing the top 75 ranked institutions as potential
participants.
The marginal effects for each variable are determined by using the estimated model
to calculate the response probability where the variable of interest is set at different
levels and the other variables are set, where appropriate, at their sample means. In some
cases it is not appropriate to set the other variables at their sample means, however.
For example, where the variable PERBORR is being considered with a value of zero,
then clearly the variable BINBORR must have a value of zero as the institution cannot
have participated in any loans for that borrower previously.
The results of the marginal effects analysis are shown in Table 9.8. The body of the
table shows the calculated response probabilities associated with particular values for
each of the independent variables, which are shown in the far left column. For example,
where the variable BINBORR is set at 1, then the response probability is calculated as
18.35%. Where the same variable is set at 0, then the calculated response probability
is 3.05%.
What is clear is that the most significant marginal effects are due to the variable
PERBORR, the percentage of previous loans for the same borrower that the institution
has participated in. When set at its maximum value of 100%, the response probability
is a near maximum 98.10%. When set at its minimum value of 0%, the response
probability is a near minimum 3.05%. This is strong evidence in support of both the
first and second hypotheses, and it shows that it is the presence and strength of the
bank/borrower relationship that has the greatest power to explain participation.

166
 The second hypothesis also proposes that the bank’s relationships with industries
and countries can also explain its decision to participate in a new loan, and the model
variables that would reflect this, PERIND and PERCTRY, seem to confirm it. Their
response probabilities move from 3.80% to 34.91% and 1.01% to 24.08% respectively as
their values are changed from the minimum 0% to the maximum 100%. That they are
less responsive than PERBORR is certainly as anticipated. In terms of the hypothesis,
an institution might satisfy some preconditions to making a new loan because it has
previously participated in loans for the same industry or country, but obviously the
effect is not as strong as if it had previously participated in loans for the same borrower
as the borrower under the new loan.
What is interesting is the relative lack of response from the binary variables BIN-
BORR and BINCTRY. This finding suggests that relationships are better evidenced
by larger numbers of previous transactions, which was anticipated in the description
of the limitations of the first hypotheses. There it was noted that an institution’s
participation in previous loans might have been simply opportunistic or evidence only
a relationship that has since lapsed. Both are more likely to be the case where the
institution has participated in only a few previous loans. This lack of response from
these binary variables might also suggests that substantial satisfaction of preconditions
to lending, as proposed in the second hypothesis, might require more than just a few
previous transaction for that borrower or in that country.
The final item of analysis is the calculation of an expectation/prediction table that
shows the predictive ability of the model in in-sample testing. Again dealing with
the top 75 participant sample, Table 9.9 shows that, with the response probability
threshold set at 50%, the model predicted that there would be 103 participations in the
sample. It is very significant that, of those predicted, 71 actually were participations
in the sample, representing a success rate of 69%. To put this into perspective, if 103
observations were selected from the sample at random, only 9.65% or less than 10,
would be expected to be participations. This suggests that the model has an excellent
strike rate in predicting participations.

167
 Dep=0 Dep=1 Total

P(Dep=1)<=50% 3279 293 3572

P(Dep=1)>50% 32 71 103
Total 3311 364 3675
Correct 3279 71 3350

Table 9.9: Expectation/prediction table

There is more to this, however. The 71 participations successfully predicted by

the model actually represent less than 20% of all the participations observed in the
sample. The model only predicted 103 participations whereas there were actually 364
participations in the sample. This suggests, contrarily, that the model is actually not
very successful in predicting participations.
It is proposed that these very interesting results can be reconciled in a way that
accords with banking theory and observation of the market. They can be taken as evi-
dence that participants in syndicated loans actually fall into two groups. The first group
is of relationship lenders who have high estimated response probabilities and whom the
model predicts very successfully. The second group comprises non-relationship lenders,
or institutions whose relationship cannot be observed on the basis of their previous
participation in syndicated loans. This group has low estimated response probabilities
and so are not selected by the model.
What is significant is that the second group is substantially larger than the first,
at least in the sample tested in this analysis. Apart from the fact that the model only
predicted 103 participations against the actual 364 participations in the sample, it can
be observed from Figure 9.3 that, of the actual participations that were observed, a
very large number actually had an estimated response probability of less than 10%.
The model performance would not be substantially improved by lowering the response
probability threshold for participation (which was at 50% in this analysis); it is simply
not picking up a majority of the actual participations.

168
 100

90

80

70

# participations
60

50

40

30

20

10

0
10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Probability (upper limit of bin)

Figure 9.3: Estimated probabilities of observed participations.

The theoretical support for this interpretation is also derived from theories of re-
lationship banking. There is incentive for firms to develop a small number of banking
relationships, and the benefits to a firm of having banking relationships have already
been described in the classic relationship banking hypothesis (see Section 9.2). In his
survey of the literature Boot (2000) also considers the optimal number of relationship
banks for a firm. He notes the argument that having only a single or very small group
of relationship banks leaves the firm open to what is called the hold-up problem, where
a single relationship bank has an information monopoly that it may exploit to the
firm’s detriment. He also notes, however, that as the size of a relationship bank group
increases the value of the relationship to each bank, the incentive for each bank to
invest in it and thus the benefits to the borrower of having the relationships would be
expected to fall. To this can also be added the observation that maintaining banking
relationships is not without cost and inconvenience to the firm.
The conclusion that a large proportion of participants in syndicated loans are non-
relationship banks strongly suggests that the number of participants required to suc-
cessfully complete a typical syndicated loan is greater than the number of ongoing

169
banking relationships the borrower firm needs to have to avoid the hold-up problem.
Recall that the average number of participants in the subject syndicated loans in the
sample is 9. It is reasonable to suggest that this is above the optimal number of re-
lationship banks that a firm should have and experience is that firms indeed do not
typically have such large relationship banking groups. Given that a syndicated loan
is the only major banking product that requires multiple bank providers, and that a
firm will require new syndicated loans only at relatively long intervals, it is entirely rea-
sonable to conclude that a syndicated loan will require utilization of non-relationship
banking capacity.
It is also interesting to consider the findings in light of the actual sample that was
tested and the market conditions that existing during the sample period. It may be
recalled from Section 2.2 that the period 1996-2001, from which the data on past syndi-
cated loan participation was drawn, was one of very dramatic growth in the syndicated
loan market. Figure 2.2, which for convenience is reproduced below, shows that the an-
nual global volume of new syndicated loans grew dramatically, by approximately 50%,
from 1996 to 2000.

2500

2000
US$billion

1500

1000

500

0
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
20
20

Figure 2.2. Annual global new syndicated loan volume, 1986-2003.

Source: LoanConnect.

170
 Coinciding with this, however, was both an unprecedented level of merger and ac-
quisition activity in the banking industry which dramatically reduced the number of
banks in the group of the world’s leading financial institutions, and the crisis in the
Asian and Japanese banking industries that led many banks to withdraw from the
international lending business. This was well recognized by syndicated loan practition-
ers and firms, who noted that the size and lending capacity their relationship banking
groups dropped dramatically in the mid-late 1990s.
Together these two factors would have been expected to manifest in an even greater
need to top-up loan syndicates with non-relationship banks, at least some of whom
would use the opportunity to enter into the firm’s banking relationship group. This
certainly was observed in practice. For example, the German Landesbanks dramati-
cally expanded the scope of their international lending operations, and represented a
substantial new group of participants in syndicated loans, at this time.

9.6 Conclusion

To draw overall conclusions from the work in this chapter it is necessary to return to
the major motivations for it. It was observed in the introduction that the extent to
which public information can explain syndicated loan participation will determine the
extent to which acquiring further private information will improve final hold forecasts
and so generate a competitive advantage in winning mandates to originate syndicated
loans.
It is now clear that this information does have value in initially screening the uni-
verse of lending institutions to generate a manageable set of potential participants that
still includes most of the likely participants, and in identifying those relationship banks
that will have a competitive advantage in participating in a syndicated loan for a par-
ticular borrower and who will therefore comprise the core of any new syndicate for
it.

171
 The public information model has no success, however, in identifying the marginal
non-relationship banks required to complete a syndicate of average size. The motivation
of these institutions to participate must be observed or estimated from other, private
information, and so it can safely be said that model-based analysis of publicly available
data cannot reasonably replace the expert judgement of syndicated loan practitioners
in forecasting final hold.

172
Chapter 10

Summation

This work commenced with the aim of developing, from first principles, a general eco-
nomic theory of syndicated loans. The scope of syndicated lending is so broad, with
the product used for borrowers of almost every conceivable type, quality, location and
purpose, and provided by syndicates made up of lenders with such a diversity of na-
tionalities, capabilities and strategic objectives, that it would seem difficult to capture
it in a general theory.
The ambition of this work is increased by the fact that, of the literature on the
subject, none is able to substantially explain observed practice in the syndicated loan
markets, and so there is a lack of existing theoretical work on which the desired general
theory might be built. This is attributable to a general lack of recognition of the
significance and uniqueness of commercial bank loans, of which syndicated loans are
an important form, and the focus of the financial press and academia on the more
transparent traded debt markets. It was just these obstacles, however, that provided the
motivation for this work and which mean that its numerous contributions are original,
significant and relevant not just to the specific field of syndicated loans but to the whole
field of commercial bank lending.
From the general aim were identified two fundamental research questions; why are
loans syndicated, and how can banks assess and price the risk of syndicated loans.
These were chosen not just because they are important questions in their own right but

173
because they address what are ostensibly very different aspects of syndicated lending.
This means that the analysis undertaken and conclusions drawn in addressing each of
them do, together, cover a wide range of issues related to the syndicated loan prod-
uct. There were four separate and significant contributions made in answering the two
fundamental research questions, and it can be seen that they together created a coher-
ent and internally consistent work that does, in fact, provide the general theoretical
explanation of the syndicated loan product that is its aim.
The work commenced by setting up one of the major motivations for it. The broad
scope of syndicated lending was demonstrated by describing the current use of the
product and a brief history of its modern development. The conclusion was drawn
that syndicated loans are not only among the most important products in the modern
globalized economy but, as one of the major sources of capital for both emerging and
developed economies, can reasonably be said to have contributed significantly to its
development. This is an important conclusion because syndicated loans have not, at
least since the sovereign debt crisis of the early 1980s, been adequately recognized as
a major channel for global capital flows and neither, therefore, has their influence on
recent important global economic events.
Next, a solid foundation for the general theory was laid by way of a detailed descrip-
tion of the mechanics of syndicated loan instrument itself, both in terms of the way it is
utilized by the parties to it and in terms of the way it is brought from initial conception
to execution. The first important conclusion was that a syndicated loan is, above all
else, a form of commercial bank loan which is structured to provide financing to the
borrower of a type that is fundamentally indistinguishable from the generic bilateral, or
single lender, form of commercial bank loan. The second important conclusion was that
it is in the way they are arranged, that is brought from initial mandate to execution by
the parties, that syndicated and bilateral loans differ most dramatically. Not only are
the processes different, but syndication introduces a major risk for the parties. This
is syndication risk, which is the risk in the number of participants that will join the
loan syndicate. Syndication risk is usually, in the competitive loan markets, accepted

174
by the institution that originates the loan and so manifests in uncertainty in its final
hold, the share of the syndicated loan it must provide itself.
This analysis of the product was not just a vital foundation of the work. It also
provided clear direction to how the two major research questions might be tackled.
The choice to use a syndicated loan was shown to be fundamentally a choice between it
and the bilateral form of loan, and not between it and other forms of debt instrument.
The answer to the question of why syndicated loans are used must therefore lie in the
different consequences for the parties of selecting the one over the other. As they are
both forms of commercial bank loan the return to the originator of a syndicated loan
should be same as its return from originating an equivalent bilateral loan except to
the extent that the amount it lends will differ between the two alternatives and the
presence of the lending syndicate in the former. The question of how banks can assess
and price the risk of syndicated loans is shown, therefore, to be ultimately one of how
can banks quantify uncertainty in their final hold.
The last preliminary work undertaken before addressing the research questions was
a closer consideration of the return to the originator of a syndicated loan and identifi-
cation of a comprehensive expression of it. This work was significant for both research
questions. One of the major consequences of selecting a syndicated loan over a bilateral
loan, and thus the possible basis of a viable answer to the first research question, is
that the returns to the parties differ. Obviously identifying the expression of return is
a necessary precursor to exploring this possibility. And the way in which syndication
of a loan varies the originator’s return compared with its provision on a bilateral ba-
sis clearly determines how the syndicated loan must be priced to compensate for the
syndication risk that goes with it.
It has already been noted that the fields of syndicated loans specifically, and com-
mercial bank lending generally, are not comprehensively served by the existing liter-
ature. As fundamental a subject as the returns from commercial bank lending, that
would reasonably be expected to have been well very considered, has not been; or at
least not in any coherent and tractable way that brings together its different elements

175
and makes explicit the relationship between them. It was necessary, therefore, to do
so in this work, and the resulting new expression of return therefore represent its first
important new contribution.
The major insight was that loans are structured to reflect the unique nature and
capabilities of their providers; financial intermediaries. This not only enables loans to
provide a form of financing distinct from that available in the capital markets, but it
means that the expression of the return to the provider of a loan is more complex than
that for other debt instruments. Clearly the return to the originator of a syndicated
loan, which must also capture the effect of loan syndication, will be the most complex.
It was shown, however, to be just an extension of the new expression of the return to
the provider of a bilateral loan. This very important new expression captures all of the
utilization options granted to the borrower, the contractually mandated income to the
lender, its costs of providing both the loan advances and the undrawn loan commitment,
and its opportunity cost of foregoing alternative investment opportunities.
The work then turned to the first of the fundamental research questions; why are
loans syndicated? A survey of the current explanations again demonstrated the short-
comings of the contemporary literature; none can explain the actual structure of syndi-
cated loans, the process by which they are arranged or observed practice in the markets.
Ultimately, this can be traced to the fact that they do not identify or explain the dif-
fering consequences for the parties of choosing a syndicated loan over a bilateral loan.
When these consequences were explored a number of important findings were made.
For the loan originator syndication of a loan is beneficial in that it reduces the rate of
its three major costs of lending; it rates of credit loss provision, net capital charge and
opportunity cost. The second major contribution of this work was to show how this
forms the basis of a rigorous new explanation for the use of syndicated loans.
The expressions of return from bilateral and syndicated loans, developed previously,
were combined. From this new expression it was shown that, because of the reduction
in the rate of the originator’s costs of lending, a syndicated loan has a greater expected
return for the bank that originates it, which can be transformed into lower financing

176
costs for the borrower, than the alternative equivalent bilateral loan. As well as being
rigorous, this new explanation for the use of syndicated loans is entirely consistent with
market practice. For example, this new explanation holds even where the originator
is at least as efficient a lender as the participants to whom the loan is syndicated,
which is a minimum requirement for winning mandates origination mandates in the
very competitive banking markets. It also explains why larger loans are more likely to
be syndicated. The marginal return from syndication, and thus the potential reduction
in syndicated loan pricing, is shown to be positively related to loan size.
Having addressed the question of why loans are syndicated, the work then moved
on to complete the development of new approaches to assessing and pricing the risk
of syndicated lending. The first step in this, and the third major contribution of this
work, was to develop new algorithms for determining the distribution of the originator’s
final hold. As the return to the originator is sensitive to its realized final hold amount
these algorithms provide the basic tools for quantifying the distribution of return, and
thus the expected return and the risk, from originating a syndicated loan on given
terms. Two alternative methods were proposed, an efficient algebraic method and
a conceptually simpler numerical approach. These new tools were are also used to
investigate the general form of the distribution of final hold, which was found to be a
truncated normal distribution, with risk to the loan originator in the direction of higher
final hold.
The final major contribution of this work was to consider the estimation of the fun-
damental inputs into these algorithms and thus the major determinants of final hold.
These are the probabilities that any institution will participate in a proposed new syn-
dicated loan. The particular question addressed was whether an institution’s observed
lending history has any power to predict its participation in syndicated loans. A sub-
stantial empirical investigation using data drawn from one of the leading commercial
syndicated loan databases found that, while statistically significant, such information
has limited power to explain the decision to participate. This suggests that there is a
competitive advantage for originators who invest in acquiring additional private infor-

177
mation, and that the judgement and experience of syndicated loan professionals is still
a vital element in the successful management of any syndicated lending business.

178
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186
Index

advances, 38, 41 best efforts, 28, 76

adverse selection, 24, 60, 62, 71, 142 bilateral loan, 1, 36, 60, 73, 93, 97, 103,
agency cost, 71, 146 108
agent, 1, 25 binary probit, 157
allotted commitment, 32, 121 bond, 37, 38
amortisation, 40 bought deal, 28, 69, 70
arranger, 14, 24, 26, 28, 74 British Banker’s Association, 42, 66
Asia Pacific Loan Market Association
capital charge, 48, 82, 99, 102
(APLMA), 22
carrying cost of capital, 48
Asian crisis, 10
Citibank, 74, 77
AT&T, 11
clear market, 30
Australian Prudential Regulation Author-
club loan, 28
ity (APRA), 76
Coats Viyella plc, 147, 155
availability period, 40
collateral benefit, 140, 145
B-Loans, 81 commercial paper (CP), 11, 39, 61, 70
Bank for International Settlements (BIS), commitment fee, 51
44 competitive advantage, 140, 146
Bank of America, 14, 30, 64, 74, 155 correlation, 88
banking book, 66 covenants, 45, 60
bankruptcy, 82 credit committee, 144
Barclays Bank, 147, 154 credit costs, 44
base rate, 42 credit enhancement, 61
Basel Capital Accord, 46 credit exposure, 44

187
credit exposure limits, 49, 76, 77, 90, Financial Accounting Standards Board
144, 147 (FASB), 66
credit loss, 44 financial intermediary, 37, 60, 63
credit loss provision, 44, 50, 80, 99 First Union Bank, 30, 148
credit ratings, 45, 60, 61, 70, 71, 119 floating interest rate, 42
credit risk, 63, 80, 102, 145 floating rate note (FRN), 42
Credit Suisse First Boston (CSFB), 67 France Telecom, 10, 78
cross-default, 80 funding period, 39, 41
funding premium, 42
Dealogic Loanware, 139, 147
default, 44 General Electric Capital Corporation (GECC),
dependent variable, 151 62
discount rate, 53 grid pricing, 51
disintermediation, 18, 37, 60, 63 gross-up, 51
distribution of final hold, 124
highly leveraged transactions (HLTs), 13,
documentation, 27
68
econometric model, 157 HSBC, 147
economic capital, 46 hybrid debt securities, 59, 118
economic value added (EVA), 36, 53
independent variables, 151
efficient lender, 103
information, 119, 144
emerging markets, 45
information memorandum, 26
equity, 45
institutional investors, 64, 69
eurocurrency, 14
interbank market, 39
Eurotunnel, 13
interest rate, 42
expert judgement, 117
International Finance Corporation (IFC),
extended relationship banking hypothe-
81
sis, 144
International Financial Reporting Stan-
final hold, 29, 54, 77, 94, 100, 108, 115, dard, 67
117, 118, 120, 127, 137 investment banks, 67

188
investment grade, 61, 70 material adverse change (MAC), 30
medium term note (MTN), 39
Japan premium, 72, 73
merger and acquisition, 155, 171
joint underwriting, 32
Metropolitan Life Insurance Company,
JP Morgan, 14, 64, 74
64
Landesbanks, 171 Millbank & Tweed, 30
large exposures, 76 moral hazard, 24, 71
league table, 149
net commitment fee, 99
lending standards, 144
net interest, 43, 99
Libor, 42
net ongoing return, 97
life cycle theory of the firm, 60
net return on loan advances, 50
liquidity, 66
net up-front return, 97
loan advances, 97
Nigeria, 62
loan agreement, 22
Northern Bank, 148
loan commitment, 38
loan facility, 38 OPEC, 16
Loan Market Association (LMA), 22 opportunity cost, 49, 89, 99, 102
loan size, 95, 105 option, 116, 127
Long Term Capital Management, 13 originated loans, 67
loss given default, 44, 80, 82 overall activity hypothesis, 146
Loy Yang B, 77 oversubscription, 31, 121

mandate, 26, 71 partial underwriting, 32

margin, 42, 50 participant, 1, 26, 63, 64, 95, 101, 118,
marginal effects, 165 121, 137, 170
marginal return, 96, 98, 101, 105 participation fee, 27, 54, 94, 98, 101,
mark-to-market, 66, 68 102, 109, 118, 129
market flex, 30 participation history, 138
market signalling, 143 participation probabilities, 115, 134, 138
match funding, 39 Poisson variable, 125

189
portfolio, 88 risk tolerance, 96
portfolio effects, 46 RJR Nabisco, 13, 18
portfolio management, 72 roadshow, 27
preference ranking of debt instruments, Royal Bank of Scotland, 147
61
scale-back, 32, 121
prepayment, 40, 63
secondary market, 69
present value (PV), 53
security, 45
pricing, 94, 105, 119, 139
Shared National Credit, 17, 19
private debt, 59, 60
sovereign borrowers, 17, 81
probability of default, 44, 80
spot loan, 38, 40
project finance, 13, 62, 81, 118
Standard Chartered Bank, 147
prudential regulation, 16
standby facility, 11, 39, 61, 70
public debt, 59, 60
strategy, 144
reference period, 149 sub-underwriting, 33
reference rate, 42 subject loans, 147
regulatory capital, 45 Sunbeam, 30
regulatory capital ratio, 74 syndicated loan, 1, 93, 97, 137
relationship banking, 141, 145, 169 syndicated loan databases, 137
relationship manager, 53, 116, 145 syndication, 26, 73, 76, 83, 108
reputation, 71 syndication risk, 28
response probability, 165 syndications group, 117
restructuring, 82
target final hold, 31, 116, 122
return, 35, 54, 80, 94, 96, 103, 118, 140,
tender panel, 39
145
term loan, 40
return-to-liquidity hypothesis, 119
term sheet, 27
reverse enquiry, 150
term structure of credit risk, 50
revolving facility, 38
threshold rate of participation fee, 101
risk adjusted return on capital (RAROC),
Tier 1 / Tier 2 Capital, 48
36

190
time value of return, 98
Toronto-Dominion Bank, 148
total initial commitments, 120
trading assets, 66
tranche, 68

undersubscription, 121
underwriter, 121
underwriting, 29, 76, 77, 115, 118, 137
underwriting conditions, 30
underwriting fee, 109
underwriting risk, 116, 117, 128, 137
unexpected credit losses, 45
universe of potential participants, 161
up-front fee, 52, 54, 99, 108

value at risk (VAR), 46

voluntary default, 81

191