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by A. M. A. Cader (FCMA London)

Background

In view of the growth in size of business and industrial units financial requirements are growing year by year considering various expansion programs and Start up projects. A prudent business does not finance a business by only parting on equity financing but also obtains certain component of borrowed funds into the project. Sometimes it so happens that a substantial portion of the project gets funded through borrowed funds which we say higly leveraged debt financing.

The rationale for Loan Syndication which is part of Debt financing of projects is that commercial banks or other financial institutions may have limitations in providing funds beyond a certain amount to a single customer because of statutory restrictions, availability of funds for disbursement, sectorial exposure limit, existence of large amount of short-term borrowings at high cost of borrowing etc. Due to these limitations one financial institution may not be in a position to meet all financial requirements of an expansion program or Start up project of company or firm.

Therefore, such a company will have to find some institution which can arrange funds for their entire project. That is why the role of an Investment Bank becomes important as a lead banker or arranger for a successful loan syndication. Sometimes, requirements of a company cannot be met by one local financial institution or terms of such financial institutions may not be favourable to the company considering its Internal Rate of Return (IRR) and pay back period, e.g. a hydropower company raising funds for its investments shall have long Pay back periods, lower Internal Rate of Return. In such a case the company might have to seek cheaper off-shore funds. It is for this purpose that the assistance is obtained from an Investment bank to arrange funds for the project.

Meaning

Debt or Loan syndication is syndication or arrangement of a loan by an institution (preferably by an investment banker) to its customer through financial institutions either within the country or outside the country based on reputed foreign currency syndications such as US Dollar, Euro and Sterling Pound. Basic Syndication Process

Syndication process includes most of the steps given below to be taken by the lead syndicator or arranger to syndicate the Debt commencing from the point of the customer making a request for a loan up to the point of funds been sanctioned. Some of the most important steps in this process are listed below: Discussion with the customer : When the customer comes for funds lead syndicator should understand in detail about his requirements and expectations and communicate to him about the services that could be provided to him.

MoU with the Customer: If the lead syndicator agrees in principle to undertake the project it should enter into a Memorandum of Understanding (MoU) with the customer.

Project Appraisal: Lead syndicator should make a comprehensive appraisal of the project on which it has to syndicate funds.

Preparation of Information Memorandum: When the lead syndicator or arranger gets fully convinced on the project an information memorandum is duly prepared and presented to the potential lenders for the project proposal.

Calling of Meetings: Lead syndicator calls a meeting of potential financiers for the project. Presentation: Lead syndicator makes the presentation on the project to the various parties attending the meeting and clarifies the queries raised by them.

Commitment from the parties attending the meeting: Lead syndicator requests various parties attending the meeting for their opinion and commitment on the project.

It is desirable to obtain commitment from the parties in principle subject to their board approval. Approval Letter: Lead syndicator obtains approval letter from the parties committed in principle to fund the project. Loan Agreement: Lead syndicator prepares draft loan agreement and circulates it to the parties approving the funds for the project.

Various parties to the agreement may suggest alterations on the agreement to suit their requirement. Considering the changes each bank has a final consensus is arrived and the agreement is finalised. Generally as an assignment the investment banker gets over after signing the loan agreement unless otherwise stated in MoU thereafter the investment banker issues letter of successful completion of assignment after this point of time.

Special Considerations

In a successful syndication of funds one has to consider some special matters. These matters are presented below:

* Presentation on the project should be completed in as minimum numbers of meetings as possible (preferably in one or maximum two meeting)

* In the same meeting where presentation is made, consent/commitment of parties to fund the project is always obtained in principle

* Similar terms and conditions to be put to all co-financiers

* In case of syndication of off-shore loans exchange risk from the viewpoint of the borrower and country risk from the viewpoint of the financiers has to be taken into consideration Loan Syndications are very attractive during decline in the interest rates scenarios to both the investor and also the borrower. To the investor a rate attractive could be offered with the sharing of business and default risk.

Whereas to the borrower a better rate could be negotiated considering viability of the project and the opportunity cost of one financial institution financing taking all risks into consideration at high interest rates in case it is financed. Therefore the option of Loan/Debt syndication should always be explored for a win win situation to any good viable project when interest rate scenarios are declining due to various economic and environmental factors as seen in Sri Lanka at present.

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