Syndicated Lending | Bulletin – June 2023 (2024)

Introduction

A syndicated loan is extended by a group of lenders to a single borrower. The borrower typically organisesthis by agreeing to terms with a small group of banks, called mandated lead arrangers. In most cases, themandated lead arrangers seek other lenders to join the syndicated loan as participating lenders.^[1]

Syndicated lending in Australia has expanded since the mid-1990s, along with overall business debt. Theflow of new loan commitments for syndicated loans (including refinancing) increased from about$10billion in 1995 to about $140billion in 2022, and annual commitments have made up around10percent of the stock of total business debt for the period since the global financialcrisis (GFC).^[2] In 2022, non-financial businesses in Australiaborrowed about seven times as much through syndicated loans as they issued in corporate bonds(Graph1).^[3] By contrast, globally, the USdollar syndicatedloan market and the USdollar corporate bond market are similar in size (Lee, Liu and Viktors 2017).

This article uses a sample from Refinitiv of 4,000loans to Australian borrowers since 1984 tosummarise the features of syndicated lending and consider why firms engage in this market.^[4]

Purpose of syndicated loans

Firms use syndicated loans for a variety of purposes that can be grouped into three categories:

• project finance – including long-term infrastructure or industrial projectsthat require significant capital investment, such as projects for transport, mining operations orrenewable energy, as well as public-private partnerships to build hospitals, schools and other publicinfrastructure
• mergers and acquisitions (M&A)
• general purposes – including loans for working capital, operating expensesand capital expenditures.

The refinancing of existing loans accounts for a significant share of syndicated loan commitments,particularly when the loan is for general purposes or project finance (Graph2). A borrower maychoose to refinance debt to access more funds, extend the maturity of a loan, consolidate multiple debtsor negotiate more favourable terms. Since refinancing replaces existing debt, commitments for refinancingonly add to total debt outstanding to the extent refinancing involves an increase in the size of theloan. Commitments excluding refinancing provide a better indicator of new lending activity(Graph3).

Most of the growth in new syndicated loan commitments since 2010 has been in lending for general purposes.Commitments for project finance have been around the same level over this period, while much of thevariation in overall commitments has reflected commitments for M&A (Graph4). This variation isconsistent with research that shows debt funding in Australia is positively correlated with M&A(Connolly and Jackman 2017). The large volume of M&A in the period leading up to the GFC and around2021 involved high levels of syndicated loan commitments. Commitments for M&A also picked uparound 2016; however, this reflected a few particularly large loans for M&A rather than a materialpick-up in total M&A.

Advantages for borrowers

Large loan size

Syndicated loans allow borrowers to raise a large amount of funds with medium- or long-term maturities.The average facility in a syndicated loan is about $300million – a similar size to what firmscan obtain by issuing a corporate bond. A single syndicated loan may comprise multiple facilities withdifferent features, such as whether the loan is fixed term or is a revolving line of credit (see below).By contrast, a bilateral loan provided by a single lender to a borrower is much smaller on average(Graph5). Large syndicated loans over $1billion have accounted for about30percent of the value of syndicated loan commitments since mid-2019 (Graph6).

The size distribution of corporate bond issuance was similar to that of syndicated lending over thisperiod, with the exception of a few very large loan facilities in excess of $2.5billion. There wereno corporate bond issues of similar size by Australian borrowers between July 2019 and December 2022.

Syndicated loans typically have a shorter term than corporate bonds, which may reflect the timeframes ofthe underlying activities being financed (Graph7). Some syndicated loans are for bridging purposes(with terms less than one year); loans for M&A tend to have shorter terms than loans for projectfinance.

More accessible than the corporate bond market

Since 2010, about 1,200Australian firms have contracted syndicated loans, while about 300firmshave issued corporate bonds. Smaller firms may be deterred by the substantial fixed costs associated withissuing bonds, such as the cost to disclose information or obtain a credit rating (Pattani and Vera2011). Firms without an investment-grade credit rating typically find it more costly and difficult toaccess funding through corporate bonds than syndicated loans; only about 8percent ofAustralian borrowers in the syndicated loan market have at least one recorded credit rating, comparedwith about half of corporate bond issuers.

Flexible loan terms

About 60percent of syndicated loans comprise multiple facilities to suit the differentfinancing needs of a given borrower – for example, a borrower may include a revolving creditfacility to meet working capital requirements as well as a fixed-term loan facility to fund a long-terminvestment. Allowing for multiple facilities improves access to credit by allowing for differentcontractual terms across facilities but under the umbrella of a single syndicated loan. Facilities canhave different collateral, maturity date, interest rate, or claim priority in the event of insolvency.Larger loans tend to have more facilities (Graph8). Having more facilities in a loan, however, canincrease transaction costs, such as legal or regulatory costs (Cumming et al 2020).

Advantages for lenders

Diversification

Syndication allows lenders to share the credit risk of a large loan and avoid excessive exposure to asingle borrower or industry. Banks are subject to regulatory requirements such as limits on how much theycan lend to any one borrower, which encourages them to share exposure to a large borrower with otherlenders via a syndicated loan (Simons 1993; Gadanecz 2004). Syndication also allows arranging banks toserve more borrowers and maintain relationships with customers to whom they could provide loans or otherservices in the future.

Access to foreign markets

Alongside the major Australian banks, foreign banks are the main participants in the Australian syndicatedlending market.^[5] Foreign lenders that lack expertise in the Australianmarket can gain exposure to Australian borrowers by participating in syndicated loans (RBA 2005).Participating lenders rely on the credit information and loan documentation supplied by the arrangers.

Over the past 30years, about 90percent of syndicated loans to Australian businesses haveinvolved at least one foreign bank. During that period, foreign banks have accounted for about one-halfto three-quarters of the value of annual syndicated loan commitments. Not all of these foreign banks haveoperations in Australia; the foreign banks that do have such operations (and so report to the AustralianPrudential Regulation Authority) have accounted for only about 30percent of total loancommitments to large businesses since June 2019 (the period for which the data are available).

Asian banks have increased their syndicated lending activity in Australia in the last two decades, whilelending by European banks has decreased since its peak in 2007 (Graph9). Following the GFC,European banks pulled back from syndicated and cross-border lending more generally (Howcroft,Kara and Marques-Ibanez 2014; BIS 2018).

Efficient monitoring and renegotiation

Banks can monitor borrowers more efficiently than can the holders of corporate bonds (Diamond 1984).Monitoring is important for identifying risks to the borrower’s ability to repay the loan. Thearrangers of a syndicated loan undertake most of the due diligence when the loan is originated, as wellas most of the monitoring effort over the life of the loan (Dennis and Mullineaux 2000). Arrangers havean incentive to monitor more actively when they hold a larger share of the loan and when borrowers areriskier or more opaque. This is particularly relevant when the borrowers are private firms, for whichthere is often limited public information available (Gustafson, Ivanov and Meisenzahl 2021).

Syndicated loans typically include covenants, which protect the lenders’ interests by restrictingwhat borrowers can do. When a borrower fails to meet a covenant, a technical default occurs, and thelenders have the right to require the borrower to immediately repay the outstanding loan in full. This isthe most extreme response and generally will cause the borrower to become insolvent. Lenders mightotherwise renegotiate the terms of the agreement to waive a violation of a covenant in exchange for: afee or an increase in the interest rate; additional collateral; or tighter loan terms. With syndicatedloans, it is feasible and relatively straightforward to renegotiate loan conditions given the modestnumber of bank lenders involved in any one deal. By contrast, it is extremely difficult to change thecovenants of corporate bonds because they are typically held by many different investors (Bradley andRoberts 2015).

Loan pricing

Syndicated loans are typically issued with a variable interest rate, paying a spread against a referenceinterest rate such as the bank bill swap rate (BBSW). The spread reflects the credit risk of the borrowerand whether the loan is secured by collateral, as well as the type of loan and its term. Data on pricingare incomplete because syndicated loans are confidential, and pricing is often not disclosed. Only40percent of loan facilities by value (25percent by number) publicly reportpricing information.

Based on the available data, larger loans tend to have narrow spreads, perhaps because larger loans aretypically issued to larger borrowers that are generally less risky (Graph10) (European Commission2019). Loans for M&A typically price at a wider spread than loans for other purposes, likelyreflecting the greater risk associated with corporate restructuring; these deals often involve asignificant increase in leverage and may be more complex than other types of corporate investment.

BBSW is the most common reference rate for syndicated loans to Australian borrowers, based on availabledata (Graph11). Since 2010, about two-thirds of total commitments (and over 90percentof Australian dollar commitments) referenced BBSW. Between 2010 and 2021, USdollar loans largelyreferenced the London Inter-Bank Offered Rate (LIBOR), which had long been the primary reference rate forsyndicated loans in the United States. However, given limitations of the LIBOR benchmark, regulatorsglobally determined that market participants should cease creating new contracts that reference LIBOR bythe end of 2021 and switch to alternative reference rates (RBA 2021). Since 2022, USdollar loanshave generally referenced the Secured Overnight Financing Rate (SOFR).

Average spreads on syndicated loans were around 170–180basispoints above the relevant reference rate in 2022 (Graph12). Interest rate spreads have increasedfor both Australian and USdollar denominated loans since the GFC, reflecting several factorsincluding increased capital requirements, bank funding costs and a repricing of risks since the crisis.

Interest rates on syndicated loans are about the same or higher than the interest rates on variable-rateloans to large businesses more broadly, or on corporate bonds that receive a BBB rating (BBB+, BBB orBBB-) – the lowest rating above the threshold to still be considered ‘investment grade’.BBB-rated corporate bonds were around 150–210basis points abovethe Australia dollar swap rate in 2022 depending on the tenor of the bond. New large-businessvariable-rate loans were around 120basis points above the three-month BBSW (the standard benchmarkused to price loans to large businesses).

This comparison does not account for loan and borrower characteristics that may affect risk – forexample, riskier private firms may prefer syndicated loans over corporate bonds, and syndicated loanstend to have longer terms to maturity than bilateral loans. However, syndicated loans are not lessexpensive than bilateral loans, after accounting for loan and borrower characteristics (Cortés, Tribó andAdamuz 2020). Spreads on different syndicated loans also tend to be quite dispersed; in particular,riskier loans mostly for M&A can have spreads much higher than average.

Conclusion

Syndicated loans are a significant source of funding for larger Australian businesses, particularly forlarge projects and M&A. The market is useful for borrowers requiring larger loans, flexiblecontractual terms or access to funds in the absence of having obtained a credit rating. Lenders benefitthrough diversification, efficient monitoring and access to foreign markets.