A syndicate loan is a loan made available to a single borrower by a group of lenders. The lenders work together to provide funds for a borrower. This kind of loan is mainly used for large-scale financing needs of an individual.
The need for such a borrower would be difficult for a single financial institution to handle alone. Such huge loans may be needed by major corporations involved in big projects. These projects are mostly large infrastructure undertakings, or huge capital expenditures in industrial or agricultural ventures. A single borrower may also apply for loan from a single lender, which is the major modality of accessing fund from financial institutions in Ethiopia.
For multiple lenders the loan is provided by a group or syndicate of banks or financial institutions. Each of these institutions contributes a portion of the total loan amount required by a single borrower. Such a borrower is normally engaged in huge investments in different sectors of the Ethiopian economy. The borrower may also be engaged in a huge investment in a given sector only. The borrower may be a joint operator of activities in collaboration with other investors in a variety of activities.
A borrower accessing syndicate loan is required by law to enter an agreement with the lenders. Despite having several lenders, there is one common agreement that determined the terms and conditions of the loan. This precludes different interpretation of the agreement by the parties to the loan. A common loan agreement prevents a waste of time caused by misinterpretation of a clear and objective contract. This is a wise strategy in keeping litigations at bay.
This enables focusing on the implications of a clear and objective loan agreement by its signatories. In fact, there are only two parties to such an agreement and these are the borrower and the syndicate lenders or financial institutions. This is a lesson to be applied by all Ethiopian banks when handling syndicate loans, if there are any.
It seems that most borrowers in the country are looking for funds only to supplement costs of projects already underway. These may be called marginal borrowers whose need may be satisfied by a single lending institution.
Furthermore, funds are to be released at different stages based on certificate of performance approved by inspectors of the lending institutions. No fund is given to the borrower in lump sum at once without periodic performance of work. This requires work plan that is agreed upon by both the lenders and the borrower. The work plan shows project activities with agencies responsible for implementing them. It also indicates the time span and persons responsible for each activity. The plan shows the monitoring and evaluation (M&E) of project activities. Based on M&E, low performance and failure to fulfill project objectives lead to strict measures by the Ethiopian financial authorities on the person responsible for underperformance. If there is failure in achieving projects, this indicates abuse of funds borrowed from the financial institutions. Failure in performance of bank financed projects has to be immediately corrected before the next round of releasing fund. In this way, financial institutions prevent abuse of syndicate loans provided to an implementing agency or individual borrower.
Syndicate loans are closely checked by financial inspectors based on agreements signed by the lenders and the borrower. Inspection takes place in line with program of project implementation by a borrowing enterprise. Syndicate loans may be inspected by lending institutions through joint team of inspectors. Each lender will have to assign its inspector to the team to ensure the safe performance of the syndicate loan. Inspection report is written jointly by inspectors representing their specific lending institution.
The joint report guarantees that the syndicate loan is used by the borrower as per the agreement they entered into. Any loan performance should be checked against agreed framework that guides periodic activities of the borrower. Any digression of project activity has to be reported to the lending syndicate before it is too late to take immediate actions for correction. The lending community believes in the saying that “a stitch in time saves nine.” In other words, errors have to be corrected in time before they go out of reach.
Initially, a syndicate loan requires a lead arranger or lead banks or underwriters who are appointed to coordinate the loan. Representing the lenders, they are authorized to negotiate terms and conditions with the borrower. Usually, the lead arranger is entitled to take on the major share of the loan and conducts the administrative duties and tasks. “Lead banks” or other financial institutions pledge to buy all the unsold shares in an issue of new shares. The issues are guaranteed success as the “underwriters” will buy whatever is not sold in the market.
These banks and underwriters coordinate the syndicate loan to be provided to the single borrower. Of course, all single borrowers may not be successful in their enterprises and may fail to meet their obligations of paying back the loan. Taking the experience in Ethiopia, there is a risk of default by the borrower due to unforeseen circumstances. This risk is spread among several syndicate lenders. Risk sharing is, therefore, expected for several reasons.
The borrower may be facing shortage of productive inputs for the production of goods and services. The borrower may not be in a position to employ much needed skilled workers within the country. There may be lack of knowledge of what the consumers need both at home and abroad.
The markets may be highly competitive, making prices lower, causing concern for the borrower who invested in the home country. This situation may not be conducive for single producers who started business by borrowing from syndicate lenders. The borrower may face the risk of default which is spread among all the syndicate lenders. However, the exposure to such risk is shared by all lenders. Individually, the syndicate financial institutions involved face lesser risk of default by the borrower than a single lender. If there is any such opportunity in the Ethiopian financial institutions, the borrower will be a beneficiary of diversified financing. A single borrower benefits from accessing a larger amount of capital with more favorable terms. This situation reflects the competitive nature of the syndicate lenders.
The syndicate loan process mainly involves mandate, information, syndication, documentation and disbursement. The borrower may mandate one or more financial institutions to arrange the loan. The mandated bank may define the terms and conditions of the syndicate loan. It also arranges for the transfer of loan to the borrower based on the agreements entered. In case of default, the bank takes immediate legal action against the borrower as experienced in Ethiopia. The mandated bank is also accountable if it fails to take immediate action against a defaulter.
However, it takes into consideration the reasons that forced the borrower to fail in fulfilling his/her obligation. If the reasons for the failure of repayment of debt are acceptable by the syndicate, the modality of loan payment may be adjusted to the reality. However, such decisions have to be based on strategic information that covers the real situation regarding the ability of the borrower to design a project with its implementation modalities.
The decision on the syndicate loan is also based on the analyses of economic and social environment in which the loan is offered to the borrower. The capacity of the borrower to face unforeseen challenges in the process of production and marketing is also analyzed. All these and other situations are taken into consideration by the syndicate lenders to minimize default by the borrower. Also, the loan arrangers prepare detailed information regarding the financial status of the borrower.
This information shows the project details and the purpose of the loan. Those who arrange the loan also invite other banks to join the syndicate. They are required to be committed to providing a certain portions of the loan. Of course, the loan agreement is documented as a legal one. Also, other related documents are finalized and signed by all parties involved, including the borrower and the lending institutions.
After the loan agreement is finalized and documented, the process of disbursement follows. The loan funds are disbursed periodically to the borrower according to the agreed terms. Any breech in this process is illegal and the upset and disturbed party may be compensated. Syndicate loans are mainly and commonly used by large enterprises or corporations.
This loan is also used by governments to fund various development projects. These projects may be derived from long-term development plans of the governments. The syndicate loans may be used to finance these projects provided that the repayment of loan is fully guaranteed by the borrower. Also, project developers ensure effective implementation by assigning efficient managers.
Similarly, private entrepreneurs are given the opportunity to access syndicate loan for financing project activities. This loan may be used to fund significant and complex projects in any sector of the Ethiopian economy. The financial institutions in Ethiopia may have to provide syndicate loans to individual borrowers engaged in huge investments in different sectors of the economy.
BY GETACHEW MINAS
THE ETHIOPIAN HERALD WEDNESDAY 3 JULY 2024
