Syndicated Lending 7th edition

Practice and Documentation

Mark Campbell, Christoph Weaver

• Publisher: Harriman House
• Year: 2019
• ISBN:
  9780857196835
• Topic: Business
• Subtopic: Corporate Finance
• Index: Business

This fully revised, updated and expanded edition of the industry standard text takes the reader through the complete life cycle of a syndicated loan. Beginning with the opening phase of mandating a lead bank, Syndicated Lending delves through negotiation, documentation, syndication and closing transactions to conclude with the secondary market.This seventh edition includes new supplements dealing with:•regional syndicated loan markets•growing regulatory framework•the influence of Brexit on the market•the challenges thrown up by the transition from LIBOR-based pricing to the proposed risk-free rate environment.The practice of syndicated lending is similarly explored in its historical context, by following the ups and downs of this most flexible, and enduring, financial market. Plus, while the market moves toward digitisation, summaries are provided for the leading technology solutions being developed.With practical explanations, reflecting practices developed by the LMA, from borrowers, bankers and investors, this book offers insight from industry professionals with decades of experience as well as detailed examples of pricing methodology. There is also an up-to-date discussion of documentary issues, including annotated term sheets and loan documents, contributed by Clifford Chance.This is the essential guide to the commercial and documentary aspects of syndicated lending for lenders, borrowers, investors, lawyers, regulators and service providers.

Chapter 1: The Creation and History of an Innovative Market

The creation of the market

In looking at the origins of the international syndicated loans market, the creation of the Eurodollar, the currency used in the embryonic phase of that market, deserves a brief mention.

Dollars have been used by banks based in London and in various other centres to finance international trade for many decades. The dollars used for these purposes were held in US bank accounts, but, as they had non-US ownership (at first, principally European), they became known as Eurodollars.

The offshore dollar market developed and grew in the late 1950s, particularly as a means of financing foreign trade. This market was given tremendous impetus as the risks incurred by certain sovereign borrowers, of holding dollars in the US, became apparent. A dramatic example occurred during the Suez Crisis of 1956, when the US Treasury invoked the Neutrality Act and froze the deposits of the participants in the conflict. Although this was lifted within a few weeks, it had a lasting effect, particularly on the depositors in the Middle East who became converts to the external dollar market. The need for a sophisticated offshore market received another boost when the Soviet Union and others of the Eastern bloc countries recognised the risks associated with the holding of their dollar balances in New York during periods of international tension.

Some would argue that 1958 was the founding year for the Eurodollar as it was during that year that non-convertibility, the last remaining impediment to the growth of the Eurodollar market, was removed. Thereafter it became possible for non-US residents to hold dollar balances, and the major European currencies became freely convertible into dollars. This, 14 years after the event, was the final major provision of the Bretton Woods Agreement to be implemented.1

Development of the market

Eurodollar availability represented only one-half of a market. Suitable uses for the offshore currency were needed as well. For the market to develop to a significant size, both borrowers and lenders of the newly available Eurodollar deposits had to squeeze into the existing rate structure for dollar denominated deposits and loans available in the well-established US money and capital markets. Soliciting, and then lending Eurodollar deposits, on the basis of an agreed margin over deposit rates provided the basis for the development of a profitable deposit and loan business, which had, at the same time, to be at a competitive all-in cost for borrowers when compared with alternative sources of finance.

Further momentum for the development of the Eurodollar market as the foremost source of international finance came from other directions. In 1964 the Interest Equalisation Tax Act was enacted; it sought to discourage foreign borrowers from tapping the US capital markets, principally in order to assist the US balance of payments but also to encourage Europeans to establish indigenous and reliable sources of long-term finance. The US also introduced the Voluntary Restraint Programme of 1965 and the Foreign Direct Investment Act of 1968, both of which were designed to make a favourable impact on the US Balance of Payments. Opinion is divided as to their effectiveness for this purpose, but without doubt they served to provide an added incentive for the development of a permanent market for offshore dollars free from control of the regulatory authorities.

International banking, particularly the syndicated loan market as we now know it, therefore had its origins in the 1960s. The birth of the Eurodollar and the development of the cross border interbank market gave rise to an opportunity to bring together lenders from different geographical origins into syndicates to participate in loans with a common funding basis and on common terms and conditions. As Paul Einzig explained:

‘the critical feature in the evolution of the market was the development of a system of raising medium-term credits with adjustable interest periods. Instead of fixing the interest rate for the entire period of a credit, it is adjusted from time to time, on the basis of pre-agreed intervals, to reflect the ever-changing market rates on interbank deposits’.2

This highlighted one of the most imaginative and important mechanisms of the new market. The most common funding basis known as LIBOR (London Inter Bank Offered Rate), was the rate at which time deposits were offered by banks to other prime institutions in the financial marketplace. The popular name for such credits, whether granted by single banks or syndicates, was ‘roll-over loans’ because, even though they might be granted for a period of years, they were automatically renewed on modified terms every six months (or other agreed period) when the underlying interest rate (LIBOR) was re-set. The loan, which was thereby rolled over from one interest period to the next until it matured, achieved a flexibility and appeal hitherto unavailable to borrowers.

With LIBOR accepted as the basis rate off which loans could be priced, various borrowers and banks worked together to establish appropriate market practices for arranging medium-term loans for borrowers of differing credit standing. The method adopted was to arrange the rollover loans with their floating (variable) rate of interest and to add to this a margin which would reflect the credit risk of the borrower. By this means, all banks, able to fund themselves in the marketplace at LIBOR (or less), could participate in a loan which used this rate as the basis rate.

LIBOR was subsequently used not just as a basis for interest rates on loans, but also as a key part of the mechanism for huge volumes of derivatives contracts and the subsequent history of the LIBOR rate is dealt with later.

The early loans were nearly all denominated in US dollars which was by far the best developed Eurocurrency. However, as confidence grew, other currencies became available and the market started to permit borrowers to change the currency of outstandings periodically during the life of the loan, thereby creating the multi-currency loan.

Early documentation for syndicated loans was, by modern standards, concise in the extreme: the $1bn syndicated loan arranged by S.G. Warburg for Ente Nazionale per L’Energia Elettrica (ENEL) in 1973 was documented on a mere eight pages. The market has become more sophisticated since that time, so much so that, reflecting the better appreciation of the risks involved in Eurocurrency lending, it is now most unlikely that a full loan agreement can be covered in less than 75 pages using normal fonts. This documentation will also cover the increasingly varied options that are included in syndicated loans, which currently are required to accommodate multi-tranche, multi-currency, multi-purpose, multi-option and multi-borrower situations.

The petro-dollar

Given that borrowers and banks were working on the development of both the market operation and the documentation of syndicated loans, it was with enthusiasm that the banks took on the job of recycling the proceeds of the oil price rise in 1973. The price of oil quadrupled over a short period of time, but some of the oil-producing countries did not have the capacity to deploy the revenues immediately in their domestic markets. International banks therefore became the recipients of massive dollar deposits (petro-dollars) from these countries and in turn were forced rapidly to look for suitable lending opportunities. Not surprisingly, the oil-importing countries were faced with huge deficits on the oil account due to the large increase in price; as a result, these sovereign states became the borrowers that the banks were so actively seeking. A cycle therefore developed with the oil-producing countries generating unprecedented surpluses on the oil account and depositing a substantial proportion of their revenues with the international banks who then lent the money to the oil-importing countries to pay their bills to the oil producers. This simplified picture of the recycling process illustrates vividly the intermediary role which the international banks so successfully played in circumstances which they had not encountered before.

The seeds of a lending disaster, however, might have been detected in the borrowing activity of the oil-producing countries with large populations and other natural resources. Using oil reserves to support their credit-worthiness, these countries borrowed heavily to finance their infrastructure and natural resource projects.

Countries which were particularly active in this respect included Venezuela, Mexico, and Nigeria but, by the mid-1980s, after a collapse in the oil price, they were all in the process of restructuring their foreign debt.

The sovereign debt crisis

Problems in eastern Europe

The borrowing activity of sovereign borrowers in the syndicated loan market was at its peak during the late 1970s and early 1980s. The common view of international bankers was that sovereign borrowers could not fail, and this view was expressed publicly by the senior executives of some of the major lending banks. The 1980s were to tell another story altogether. First there was the crisis in eastern Europe which arose when banks and other institutions became nervous of further lending to the Soviet bloc and its satellites because of the sheer size of their international debt, a problem brought into vivid focus in late 19...