Difference between loan syndication and a consortium

In this article, Gupta Shubham pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses the Difference between loan syndication and a consortium.

Before going into the details and for better understanding, a rough idea about the concepts of Loan Syndication and Consortium is necessary. “A setup in which group of individuals or entities decides to pool resources towards fulfilling a debt or financing a single borrower wherein the setup is governed by a legal contract that delegates responsibilities among its members, is known as Consortium” whereas a Loan Syndication is somewhat a similar process, the term is generally reserved for loans that involve international transactions, different currencies and a necessary banking cooperation to guarantee payments and reduce exposure, this setup is headed by a managing bank that is approached by the borrower to arrange credit.

Loan Syndication

Syndicate as term in general sense has originated in the U.S. Loan Syndication refers to a lending process wherein a borrower approaches a bank for a loan amount that is comparatively heavy and also involves international transactions and different currencies. Here, as and when a bank is approached by a client for availing a loan, the said bank fixes up the interests and other borrowing terms and conditions of the loan with the client and itself approaches other banks for selling of this loan. The other banks, if agree, “Purchase” a part of the loan on the same or different terms and conditions. In a Loan Syndication process, the client deals with one Bank only. The bank approached by the borrower to arrange credit is referred to as Managing Bank that is responsible for negotiating conditions and arranging the loan amount. Here it is important to note that the Managing Bank need not be the “Majority lender” or “Lead bank” but only plays the role of manager in arranging the loan amount in association with other banks. Depending on the terms and conditions of the agreement any bank can play the role of Managing Bank. The lead bank acts as recruiting bank of other sufficient banks in the process of producing of loan, negotiating the terms, negotiating details of the agreement and preparing documentation. The bank that is awarded/ given the mandate by prospective borrower and is responsible for placing and managing the loan process, its terms and conditions and finalizing the same is known as Lead Manager, Lead Bank, Syndicate Bank. They are entitled to arrangement fees and undergo a reputation risk during this process.

The banks that participate in process of lending a portion of total loan amount entitled to receive interest and participation fees are Participating Banks.

Syndication may be termed as Secondary Intermediation between the borrower and other Financial Institutions.

The manager/lead bank is responsible for repayment and disbursement of the loan amount and also for providing the borrower’s financial statements to the banks involved in the syndicate lending process. The manager/ lead bank is paid a fee by the borrower for these services. The Managing bank may hire one or more other banks as co-managers to assist in the process, who share in the fee in return for helping with the manager’s duties.

A research paper on “Why do banks Syndicate Loans?” by Katerina Simons, has found no evidence that lead banks exploit participating banks by persuading them to take a larger share of inferior loans. For better understanding article can be referred to at:https://www.bostonfed.org//media/Documents/neer/neer193c.pdf

A borrower takes resort of Loan Syndication for Working Capital credit, Export Finance, Capital goods financing, Mergers and Acquisitions, Project Finance, Standby facility, Trade finance, guarantees etc.

Advantages

1. Allows the borrower to access from diverse group of financial institutions.
2. Saves funds. The interest rates, other terms and conditions are agreed upon by one bank that has to approach the pool of banks for the loan; this process saves money and time on part of the borrower.
3. Raise substantial financingfacilities on pre-agreed terms which would exceed the capacity of any single bank

Disadvantages

1. Each bank has to come to an understanding about business and how its financial activities take place.
2. Comfort level must be arrived at, that requires time and effort.
3. Negotiating the documents and other terms with one bank takes days. Here the borrower has to negotiate with numerous banks and is time consuming.

Consortium

There arise cases where a borrower approaches a bank for huge loans; this high amount means high risk to a single lender.  In such cases banks resort to a lending mechanism known as Consortium to reduce the risk involved in the Loan Process. A consortium is successful where it is not possible for a single bank to finance the loan amount to the borrower; it has nothing to do with international transactions unlike Loan Syndication, simply the loan amount is too large or risky for a single lender to provide.  Consortium financing occurs for transactions that might not take place with a single lender. Here when a borrower approaches a bank for loan, several banks club together to supervise the said loan amount.  A common appraisal, documentation, joint supervision and follow-up play the key role.

These banks have a common agreement between them. Sometimes the participating banks form a new consortium bank to look after the process of funding of loan, leveraging assets from each institution and ultimately disbanding after completion of the project. The lender who has taken the highest risk (by giving the highest amount of loan) acts act as a leader and administers all the transactions, agreements etc. between the consortium and the borrower. The consortium agreement is a crucial document and not easy to draft. It must be clear on the rights and obligations of the parties, which need to be focused firmly on the purpose of the consortium.

Advantages of consortium

1. No capital is required to create a consortium.
2. Ease of formation, no formal procedures need to be followed.
3. It is easy to terminate because it can be set to expiry on a particular date and happening of an event without any formal requirements.
4. It is easy to terminate, can be set to expiry on a given date or on the occurrence of certain events without the formal requirements needed in the case of dissolution of a corporation.
5. The individual members are subject to tax and not the consortium.

Disadvantages of consortium

1. A consortium member can’t restrict or limit its liability. Members may even become liable to third parties for the non-performance of other members of the consortium or the debts of such members incurred in undertaking the common project.
2. Third parties often find it difficult to enter into contract with a non-legal entity like a consortium. Because it is a non-legal entity funding is also normally only available to the individual members and not the consortium itself. So it becomes difficult to maintain External relationship and funding.
3. The lack of a permanent structure makes it difficult for a consortium to establish long-term business relationships with third parties.

Role of Lead Bank in Consortium

1. Conducting consortium meetings.
2. Obtaining of necessary documents, clarification etc. from the borrower.
3. Making arrangements for joint appraisal of loan proposal by all member Banks. Preparation of joint appraisal report and sending the same to all member Banks and finalization of decision after discussions.
4. Fixing and Deciding of Loan limit.
5. Custody, Verification of documents, securities etc., on behalf of itself and consortium Banks.
6. To maintain mutual interest between consortium Banks and term loan lending institutions, making correspondence with National/State level Financial Institutions.
7. Obtaining stock statement and other legal obligations every month and ensuring maintenance of adequate stock for the loan.
8. Passing on recoveries on pro rata basis to the entire consortium Banks.
9. Ensuring of all transactions by borrower through Cash Credit A/c maintained with the Lead Bank and that the utilization of the loan advanced is only for production activities.

Role of Consortium Banks

1. Participating in consortium meetings and using their expertise in the general interest of consortium.
2. Authorizing the Lead Bank to take decision in the interest of consortium Banks.
3. The Consortium Banks are not supposed to demand the loss incurred and change their lending share without obtaining prior approval from the consortium members.
4. Act in accordance with the terms and conditions agreed upon between the Lead Bank and other banks.

Faced with higher defaults, banks have become more cautious on non-investment-grade corporate loans. They have started pushing more corporate loan accounts to enter into consortium lending arrangements, to improve the access to information and avoid surprises.

Conclusion

To conclude, every syndicate is a consortium, but not every consortium is a syndicate. When it comes to loans, the big difference (in my opinion) is when the lender cannot repay. With a consortium the lender can repay one bank and fail on another. With a syndicate there is only one loan, the lender will have to fail on the whole loan which may create legal complexities and make the borrower face other legal consequences. They may look alike and both the terms are used as synonyms to each other yet there exist technical differences when it comes to operations, procedures, relationships, legal complexities etc.

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