Syndicating the Loan. Loan syndication is essential in most deals from the middle market up to large cap. Most banks cannot afford to hold an entire loan to term, nor do they really want to. The syndication of the loan allows the bank to sell down their holding to a manageable amount to other banks, known as the bank group. Banks pitch to be the lead arranger on a deal. If the deal is big, the lead is sometimes split into co-arranger roles. In a smaller deal, this would be the agent bank. One of these arrangers or co-arrangers will also be the documentation agent and the administration agent. They will handle the paperwork and ensure that the interest and principal get back to the lending banks. The major types of syndication are an underwritten deal in which the lead bank or banks assume most risk and take on the entire issuance with the expectation that they will place the loan successfully via syndication. There's also a best-effort syndication used for complex loans or risky credits. In this case, the lead bank will only commit to raising what it can via syndication. The bank group are the banks that help take the larger loan off the arranger's books. Depending on the size of the bank's commitment, they may be awarded the title of co-arranger. This is merely a title for prestige without any economic significance to reward those banks for making large commitments. Below that are often smaller banks with either a connection to the borrower, perhaps a geographical or regional connection, or they might also feel obligated to be in the bank group due to a past relationship with the borrower. However, they don't particularly want a large piece of the deal and therefore contribute a smaller amount. A final type of underwritten deal is called a club deal, and that's a small loan offering with a handpicked group of banks. Similar to the equity markets, loan origination is referred to as the primary loan market. While banks still drive the middle market and investment-grade unsecured loan markets, institutional investors have come to dominate the syndicated loan market, particularly when involving secured loans. Institutional investors are mutual funds or prime funds that are looking for better returns, they can also be hedge funds or privately managed credit funds in CLOs, or collateralized loan obligations. Financial companies make up a small portion of the funding. They are non-depository companies that often specialize in specifically asset-backed loans. This is only in the US as asset-backed loans have not spread in popularity in Europe or Asia. CLOs use funds received from the issuance of debt and equity to acquire a diverse portfolio of senior secured bank loans made to businesses that are rated below investment grade. The bulk of CLOs underlying collateral pool is comprised therefore of first lien senior secured bank loans, which rank first in priority of payment in the borrower's capital structure. In addition to first lien bank loans, the underlying CLO portfolio may include a small allowance for second lien and unsecured debt. As senior secured claims, these loans enjoy the senior most claim in all the related company's assets in the event of a bankruptcy and represent the least risky investment in these companies. The CLO then creates debt and equity securities which are sold in tranches where each CLO tranche has a different priority of claim on the cash flow distributions and exposure to risk of loss from the underlying collateral pool. Cashflow distributions begin with the senior most debt tranches of the CLO capital structure and flow down through the bottom equity tranche. This is a distribution methodology that is referred to as waterfall. Like the capital markets, loans are made or originate in the primary market and are then traded in the secondary markets by commercial banks who act more and more like portfolio managers or traders than commercial bankers. Borrowers do not always like having their lending group trading their debt away, although, more and more, this is the way of the finance world. There are two ways for a lender to sell down a position. The first is via assignments. The assignee becomes a direct signatory of the loan and now receives interest in principal from the admin agent. The arranger will often charge a fee to assign a loan but will waive the fee in order to get the loan trading business. One thing to note here is that due to complex tax laws, CLOs cannot buy loans in the primary markets so they receive what are called primary assignments, which are technically in the secondary market. A second way to sell down a loan is through participation. In this case, the original lender transfers the economic interest in the loan to a buyer, but the borrower remains obligated to the originating lender. This is riskier for the institution accepting the participation as there is no direct claim in case of a default. Loan trading is complex, particularly compared to bonds which have fixed rates and time periods. To price loans which can be repaid at any moment, traders use a yield to a theoretical call with a three or four-year average life.
