Syndicated loans are among the most important external financing sources for firms all over the world. To give a sense of scale, according to Thomson Reuters DealScan, the annual average proceeds from syndicated loan issuances were approximately $2 trillion from 2005 to 2022.
Such loans are much larger than corporate bond issuances and several times the proceeds of equity offerings, including both initial public offerings (IPOs) and seasoned equity offerings (SEOs).
Furthermore, the growth of the market has clearly dominated that of the bond and equity markets, especially since the 2007-2009 global financial crisis. While typically only large and public firms have access to the bond and equity markets, borrowers in the syndicated loan market range from large public corporations to medium size private entities.
Almost every large merger and acquisition deal is financed by syndicated loans. For instance, Elon Musk, the current CEO of X (successor of Twitter) issued a $25.5 billion syndicated loan led by Morgan Stanley (participant lenders included Bank of America and Barclays) to buy Twitter in April 2022.
Private equity firms are also frequent borrowers in the syndicated loan market. In July 2023, one of the largest private equity investors in the technology industry, Silver Lake, raised about $1.1 billion in a syndicated loan arranged by JPMorgan, Citigroup, and Santander to fund its takeover of a German company Software AG.
Some firms also tap the syndicated loan market to raise finance for general corporate purposes. In May last year London-based data centre business AtlasEdge raised $900 million from a syndicate of banks including ING Bank (the lead arranger), Scotiabank, NatWest, Santander, and UniCredit Bank for a cross-border expansion strategy.
Although syndicated loans are not securities that can be issued to public investors, they use the same book-building process in the primary market as issuing stocks and corporate bonds.
For instance, after a bank wins the lead mandate it will prepare an information memo (IM) that includes a preliminary term sheet describing pricing, collateral, covenants, and other credit terms. The lead bank then distributes this IM to potential investors to solicit demand and each potential investor performs its own credit analysis and comes up with the amount and price at which it is willing to commit.
If the loan is under-subscribed, the lead bank will need to sweeten the deal by increasing the yield-to-maturity (YTM). If the loan is over-subscribed, the lead bank would reduce the YTM. This so-called ‘book-building’ process continues until pricing is agreed upon and all investors’ allocations are finalised.
This practice creates an interesting trade-off for a lead bank. On the one hand it could conduct its own due diligence about a borrower to reduce the need to collect information from other investors. On the other, it could spend less time on due diligence and rely on information from other investors with a cost.
A recent paper* I co-authored Lending Relationships and the Pricing of Syndicated Loans, which is due to be published in Management Science, examines how this trade-off affects the pricing process and borrowing costs for syndicated loan borrowers.
We find that a lead bank that has a stronger prior lending relationship (measured as the percentage of loans arranged by the lead bank out of all the loans by the borrower within the past five years) with a borrower relies less on information from other syndicate members and selects fewer participant lenders that have relationships with the borrower. As a result, the size of the yield-to-maturity (YTM) adjustment is smaller during the pricing process. We also find that a stronger borrower-lead bank relationship reduces loan underpricing - the first secondary market trading price (higher than the offer price) minus the offer price.
What our study therefore suggests is that collecting information from other investors can be exceptionally expensive for syndicated loan issuers. And ultimately, borrowing from relationship banks could save millions of dollars for borrowers in the primary market of syndicated loans.
*Yafei Zhang co-authored the paper ‘Lending Relationships and the Pricing of Syndicated Loans’ with Donghang Zhang from the University of South Carolina and Yijia (Eddie) Zhao from the University of Massachusetts Boston.