A loan syndication is when a group of lenders join together to make a large commercial loan to the borrower. To the borrower, the loan is from one lender, so one lender acts as the originator for the loan. Behind the scenes, though, the loan is held across several lending institutions, which reduces the amount of risk of default for each of the lending institutions involved in the transaction.
Primarily, a syndicated loan is used by large corporations in the United States and Europe. The corporations approach one lender and get the lender to work as the corporation’s agent to help it raise the money or capital it needs for a specific business purpose. The lender responsible for arranging the large loan and acting as liaison between the borrower and all of the lenders earns a fee for its services, similar to how a mortgage broker in a residential or consumer transaction receives a fee for providing loan-seeking services.
Three types of lending institutions are involved in loan syndication. These institutions include commercial finance companies, banks and institutional investors. In addition, three types of loan syndication underwriting situations exist: underwritten, best-efforts and club.
In an underwritten loan syndication, the lender that the borrower approaches is the institution that makes the loan. After the loan closes, the lender then syndicates, or sells portions of the loan to other lenders to spread out the risk of the large loan amount among various lenders rather than holding the entire obligation on its own books.
Best-efforts syndication occurs when the lending group originating the loan does not agree to fund the entire loan amount but instead agrees to a portion of the loan amount requested by the borrower. The most common use of a best-efforts syndication loan is when the borrower has bad credit or poor credit. In some situations, the deal might not close, because the borrower needs the entire loan amount, but in other cases, the borrower takes the amount that the syndication group agrees to lend.
In a club syndication deal, the group of lenders works together up-front on working out the details and approving the loan. In a club syndication, all of the lenders involved split the loan amount and the fees charged to the borrower equally or nearly equally. These typically are smaller loans than those involved in underwritten syndication or best-efforts syndication.
