The sub-prime crisis dominated the headlines for the latter half of 2007, with financial institutions across the financial services sector assessing the continued impact into 2008 and beyond. In commercial lending, following a decade of strong growth, the market faces more challenging times ahead.
Large write-downs have reduced the capital available to banks, which in turn has limited their willingness and ability to lend. As a result, the syndicated loan market may gain strength as the appetite among the smaller players for a larger share of the lending market and the need to spread the risk involved in lending deals has increased.
Following the advent of the sub-prime crisis in 2007, the industry has largely lost trust in the asset-backed securitisation model. In addition, the continued trend for mergers and acquisitions is having an effect on the number of deals, with increased competition for fewer deals at a higher value.
With the limited availability of funds and the increasing cost of interbank short-term lending, smaller financial institutions are facing the challenge of finding the funds to continue to grow their portfolios of deals. Although committed and existing funding lines can go some way to addressing the issue, syndication among banks is becoming an increasingly attractive tool. With its distinct advantages, this could partly replace the securitisation of commercial mortgages across all tiers of the commercial lending sector.
For the larger firms, it is an attractive option to enable them to spread the risks, albeit to a smaller group than with asset-backed securitisation. For the small and medium-sized firms, in addition to the benefit of reduced risk, participating in syndicated deals is a particularly effective way to build their portfolio within commercial lending. This allows several banks to be a part of a larger and otherwise unobtainable deal.
Syndicated loans played a valuable role in the growth of the commercial lending market, providing opportunities outside of the smaller commercial deals that are better served through bilateral loans. With the market’s international scope, the only limitations have traditionally been the institutions’ own knowledge or appetite for risk, rather than any national and regional boundaries.
A key factor in the future of the market is the differentiation between the impact of the credit crunch on the securitisation and the syndicated lending markets. Early indications are that the syndicated market is not as badly hit, largely because it provides greater transparency into the deals and the lending security. In addition, participants are dedicated professional players in the commercial lending space compared with the more diverse skill-sets under the securitisation model.
However, in order to evaluate and manage the risk involved in syndicated lending, firms must put in place efficient business controls and risk analysis tools. This is of particular importance given the complex nature of the name lending and project-related deals that are commonplace in this market.
The management of syndicated loans is often a manual process. This is particularly the case in smaller firms which can rely heavily on spreadsheets to set up and administer the loan. However, with little or no control over user access and change management, spreadsheets lack the traceability, accountability and overall business controls to ensure the firm can efficiently maintain and service the loans. It is also important for firms to have the flexibility to quickly make changes to the syndicate. Greater business controls in syndicated lending enables the lenders to be confident that they are adhering to regulations embedded in the system to lessen any potential risks.
Another key consideration is the management of information. Often the loan data is not captured in a sufficiently structured way among participant banks. This fragmentation is magnified when the various lending officers set up their own models to manage the loan, leading to a lack of organisational process.
As the greatest value lies in being the loan arranger, the issue of business control becomes of even greater importance for these firms. To support this role, a firm needs systems that are sophisticated and highly controllable, with excellent reporting capabilities and real-time responsiveness. Without these features in place, it risks being non-compliant with regulations such as the IRB element of Basel II. As an agent bank, the firm also has an obligation to the syndicate, such as in the insurance of assets and covenants, all of which must be followed up and failure to do so will expose the bank to risk.
With syndicated loans presenting an attractive alternative to the decreasing securitisation model, it is likely that small and medium-sized lenders will turn to them more frequently as a means to fund new commercial loans and spread risk. As such, they will play an increasingly important role in the corporate finance mix, alongside equity capital and bilateral lines with relationship banks.
In order for firms to succeed in this area, they will need to review their legacy systems and deploy effective business controls to ensure that both regulatory and the syndication requirements are met.