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Debt Syndication

By Neeraj Basur, CFO, Blue Star

Business enterprises need capital in the form of equity or debt to meet various requirements.  Depending on the business fundamentals, finance managers evaluate funding options and decide on an appropriate debt/ equity mix and composition. Consistency and predictability of earnings typically determine the ability of a business to service the cost of funding, be it equity or debt. An entity with proven earnings track record and a robust business model would find it more attractive to leverage financially and generate higher returns for its shareholders.

Providers of debt financing find it quite comforting to lend money to an entity where they have experienced consistency in servicing interest and timely repayment of principal. Their appetite for risk-reward trade off typically determines the cost of debt that the lender is usually willing to charge.

Alternate debt financing options

Depending on the deployment needs and the duration of funding, debt financing could comprise of term loans, working capital loans, receivables financing, bonds, commercial paper, debentures, deposits etc. 

Foreign currency borrowings in the form of external commercial loans, buyers’ credit, suppliers’ credit, floating or fixed rate bonds are also available. External commercial borrowings are generally cheaper in terms of costsince interest rates on these borrowings tend to be linked with LIBOR. However, true cost comparison for external commercial borrowings is best done on a fully hedged basis to alleviate currency depreciation risk for the borrower.

Need for debt syndication

One of the mechanism for raising borrowings is through the debt syndication platform. Syndicated loans are now steadily finding favour with many Indian firms who need large sums of money to finance new projects but may not wish to raise funds through equity for strategic reasons. Some may not be able to raise money through bonds for lack of a suitable credit rating.

Loan syndication is the process of involving several different lenders in providing various portions of a loan. Loan syndication most often occurs in situations where a borrower requires a large sum of capital that may be outside the lending appetite for one single lender or outside the scope of a lender's risk exposure levels.A syndicated loan is by a group of lenders (called a syndicate) who work together to provide funds for a single borrower. The loan may involve fixed amounts, a credit line, or a combination of the two.

Debt syndication categories

Globally, there are three types of debt syndication: an underwritten deal, best-efforts syndication, and a club deal.

An underwritten deal is one for which the arrangers guarantee the entire commitment, then syndicate the loan. If the arrangers cannot fully subscribe the loan, they are forced to absorb the difference, which they may later try to sell to investors. A best-efforts syndication is one for which the arranger group commits to underwrite less than or equal to the entire amount of the loan. A club loan is a form of multi-bank financing whereby several banks lend to the same borrower on materially the same terms (other than pricing), but there is no bank syndicate or facility agent, and the participant financersare usually self-arranged by the borrower. Consortium banking is one form of debt syndication.

Why go for debt syndication?

Syndicated loans are win-win for both lender and the borrower. For example, some of the large financing deals in India in last one decade were syndicated – project financing for large power plants, large refineries, steel plants and funds raised for acquisition financing. Some large debt syndication have been done in the recent past by Bharti, Essar and Tata Groups. Financing these deals would have been a nightmare for single lender considering the quantum and risk associated. Equally, it would be cumbersome and long drawn process for borrower to individually approach multiple lenders. Income generated from arranging syndicated loans now account for almost half of the country’s investment banking revenue, unlike in major economies where debt capital market and mergers and acquisitions account for bulk of the fees.

Using debt syndication to expand corporate debt market in India

Traditionally, the equity market in India has been quite active and the size of corporate debt market is very small in comparison with developed markets and also emerging market economies in Asia. A liquid corporate debt market can play a critical role by supplementing the banking system to meet the requirements of the corporate sector for long-term capital investment and asset creation as well.

According to Securities and Exchange Board of India database, outstanding corporate bonds amounted to Rs. 19 trillion, around 14% of GDP. In contrast, outstanding corporate bonds are close to 90% of the GDP in the US where the corporate debt market is most developed and bond market financing has long replaced bank financing as a funding source for the corporates; around 34% in Japan and close to 60% in South Korea.

Development of the domestic corporate debt market in India is thwarted by a number of factors, the prominent ones being low primary issuance of corporate bonds leading to illiquidity in the secondary market, narrow investor base, high costs of issuance, lack of debt market accessibility to small and medium enterprises, dearth of a well-functioning derivatives market that could have absorbed risks emanating from interest rate fluctuations and default possibilities, excessive regulatory restrictions on the investment mandate of financial institutions, large fiscal deficit, high interest rates and the dominance of issuances through private placements, which in turn also prevent retail participation and aggravate the dependence on bank financing.

Indian corporate debt market potential is vastly untapped and debt syndication mechanism can take care of a number of these challenges and play a vital role in bridging the gap and contributing to India’s GDP growth and development.

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