My first exposure to the debt capital markets was way back in 1989 when I spent 6 months working for Citicorp in Manhattan, writing up the assignment and assumption agreements in the legal department when loans were sold. I think it took 5 of the 6 months for me to figure out what was going on, and then I got a job in environmental consulting and went back to doing stuff I felt knowledgeable about.
Back in 1989, I had only the vaguest notion that I was a cog in the machine that was originating and selling corporate debt and real estate loans, mostly to smaller banks and savings and loans. It was years later that I remembered the parade of names I had inserted into my document templates as the savings and loan crisis continue to unfold and led to the failure of over 1000 small banks.
Syndicating a loan spreads the risk
So first things first, what is an assignment agreement or an assumption agreement? It’s the way that a large loan that is originated by one bank gets broken into smaller pieces and sold to other banks. Assignments pass along the debt to the purchasing bank while the selling bank may retain responsibilities such as serving as agent. Assumption agreements pass along all aspects of the debt to the purchasing bank, and there is no remaining responsibility for the seller.
Another option is for a group of banks to get together and originate the loan as a club, in which case all their names are included in the origination credit documents and there is no assignment or assumption agreement.
In all of these cases, there will be one or more agent banks, one administrative agent bank, and participating banks, all holding a piece of the total loan. The whole process is called syndicating a loan, and the virtual place where this happens is the debt capital markets.
Why do banks syndicate loans? Banks that originate loans may choose to sell all or pieces of the loan in order to reduce their overall exposure to a particular borrower or industry or region. Banks that buy the loans have an easy way to extend credit on a project with attractive interest rates without the cost and time it takes to originate the loan themselves. Agent banks receive extra fees for serving as the agent bank, coordinating all the banks and overseeing the performance of the loan.
Due Diligence and Syndicated Loans
Let’s talk about agent banks first. When a bank serves as the administrative agent during a loan origination, their appraisal, engineering, and environmental department will coordinate all the third party due diligence. When I know that a loan will be syndicated, I check to see if there are other banks involved in the underwriting, and as much as possible I try to coordinate our scope of work so that we are meeting all policies and procedures for the banks that are helping to originate the loan. Each bank must independently review and approve the proposed loan, so we sometimes talk with the environmental or engineering staff at the other banks to make sure that we’ve identified all the risks and put in place mitigants or post-closing requirements and corresponding loan agreement language to manage environmental conditions, capital improvements, natural hazards, or construction risks.
Once the loan has closed, when a bank is selling all or a portion of their position, the bank who makes this purchase is committing to a secondary participation. Since all the due diligence was completed and all the risk decisions were made at the time of origination, there is no room to make changes and the bank is making a yes or no decision based on the information that’s available.
What happens when a syndicated loan fails?
Even before a loan defaults, each of the participating banks are monitoring the loan and communicating about any concerns over the borrower’s repayment of the loan. If something bad happens and borrower defaults, then the administrative agent bank is responsible for communicating with the borrower, gathering information as needed, and coordinating with all the participating banks to get the loan back on track or to work out a bankruptcy or liquidation or other problem.
As the manager of my bank’s environmental and engineering risk team, I am involved with both the originating of loans and also the workout and eventual resolution of defaulted loans. It is a great learning opportunity to have a full understanding of the different ways that banks respond to defaults. There are a number of ways to recover the loan amount, but we are most involved when the bank has decided to take the assets that make up the loan collateral. When we order environmental and engineering studies from our consultants, the scope of that work is dependent on whether the loan is being originated, whether we are studying one particular aspect of a non-performing loan, or whether we are considering enforcing on the collateral, whether it’s a piece of real estate, a construction project, or a company.
Sometimes a bank ends up owning the asset and holding it for a while before it can be sold to recover some of the loan amount. That’s a good topic for a future post!