Transfer of Secured Syndicated Dept - Coursework Example

MECHANISMS USED IN TRANSFER OF SECURED SYNDICATED DEBT Insert Introduction A loan facility that is provided by several lendersand which is arranged, structured and administered by investment or commercial banks is known as a syndicated loan1. The banks in this case are known as arrangers. The arrangers raise the investor funds for the issuers that are in need of capital. As a result of the service rendered, the issuers pay the arranger a fee. The fee increases based on the complexity and the risk involved with the loan facility2. In the United States, private equity sponsors and corporate borrowers drive the issuance of syndicated loans even-handedly. On the other hand, in the European market, the issuance is mainly done by private sponsors of equity due to its relatively low corporate activity. Investment grade high quality companies are charged lesser fees for loans compared to the leveraged or speculative grade borrowers2. Leveraged borrowers carry credit profiles that are generally riskier and therefore end up paying higher fees for complex loans1. Under common law, trust structures offer security for the secure syndicated facilities. The security mechanism holds for various groups of lenders which mean there is no need for subsequent registration in case the lender changes. In other jurisdictions, especially where trusts may not be recognized, provisions of parallel debt are used under civil law. The parallel debt provisions achieve a similar purpose where the obligor of the debt acknowledges a separate and an independent debt to the trustee of the security for amounts that are equal to the ones specified in the financial documents of the debt thereof. Under parallel debt, the bank or a nominee of the bank acts as the security agent to administer security for each of the lenders and the finance parties. The agent, therefore, holds the benefit of the claim to the parallel debt as the property of the lenders and for the lenders’ benefits2. Reasons for transfer of secured syndicated debts The process of syndicating a loan is normally initiated by the borrower. The borrower appoints the lender by granting the party the mandate to act as the arranger. The arranger is responsible for advising the borrower on the suitability of the facility and the terms thereof. It is the arranger that determines a syndicate of banks that would provide the facility2. A lender of a syndicated loan may decide to transfer their commitment for a number of reasons. The transfer may be necessitated by risk or portfolio management activities where the lender may consider its loan portfolio as being weighted with much emphasis put on a given type of loan or borrower and might, therefore, wish to improve the yield dynamics of the loan portfolio. By transferring the commitment from the loan portfolio, the lender may lend elsewhere which will enable diversification of the portfolio thereof2. A transfer can also be facilitated by requirements for capital regulations. Finally, the transfer of a syndicated loan facility may be done to crystallize a loss where the lender may come to the decision to sell the commitment due to the borrower running into financial difficulties. For such a loan, the market is provided by specialists who are dedicated to dealing with distressed debts3. Even though the transfer of secured syndicated debts is possible, the lender should consider the consequences that are brought about by the mechanisms of transfer that are at its disposal before doing the actual transfer of the loan portfolio. The following five mechanisms are used in various jurisdictions when transferring syndicated loans. The first two lead to the lender disposing of their loan commitment while the new lender assumes the initial contractual relationship with the borrower. On the other hand, the last two mechanisms allow the lender to retain their contractual relationship with the borrower. Mechanisms used in the transfer of secured syndicated loans The first mechanism which is practiced under common law is known as novation. Novation involves a lender effectively transferring all the rights and obligations to a loan portfolio just as it is stipulated in the loan agreement3. This means that the process involved during the transfer will effectively cancel all the existing rights and obligations of the lender to the loan while the new lender takes up similar rights and obligations at the existing costs. The contractual relationship that had existed between the lender and the other parties to the loan agreement prior to the transfer are transferred to the new lender who establishes a direct relationship with the borrower, other lender and the agent of the loan facility3. At the time that the new lender assumes the responsibility and becomes party to the loan facility’s agreement, the loan can be drawn fully especially if it is a term loan. However, if the loan facility is a revolving credit, the new lender’s obligations involve those of advancing monies and other financial services to the borrower. The borrower is therefore party to the novation process. The contents of the relevant documents in the novation process are largely dependent on the initial loan agreement’s provisions. Even then, most such loan agreements have a certificate of transfer which is also acts as a schedule whose operation is based on the novation2. The loan agreement should also entail a provision where all parties to the loan agreement including the borrower agree to consent to the novation by executing the transfer certificate provided all the conditions set out in the agreement thereof are complied with to the letter. The only parties that are usually required to carry out the provisions of the certificate of transfer are the agent, the existing lender and the new lender4. The second mechanism that transfers the ownership entirely, and that is practiced in various civil law jurisdictions is the legal assignment. In this case, only the rights are transferred while the obligations remain intact as before. In the United States, the legal assignment as stipulated in the Law of Property Act provides that such a transfer must be absolute, that is, the whole debt that is outstanding is transferred from the existing lender; the assignment must be in writing and duly signed by the existing lender; and the borrower must be notified in writing about the transfer and the provisions of the transfer thereof4. If one or more of the elements of the requirement is altered or missing, then the assignment may be equitable. In this context of a secured syndicated loan, all the rights of the lender that exist under the agreement of the loan facility are transferred by a legal assignment to the new lender, including the right that appertains to discharging the assigned debt and the right for suing the borrower. However, the obligation to provide funds to the borrower by the existing lender is not transferable by legal assignment and therefore remains with the initial lender. The new lender is required to pay the initial lender all dues under the loan4. The existing lender is then obligated to send the funds duly paid to them by the new lender to the agent, who will then pass the funds to the borrower. Equitable assignment is another mechanism that is common in various civil law jurisdictions. In the United States, the creation of the equitable assignment is necessary whenever one or more provisions of the Law of Property Act, section 136, is met in part or is not met at all1. This is possible provided there exists the intention to assign between the parties involved thereof. Unlike in the legal assignment, the equitable assignee, that is, the new lender must collaborate with the existing lender in all actions on the debt as the assignor4. The most prominent difference between an equitable assignment and a legal assignment arises in the case where there is failure to notify the borrower of the assignment. In the situation where the borrower is kept unaware of the assignment, all equities including mutual rights of set-off are subjected to the new lender1. The equities mainly arise between the borrower and the existing lender, sometimes long after the loan has already been assigned. Funded participation is also a mechanism in the transfer of syndicated debts under common law in several jurisdictions. In the case of a funded participation, the participant and the existing lender enter into a binding contract whose provisions are such that the existing lender consents to pay the relevant share or all of the principal amount and the interest thereof received from the borrower in respect to the amount to the participant in return for the participant paying an amount that is equal to a part of or all of the principal amount to the existing lender5. A funded participation involves an agreement made between the participant and the existing lender. Out rightly, the agreement initiates contractual rights between the participant and the existing lender. The rights mirror the already existing rights contained in the agreement between the borrower and the existing lender4. However, it should not be mistaken for an assigning of the already existing rights. The borrower and the existing lender remain in direct contractual relationship. In funded participation, interest is paid to the participant as a way of servicing the deposit made thereof. The deposit is only repaid when the loan that the borrower has taken from the initial lender is fully serviced and repaid. The participant, therefore, effectively takes the risk from the first loan3. The agreement that ensures funded participation ensures that the participant puts enough funds in the bank in time to ensure the borrower’s demand for drawdown are met so as to remove the elements of risk from the whole process of debt transfer. As per the syndicated loan agreement, the initial lender remains liable. Syndicated loans can also be transferred through the mechanism of risk participation. Risk participation mechanism acts as a guarantee and is practiced under civil law. The risks participant is not required to place any money immediately with the existing lender. Instead, the participant agrees that in certain circumstances they will put the initial lender in funds for an agreed fee5. It is typically on default payment made by the borrower. The mechanism of risk participation can be provided as an interim measure by the new lender before the syndicated loan can be fully transferred. For either risk participation or funded participation, no consent is required from the borrower which means the entire process of debt transfer can be confidential. A contract does not exist between the borrower and the new lender. Instead, the participant obtains rights of subrogation which means that if the borrower defaults then the participant has an obligation to pay6. In the process, the participant obtains the right to take the position of the existing lender and, therefore can pursue all the necessary remedies that the existing lender can take against the borrower. Conclusion The transfer of syndicated loans which is an equivalent of selling of the loans is a phenomenon that has been ongoing in various capital markets around the world. In fact, large banks have been known to transfer portions of syndicated debts as a move to avoid been caught by regulations that restrict overconcentration of loan portfolios. With time, defaulted loans were also added to the activity of debt selling. The transfer of syndicated debts stimulated the secondary loan market. Regulations that were introduced in the market in late 1980s especially in Europe and the United States created incentives that enabled banks to shift portions of their debt portfolios from their balance sheets in order to alleviate the impact of the new capital requirements stipulated in the regulations3. This saw huge transfers of syndicated loans from the banks. In early 1990s, the transfer of syndicated debts from primary to secondary markets grew exponentially at an annual rate of about 14 percent per annum. The transfer of syndicated loans from the primary to the secondary market is mainly done through participation or by assignment. The main difference between assignment and participation being that assignment substitutes the buyer as the lender while participation transfers the right of repayment to the buyer while at the same time leaves the relationship between the initial lender and the borrower. Normally assignments require the consent of the borrower. On the other hand, participations are created based on an agreement between the participant and the initial lender which means it rarely involves the consent of the borrower. Even then, participation involves additional elements of risk to the buyer due to the fact that the participant does not have any direct claims to the borrower especially in the event that the original lender becomes insolvent5. The most recent introduction of credit default swap and collateralized debt obligation in the credit risk transfer market have enabled banks to transfer large amounts of risk associated with corporate credit as well as from the financial to the non-financial sector. Bibliography A Elliot, ‘Corporate Loans as an Asset Class’ (1996) 22 ASIL 4 B Gadanecz, ‘Developing Country Economic Structure and the Pricing of Syndicated Credits’ (2003) BIS Working Paper 132. FJ Fabozzi, Collateralized debt obligations: structures and analysis (Second edition John Wiley & Sons, New Jersey 2006) H Suggitt, ‘Default Rates in the Syndicated Bank Loan Market: A Mortality Analysis’ (2000) 24 APL&PJ 17 T Assender, ’Growth and Importance of Loan Ratings’ in T Rhodes (ed) Syndicated Lending: Practice and Documentation (3rd edition Euromoney, London 2004) V Kothari, ‘Securitization: the tool of financial transformation’ (2007) 46 CJLS 13 Read More