Asset-based lenders can be roughly classified into three groups: large bank asset-based lenders, specialty finance bank asset-based lenders and non-bank asset-based lenders.
All lenders, regardless of type, deal with the element of risk created by the size of their exposure relative to their overall loan portfolio, a particular borrower, related borrowers or even borrowers in a particular industry. One of the best ways to manage that element of risk while maintaining the relationship with a borrower is to seek a co-lender or, if the deal size warrants, to form a loan syndicate or “lender group.” Syndication among asset-based lenders for large credit facilities is very common. Mid-size deals may be syndicated to a group of relationship lenders who
participate with each other regularly, leading to what is known as a “club deal,” while larger deals typically involve a syndicate of lenders that may be less familiar with one another.
The syndication process typically follows the following pattern: A key lender initiates the loan opportunity, arranges the syndicate and then typically serves as the administrative agent for the participating lenders (the “members”).1 The agent lender then receives fees for arranging and administering the loan and the supporting collateral in addition to the interest that all lenders in the syndicate receive pro rata to the amount of their participation. Another benefit of loan syndication is that the agent and the non-agent lenders may refer loan syndication opportunities to one another in the future.
Lender Group Democracy
It is important for agents and non-agent lenders to recognize that their participation in the loan syndicate may restrict their ability to make totally independent decisions and to exercise their rights and remedies independently with respect to the loan. The agent typically has the authority to make day-to-day decisions, although the loan documents may include “lender group democracy” provisions that govern how the lender group can make certain decisions, e.g., regarding dealing with borrower issues such as covenant or monetary defaults, waivers, extensions, over-advances, etc., as well as any disagreements among the lender group about how best to proceed. Thus, in negotiating the requisite percentage of lender approval required for certain actions or amendments to the credit agreements, which may be measured by the number of lender group members or by the cumulative percentage of their participations, the lender group may decide to require a simple majority of lenders to approve minor amendments to the credit agreement and two-thirds of the lenders to approve material changes, such as changing the maturity date or waiving a covenant default.
Because of these “lender group democracy” provisions, agent lenders typically want to include as members those lenders with which they have worked successfully in the past or that have a similar appetite for risk and a similar approach to loss and recovery in the event of default, to the extent this can be determined in advance.
Bank and Non-Bank Lenders
Of course, bank asset-based lenders remain subject to regulatory control and scrutiny, which includes syndicated loans in their portfolios. Thus, in dealing with a borrower who is in default of requirements contained in the loan documents, a bank asset-based lender must adhere to rather rigid regulatory requirements, such as mandating that the borrower be placed on the bank’s “watch list,” moving the loan to the “special assets” portfolio and taking an appropriate charge against the P&L and/or establishing a reserve. Non-bank asset-based lenders are not subject to the same regulatory constraints, and bank-owned specialty finance asset-based lending groups may not be as well, depending upon how the ownership is structured, and therefore, they may be more flexible and creative in dealing with a borrower that falls short of meeting the requirements under the loan documents.
Understandably, this may cause issues among members of a lender group when some are regulated, and others are not. Additionally, even when all lender group members are regulated, some may have regulatory difficulties unrelated to the loan at issue or have other portfolio problems, causing them to be more conservative in dealing with a borrower’s problems.
Since regulatory bank examinations cannot typically be challenged on a line-item basis the way some other government reviews are (e.g., IRS audits), regulated banks tend to err on the careful side so as not to invite criticism by regulators that could lead to increased severity in other areas. They may take write-downs or establish reserves earlier and in larger amounts, leading to a sort of “regulatory arbitrage” when a lender’s book value for a loan is compared with its actual collectability.
Furthermore, lender group members typically have the right to “sell down” their participation to a loan buyer in part or even to sell their participation completely. In this way, “new faces,” which are typically unregulated lenders or funds, may appear around the table of the lender group, adding to the diversity of perspectives and needs that can make lender group decision-making a challenge.
Lender groups that encounter difficulties with a borrower should consider engaging a financial advisor early in the process, since the agent may be afraid of “getting shot in the back” by unhappy member lenders or their successors who have purchased initial lender interests and may feel that the agent is “asleep at the switch” and not being proactive enough. It should be noted that this is different from recommending or requiring that the borrower engage a turnaround professional because the lender group’s financial advisor is there to help the group harmonize their differing viewpoints and live within their documents.
In addition, when the lender group is being organized and agreements are being negotiated, agents should consider how prospective group members will behave “when the chips are down” in deciding which lenders to invite, and prospective group members should consider a prospective agent’s track record at dealing with difficulties before accepting an invitation.2
Furthermore, lenders should carefully negotiate the following provisions in their syndicated loans and participation agreements, among others:
- The ability to assign an individual member’s interests
- Decision-making regarding the borrower, including enforcement actions, modifications and forbearance agreements, waiver rights, loan advances, etc.
- Information and notice rights
- Liability and standard of care applicable to the agent and the non-agent lenders
- What happens in the event of group members’ defaults
These provisions should anticipate that group members may someday sell their loan position and that the buyer may be nonregulated.
ABL syndication remains a valuable way for lenders to reduce their exposure and avoid excessive concentration, and the relationships with other lenders created through such syndications can be worthwhile sources of potential future business; however, loan syndication also includes new considerations and potential risks and these are best handled by planning in advance through loan documents.
- While similar, loan syndications should not be confused with loan participation agreements. In a loan participation, the originating lender transfers or sells a portion of its interest in a loan to a participant pursuant to a participation agreement. The participant lender does not enter into a contractual relationship with the borrower, who remains obligated to the original lender. The originating lender does not become an agent or a fiduciary of the participant. Instead, the parties define the extent of the participant’s rights to consent to the originating lender’s decisions with respect to the loan in the participation agreement. In a syndicated loan arrangement, the borrower enters into a single credit agreement with a group of lenders and may execute a separate promissory note evidencing the borrower’s obligation to repay each lender’s share of the credit facilities. One lender is designated as the agent for the group and authorized to handle communications with the borrower, disbursements and protection of the collateral. Generally, a syndicated loan provides more rights for the member lenders than a participated loan.
- For a broader discussion of potential syndicated lender group issues, see, Brownstein H., “Harmonizing Your Lender Group…Or Else, ‘There Be Dragons,’” ABF Journal, 2009.
Inez M. Markovich, Esq., is a partner in the Philadelphia office of the law firm of McCarter & English, LLP, and Howard Brod Brownstein is president of The Brownstein Corporation, a turnaround management firm in Conshohocken, PA