If you want to get a deal that fits your needs, you owe it to yourself to do your homework
When speaking to treasurers and CFOs about the renewal of their bank facilities, I often hear that they’re getting plenty of advice from their banks, so they do not see the need for external, unbiased opinions. I always point out several aspects of the market that they may not have considered, and I’d like to share them with you today.
It’s a cookie-cutter market, but you are not a cookie
The Loan Market Association (LMA) and the Loan Syndications and Trading Association (LSTA) have made significant strides in standardizing credit facility terms in the U.S. market. Their objective is to create standardization so that investors and banks can more easily trade in and out of their exposures to companies. This is great for liquidity in the markets but is not necessarily in your interest as a borrower.
The European market is much more diverse, with significant differences in pricing and terms between companies. While that can make loan trading more difficult, it also reduces the banks’ tendency to be there when you don’t need them and run when you do. While you may be afraid that your banks wouldn’t participate in this type of market, a quick look at the European league tables will show you that top tier U.S. banks are very active, despite these significant differences.
This begs the question: with all of the transparency in the U.S. markets, why is there so little difference in pricing and terms in the syndicated lending market for companies at the same public rating level while there is a significant difference in the borrowers’ characteristics (size, industry, bank rating, ancillary business, size and structure of the debt, etc.)?
Your banks aren’t cookies either
Your banking partners have internal risk assessment processes that significantly differ from one another. Here at Redbridge, we have seen banks internally rate the same credit facility two or more notches differently. The banks that are rating you lower need more ancillary revenue to generate the same returns. Make sure you know how each bank rates you internally. Try to work with banks that understand your business, give you appropriate benefit for their priority in your debt stack and any collateral you are providing, and will be there to support you through cycles.
Bilateral credit facilities allow you to take full advantage of the differences in how your banks view you, your business, and your collateral. Letters of credit (LCs) are a perfect example. While most syndicated credit facilities include the ability to issue letters of credit, it is usually significantly more expensive to do so under the credit facility than to work bilaterally with the banks to issue LCs. While many borrowers recognize this disparity and have separate LC facilities, bilateral revolving credit facilities are much less common in the U.S. Yet, the same truth holds: the best way to optimize your credit facilities is to negotiate them bilaterally and/or arrange the syndication yourself.
Your banks diversify their risk by syndicating their exposure, but they keep most of the benefits
The prime objective of syndicated lending is to distribute the risk of a borrower’s default across multiple lenders, including banks and institutional investors. Syndicated lending is a common way to handle loans that are too large for one bank alone to absorb the risk exposure. Since each lender’s exposure is lower, it should result in better, more efficient pricing for the borrowers. Unfortunately, that is often not the case.
The lead bank needs to structure and price a deal that can attract enough lenders to achieve the desired size. To ensure that it can distribute the risk and attract enough lenders, the lead bank structures the deal to appeal to the last bank in. This often results in significant oversubscription.
Oversubscription may seem like a good thing, but it isn’t necessarily a good thing for you – the borrower. While you need to close the deal, the terms and conditions shouldn’t be so generous that the deal is a ‘slam dunk.’ If your deal is significantly oversubscribed, it’s a sign that you’re either paying too much or that you’ve given away too much flexibility in your terms and conditions.
Your banks’ interests are fundamentally misaligned with yours
You may think that because your lead arrangers give you advice on sizing and structuring your credit facility, that they have your best interests in mind. That is not the case. By its very nature, the syndicated lending market pits your interests against those of your lead banks. The banks tell you as much in their documentation. Your credit facility will certainly have two paragraphs that, when translated from legalese to English, say, “we may sound like we are giving you advice, but we don’t have your best interests in mind.”
Why don’t we see more multilateral lending strategies that are common in other markets?
With all these negatives for borrowers in the syndicated market, there must be a reason we don’t see more multilateral lending strategies that are common in other markets, right? Let’s look at the pluses:
- Syndicated facilities save companies time and effort that may have been wasted in time-consuming individual negotiations with each bank for a bilateral deal. Negotiating with one bank can take several weeks; managing multiple bank facilities is an arduous and expensive task.
- Legal expenses can also be significantly lower for a single syndicated facility versus individual documentation for multiple bilateral facilities.
- If waivers or amendments are required, it may be easier to get 51% of lenders in a syndicated deal to agree to the necessary changes than to get 100% of bilateral lenders to each agree on changes to their agreement.
So, what should a borrower do?
With the help of an independent advisor, a self-syndicated deal can give you the best of both worlds: a syndicated facility that is easier to manage than bilateral deals, but is optimized to your credit profile, business needs, and the banks that best understand and can support your business. You first need to determine the flexibility that your business needs and the importance of the terms and conditions you will be negotiating. Once you have that, you can begin the syndication process, positioning your credit with the bank market.
To best position your risk profile, you need to know the following about every potential lender in the syndicate:
- How they view your risk profile and what credit rating (both probability of default and loss given default) they internally assign to your credit facility
- How they would price a loan on a stand-alone basis with the terms and conditions you need to provide the flexibility you want
- Which terms you are requesting might present problems for them and how much benefit (in terms of pricing or additional exposure) they would be able to provide if you modified the terms
- The minimum risk criteria they can accept
- The maximum commitment they could provide
Once you have that information about each bank, you can begin leveraging each of the factors, including:
- The size of each bank’s commitment
- The guarantees and covenants that give you the most flexibility for the price
- The optimal size and type of baskets to give you the most flexibility in your liquidity, financing, and industrial strategy
- The most effective type of pricing grid (ratings-based vs. leverage)
- The banks that best understand and price your credit
Having legal counsel is not enough
It can be tempting to believe that your lawyer has your company covered, but the lawyer’s job is to ensure that the legal language matches the business terms and doesn’t leave you exposed. Your attorney is not there to advise you on the business terms of the facility. An independent advisor can help you assess multiple business terms, including what size facility you need, what baskets you should have to give you the most flexibility, pluses and minuses of different margin grids, the tradeoffs between pricing/size and terms/covenants as well as other factors involved in the loan.
Our clients often overlook another key point: you need to ensure that your legal counsel has a strong corporate franchise. Many law firms in the syndicated lending market source most of their business from financial institutions. In addition to not having the expertise to negotiate the business terms, they may not be motivated to ‘bite the hand that feeds them’ and challenge the banks on terms.
Getting an effective, optimized credit facility that supports your business’ needs is time-consuming. You need to prepare, compare, and negotiate. Self-arranging a credit facility is no different from managing a request for proposal (RFP) on the value of the business you do with your banks and the costs of providing you credit. Taking the time to prepare your needs and negotiate with potential lenders can drive significant value in both pricing and flexibility. Using a truly independent advisor can help you drive the process, evaluate the alternatives, and implement a facility that best meets your needs.