Building a Strong Syndicated Credit Facility

by Karen M. Kroll

Companies are increasingly turning to the syndicated loan market to fund

acquisitions or pay down more expensive debt.

In late 2004, II VI Inc., a Saxonburg, Pa.-based manufacturer of products that

incorporate synthetic crystal materials, was seeking to acquire thermal technology
provider Marlow Industries Inc. The opportunity was too good to pass up; Marlow
Industries' thermoelectric cooling technology would greatly extend II VI's ability to
grow and fabricate crystals, recalls Craig Creaturo, II VI's CFO and treasurer.

To pay for the deal, Creaturo needed to beef up a $45 million line of credit his
company had negotiated with a syndicate of four banks in 2000. He worked with
these lenders to boost the facility to $60 million, which enabled II VI to complete the
acquisition. "We could [distribute] the risk among the banks, so the deal would allow
us to grow," he reports. "And we were able to bring together the dollars pretty
quickly."

Many other organizations are turning to the syndicated loan market to finance
acquisitions or pay down more expensive debt. Overall syndicated loan volume grew
from $1.02 trillion in 1999 to $1.35 trillion in 2004, according to research from New
York City-based Loan Pricing Corp., a company that analyzes the loan market. That's
a 32 percent increase. (See Syndicated Loan Market Soars.)

Midsize companies -- those with annual revenue of up to $500 million -- borrowed

$168 billion through syndicated deals in 2004, up 57 percent from the previous year's
$107 billion. Activity among larger organizations tracked with this midmarket boom.

A large part of the explanation for the market's rapid expansion is the fact that many
banks' financial picture has become distinctly rosier in the last 18 months. They have
money available, and they are looking to lend it.

At the same time, many institutions have tightened their lending policies, and they are
more reluctant to hold large amounts of debt from a single issuer, according to John
Fox, executive vice president of Memphis, Tenn.-based First Horizon Corporate
Financial Services, a division of First Tennessee Bank. In fact, many banks today
won't lend a company more than $35 million, notes Richard Rodgers, managing
director of corporate lending with Stamford, Conn.-based GE Commercial Finance.
By joining a syndicate, a bank can fund larger ventures without compromising its
lending policies.

A surge in refinancing is also fueling the market uptick. In 2004, refinancing deals
accounted for about half of middle-market syndicated loans, according to Loan
Pricing.

How Syndicated Credit Stacks Up

Fox sees commercial lending as a continuum of relative complexity. Traditional
business loans made by a single bank occupy the less-complex end of the spectrum.
When a company outgrows its bank's ability to meet its credit needs, it may decide to
spread its borrowing across several institutions. In small "club" transactions, for
example, two to four banks work together to structure a loan.

Syndicated loans reside at the most-complex end of the continuum. The key
characteristic of these deals is that a primary lender -- the lead bank -- creates and
structures the credit facility and then markets it to other loan providers.

So how do syndicated loans stack up against other forms of financing? First the pros:
Taking out a syndicated loan usually is a less expensive option than issuing debt or
equity in the public markets. In part, that's because syndicated loans are senior debt
instruments. If the borrower runs into trouble paying its bills, holders of the
syndicated debt stand in line ahead of other creditors and shareholders. Because their
risk is lower, syndicated lenders are willing to accept a lower return.

Unlike bonds, syndicated loans don't require issuers to undertake the time-consuming
and costly process of preparing a public prospectus, notes Don McCarthy, research
analyst with the Milken Institute, an economic think tank in Santa Monica, Calif.
However, that's not to say that syndicated loans are free. Banking fees can range from
50 basis points (bps) to 200 bps, according to Douglas Shaffer, senior managing
director of PNC Capital Markets Inc. in Pittsburgh. For a $200 million loan, these fees
would range between $1 million and $4 million. That's in addition to any fees paid to
attorneys to review the loan documents. Plus, some syndicated loans are rated by
credit agencies such as Moody's and Standard & Poor's; when that occurs, the
agencies also receive a fee.

Of course, the borrower also pays interest. The rate typically varies with a base rate
such as LIBOR, the London InterBank Offered Rate. The spread, or premium to the
base rate, depends on the borrower's riskiness. High-quality loans may be priced at
about 100 bps over LIBOR; lower-grade loans may run as high as LIBOR plus 400
bps, reports Ioana Barza, vice president and senior market analyst with Loan Pricing.

One drawback of syndicated loans is that they tend to have shorter tenors, or terms,
than corporate bonds, observes Eric Lloyd, managing director and co-head of
leveraged finance origination with Wachovia Corp. in Charlotte, N.C. Most
syndicated loans have tenors of between one year and seven years, whereas high-yield
bond terms can go out as far as seven to 10 years.

Another disadvantage of syndicated loans compared with bonds is that they usually
include more covenants. These are restrictions designed to reduce the issuing banks'
risk. According to a 2004 study by the Milken Institute titled "The U.S. Leveraged
Loan Market: A Primer," typical covenants include limits on the amount of additional
financing the borrower can secure and restrictions on the use of any funds it might
realize from asset sales.

Of course, most treasurers would prefer to obtain a loan with few, if any, covenants.
But at the same time, covenants reduce the cost of the debt, notes McCarthy. A
covenant that requires the borrower to maintain a minimum ratio of current assets to
current liabilities, for example, lowers the risk of default -- and that should be
reflected in the interest rate.

The art of negotiating a syndicated loan's covenants lies in achieving an acceptable

balance between protecting the lender and reducing the cost of the loan on the one
hand, and ensuring that the borrower retains ample room to operate on the other. The
key? "The loan should allow the borrower to do what it intends to do in its business
plan," says Ted Fauls, partner and practice leader of the lending and structured finance
group with Troutman Sanders LLP in Richmond, Va. For example, if an organization
plans to sell equipment or a subsidiary and use the proceeds to fund its operations, it
will want to make sure that the loan's covenants don't require it to use such funds to
pay down debt.

Marshaling the Banks

To set up a syndicated loan, a treasurer first meets with several banks and chooses the
lead bank. The treasurer and the lead bank's team then draw up a document that's
usually called a "term sheet" -- a summary of the terms and conditions of the credit
facility.

Next up is the bank meeting. The treasurer and the lead bank invite potential lenders
to a meeting in which they describe the proposed loan and invite them to join the
syndicate. Potential participants have several weeks to evaluate the deal and decide
whether they want to sign up. Once the syndicate is formed, the lead bank coordinates
the documentation and closing of the loan. The entire process usually takes six to 10
weeks.

Treasurers who are considering a syndicated loan should be knowledgeable about the
various classifications of these instruments. Investment-grade loans, for example, are
those that receive high marks from the rating agencies. Loan Pricing considers a loan
to be investment-grade if it carries a rating of at least BBB- from Standard & Poor's or
Baa3 from Moody's.

Syndicated arrangements that carry lower grades are called leveraged loans. In the
leveraged syndicated loan market, most lenders require some form of security, notes
GE Commercial Finance's Rodgers. Sources of collateral include the borrower's assets
-- accounts receivable, inventory, or plant and equipment, for example -- and its
projected cash flow. In general, banks view loans secured by assets as less risky than
cash flow loans, Rodgers notes. As a result, asset-based deals tend to be 50 bps to 75
bps cheaper than those secured on cash flow, he reports.

Syndicated loans also can be classified as "underwritten" or "best-efforts" agreements.

In an underwritten arrangement, the lead bank guarantees that it will make the entire
amount of the credit available to the borrower. If the bank fails to sell a good part of
the loan to other financial institutions, it may end up holding a larger portion of the
debt than it expected.

In a best-efforts arrangement, the lead bank commits only to an amount that's less
than the full amount the borrower is seeking. If it can't persuade enough banks to sign
up for the remaining portion of the loan, it isn't obligated to make up the difference.
Most syndicated loans today fall into this category, according to the Milken study.

Not surprisingly, underwritten loans carry higher up-front fees because the lead bank
assumes more risk, says PNC Capital Markets' Shaffer. "Borrowers take a bit of
market and timing risk off the table, but they pay for it," he notes.

Quite often, banks that participate in syndicated deals later sell their interest in those
loans to other investors. The total value of syndicated loans traded in the secondary
market rose to almost $145 billion in 2003, a 30 percent increase over the previous
year, according to Loan Pricing. Secondary market deals generally involve loans in
amounts of at least $250 million, Rodgers points out.

Given the increasing popularity of the secondary market, a treasurer who arranges a
syndicated deal can't be sure that he or she will know the institution that will be
holding that debt a year or two down the road. Treasurers who prefer a close
relationship with their bankers may want to consider that point, says George A.
Nation III, professor of law and business at Lehigh University's College of Business
and Economics in Bethlehem, Pa. "Some borrowers prefer relationship banking,
where you can sit down and modify the covenants," he notes.

Keys to Success

Treasurers who have successfully navigated the syndicated loan process say that
choosing the right lead bank is crucial. Borrowers should ensure that this key player
has solid experience in syndicated lending. The lead bank "has to be able to identify
potential participants in the bank deal and then get them to the finish line," says
Robert T. Ray, senior vice president, CFO and treasurer of Houston-based retailer
Group 1 Automotive Inc., who is a veteran of several syndicated loan deals.

Treasurers must take careful note of the loan amount that the lead bank is willing to
hold, says Rodgers. That figure is critical because no other member of the syndicate
will assume a larger portion of the loan than that issued by the lead bank. For
example, if a company wants to borrow $100 million and the lead bank limits its share
to $10 million, the deal will require at least nine other banks.

What's more, syndicate members that have a sizable interest in the loan will expect to
pick up other business -- cash management services, for example -- from the
borrower. "Everyone is looking for ancillary business," says First Horizon's Fox. The
bigger the syndicate, the bigger the challenge the borrower faces in offering each bank
enough business to keep it satisfied.

While the lead bank's role is key, the other members of the syndicate should also bring
value to the table. "Everyone in the syndicate should understand why they're there,"
says Fox. "If done properly, the selections are very relevant to the [borrowing]
company's longer-term plans."

When Richmond, Va.-based Cadmus Communications Corp., a publishing services

provider and periodicals printer, was negotiating a $100 million syndicated loan in
January 2004, it worked with Wachovia, its lead bank, to identify potential syndicate
members that had operations abroad. "We're looking to increase our global presence,
so we tried to identify international banks that could help us as we look at
international markets," explains Chris Schools, the company's vice president and
treasurer. That strategy secured the participation of BNP Paribas, a French bank.

Cadmus Communications' syndicated credit facility is just one element of its complex
capital structure, which also includes a 10-year note as well as equity instruments.
"We try to do a balance between fixed- and floating-rate [loans] and nearer-term and
10-year [debt]," reports Schools. "All have different pros and cons."