“The apparently private and technical theme of

corporate financing leads us step by step to the

heart of major problems of national policy … We
are dealing here with serious and far-reaching
matters which deserve our undivided attention.”
Hans J. Mast, Crédit Suisse

Contemporary Financial
Intermediation

Chapter 9. Special
Topics in Credit:
Syndicated Loans,
Loan Sales, and
Project Finance
Key Questions

• What is syndicated lending? Why

do we observe syndicated lending?

• What is a loan sale? What is the

difference between loan syndication
and loan sales?

• What is project finance? Why is

project financing used for some (but
not all) projects?

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What is Syndicated
Lending?
• A syndicated loan is a credit granted by a
group of lenders, typically banks, to a
borrower

• A single loan agreement, with each lender

having a separate claim on the borrower

• Originating banks, called the senior

syndicate members, provide key financial
intermediation services of:
– Resolving precontract informational
asymmetries
– Designing the loan contract

• The others in the syndicate, called the

junior banks, provide a portion of the
funding, depending on
– The size, complexity and pricing of the loan
– The borrower’s willingness to expand its
banking relationship
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Syndicated Lending:
Why?
• Need for the senior lenders to
diversify their credit risk exposure
– The seniors can avoid excessive exposure
to a single borrower while still earning a
fee for their origination expertise
– A way to solve an inherent tension between
the benefits of specialization and the
benefits of diversification

• Enables the juniors to participate in

the syndicate without the costs of
origination expertise
– Loan portfolio diversification
– Exposure to the borrower, which creates
the possibility of a further relationship

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Stuart I. Greenbaum, Anjan V. Thakor, and Arnoud W. A. Boot
The Market for
Syndicated Loans
• Very popular in U.S. domestic lending for many
decades

• Has become an important part of international

lending since the 1970s
– First developed as a sovereign lending business
– Shrinkage due to repayment difficulties experience
by Mexico and other sovereign borrowers in 1989
– Revival in the early 1990s

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Stuart I. Greenbaum, Anjan V. Thakor, and Arnoud W. A. Boot
The Market for
Syndicated Loans
• The role of the Brady Plan in the explosive
growth of the syndicated loan market in the
1990s

• New loan signing reached $1.3 trillion in 2003,

with borrowers from a wide range of
geographies tapping this market.

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Stuart I. Greenbaum, Anjan V. Thakor, and Arnoud W. A. Boot
The Market for
Syndicated Loans
• Increasingly traded on secondary markets

• Participants include (i) market makers, (ii) active

traders, and (iii) occasional sellers/investors

• The biggest secondary market is in the U.S.,

followed by Europe

• Small secondary trading volumes in the Asia-

Pacific region, but expected to grow

1 In billions of US dollars.
2 As a percentage of total loan trading. For Europe, distressed and leveraged.
3 From non-LMA members.

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Stuart I. Greenbaum, Anjan V. Thakor, and Arnoud W. A. Boot
Pricing of
Syndicated Loans
• Syndicated lending is somewhere between
a relationship loan and a transaction loan
– Relationship lending for the senior bank
– Transaction loans for the junior banks

• The pricing structure of a syndicated loan

resembles that of a loan commitment with a
variety of fees being charged:
– Arrangement fee, legal fee, underwriting fee,
participation fee, facility fee, commitment fee,
utilization fee, agency fee, conduit fee,
prepayment fee

• Mechanisms used to control risk exposure:

– Guarantees, collateral, and covenants

• An increasing number of banks selling

loans through syndication; an increasing
number of loans being sold to buyers
outside the U.S. banking network
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What are Loan Sales and How
Are they Related to and Different
from syndicated Lending?
• Similar to a loan syndication in that the
originating bank is able to ensure that part
of the funding for the loan comes from
other lenders

• Two kinds of commercial loan sales: loan

strips and loan participations

• A loan strip is a short-term share of a long-

term loan:
– When the strip comes due at the end of a given
period, the selling bank must repay the strip
holder the contractual amount
– To continue funding the loan, the originating
bank must resell the strip for another period or
provide funding itself
– Whether a loan strip is a loan sale without
recourse is less transparent since it exposes the
bank to refunding risk

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Stuart I. Greenbaum, Anjan V. Thakor, and Arnoud W. A. Boot
Loan Participation

• Loan participation is a multi-lender

financing arrangement:
– Differs from a loan strip in that it is an outright
sale of a loan
– The Lead sells a participation in a loan to one or
more participation lenders and continues to
manage the loan on behalf of the participants
– The relationship among the lenders is
formalized in a participation agreement
– Unlike a syndicated loan, the participants do not
contract directly with the borrower
– The Lead negotiates with the borrower and
participants make advances to the Lead and
receive an undivided interest in the loan 
a pure transaction loan or capital market
investment to a participant
– Advantage of loan participation to the Lead
(relative to a syndication): retains exclusive
control over its relationship with the borrower
and does not invite competition for relationship
lending
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What is Project Finance
and When is it used?
• A technique for financing large-scale
infrastructure projects
– Examples: projects in the natural-resource
sectors, like energy and mining

• Differences from conventional financing:

– The firm or public sponsor incorporates the
project separately as an independent entity and
seeks financing that represents a claim only on
the cash flows of the project
– The financing mix for the project typically
involves a relatively high proportion of debt
– Debt used on the project is typically
nonrecourse to the sponsor, i.e., the lenders
have a claim only against the cash flows of the
project and not against any other cash flows of
the sponsor
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Project Finance: Why?

• Why is project financing used?

– The cash flows of the project not
commingled with those of the sponsor 
easier for lender to resolve the precontract
informational asymmetries and thus lower
information processing costs
– Reduced asset-substitution moral hazard 
lower cost of capital for the borrower to
finance the project and higher degrees of
leverage permitted
– Risk-sharing advantages due to the
involvement of multiple lenders (similar to
syndicated lending)
– The sponsor not exposed to the risk of
financial distress in case the project
experiences difficulties

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Project Finance: Why?

• Why is project financing not used

for all projects?
– Fixed costs incurred in establishing a
special-purpose entity (SPE) to incorporate
the project independently
– Coordination costs incurred because the
success of the project typically depends on
the joint efforts of many different parties
– Project financing is attractive only when its
benefits exceed these costs

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Trend in Global
Project Financing
• Project financing has become an increasingly
globalized business since the 1990s due to
privatization and deregulation of many industries
around the world:

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Trend in Global
Project Financing
• Significant growth between 1998 and 2000
in part due to the reallocation of global
investors:
– Portfolios from developing to industrialized
economies following the East Asian crisis in
1998-99
– New project financing investments in Europe
and North America

• Global decline after 2000 due to general

economic slowdown, particularly in the
telecommunications and power industries

• Still bullish long-term outlook for project

financing:
– Future demand for infrastructure financing in
developing as well as industrialized countries is
apt to grow faster than GDP

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Project Financing Structure
and Recent Developments

• A typical project financing structure is the

nexus of multiple contracting relationships

• Hybrid structures being developed:

– Idiosyncratic risk of the project diversified
away by lenders who finance portfolios of
projects rather than single ventures
– Partnerships between private companies
(assuming construction and operating risks) and
host governments (taking on market risks)

• Two recent developments:

– Growing popularity of various forms of credit
protection and new insurance products
– Project finance loans being increasingly
securitized

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Stuart I. Greenbaum, Anjan V. Thakor, and Arnoud W. A. Boot
Conclusion

• Loan syndication creates a loan that

combines aspects of a relationship loan
and a transaction loan.

• Loan sales share a lot of similarities with

loan syndication; one key difference is that
loan participants contract directly with the
lead lender, not the borrower.

• Project financing permits borrowers to

undertake large infrastructure projects with
significantly higher leverage than would be
otherwise possible.

• Project financing usually involves loan

syndication.

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