Just a couple of years ago, it wasn’t unusual for a bank to fight to be the sole underwriter on a $1 billion loan. It could feast on three quarters of the upfront fees before giving the leftovers to its syndicate for distribution.
Times have changed (see graph). With companies running into credit trouble practically overnight, the role of sole lead arranger has lost some appeal. No bank wants virtually all of the risk from, say, a telecommunications or merchant energy loan. Similarly, more lenders are reluctant to join a syndicate for a tiny fee if they believe the borrower’s creditworthiness might come into question. How are banks dealing with this problem? By bringing in more co-leaders, who will get a bigger fee than syndicate members and help spread the lead arranger’s risk.
Indeed, the trend has become so prevalent that recent loans recall “club” deals of a decade ago, when a handful of banks would underwrite generally smaller, middle-market transactions. “Pro rata [low-priced revolving-credit] loans have dried up, and now we’re back to the days of doing club deals,” says Joseph Lipscomb, managing director at Carlyle Group, a Washington based private equity group. “It’s a little back-to-the-future.”
Offering co-leadership roles on these revolving lines of credit is particularly common because banks traditionally agree to participate to sustain a relationship with a borrower rather than make a big profit. Still, in these treacherous times the credit risk on such a low-yield play may outweigh the benefit of preserving a client relationship. Just ask the bank syndicate that funded WorldCom’s $2.65 billion draw-down in May.
To compensate for the higher risks today, banks that were once content to nibble on a small piece of the pie want a more generous slice. “Every time a bank comes to us, they say they don’t want to be a participant, they want to be a lead,” Lipscomb says. And sharing titles on revolving debt isn’t the only cost of spreading the risk. To get firms into the re- volvers, lead underwriters often also offer to share the title on other capital markets deals, like bonds and equity -- as well as the higher fees they command.
The recently launched $1 billion construction financing for Wynn Resorts’ Le Reve casino project in Las Vegas is an example. Banks are splitting up a $750 million construction facility to get a piece of a $200 million equity offering and a follow-on bond deal. Two years ago Deutsche Bank probably would have underwritten the entire credit itself, taken most of the upfront fees on the revolving credit and led the other capital markets business. Now the bank has brought in co-leads Bank of America and Bear, Stearns & Co. on the revolving credit line and will offer co-management titles on the bonds and equity -- just to get other firms to climb aboard.
“More time has been spent to get people titled and into this deal than will probably be spent on building the casino,” jokes Dan Toscano, head of senior debt capital markets at Deutsche Bank. “Five years ago if you wanted to raise $750 million, you would just go out and get it in $15 million and $40 million pieces” from a wide variety of syndicate banks.
The shared responsibility has benefits, even with lower fees, says Richard Hassard, managing director for leveraged finance at CIBC World Markets. “It’s very difficult for a lead bank to sell down [its holdings] to zero on a credit that may have a problem. Leads are looking to reduce underwriting risk.” The more leads there are, the more diffuse the responsibility.
Of course, more banks may mean higher upfront fees for borrowers. A lead arranger that once collected 200 basis points on a $1 billion deal must share that fee with co-leads, so it may charge more. But in an environment where capital is harder to raise, more leads help assure good execution. “Borrowers want more certainty that deals will get done,” says Lipscomb. “If one [lender] is sitting on $200 million, you may be looking at a flex up [repricing upward] later.” For borrowers, it is worth paying a bit more to avoid repricing further down the road.
