Loan Syndication In Banks

LOAN SYNDICATION IN BANKS (A CASE STUDY OF INTERNATIONAL MERCHANT BANK PORT – HARCOURT)

WHAT IS LOAN SYNDICATION

          loan syndication is a practices carried out mainly by merchant banks. It is a situation of bringing together syndicates of banks, financial houses or persons, etc. to finance an investment or a business that is usually of a huge amount of money that will over time yield adequate returns (profit).

One of the mobile phone (GSM) operators in Nigeria was able set-up the company through loan syndication, syndicates of banks put their fund together to finance the investment with a view of making adequate return (profit) over time. These syndicates of banks do consider the risk factor, government regulation and economic factors in Nigeria that are likely to affect the investment. A careful analysis of these factors will help to determine the rate of return in the syndicated investment.

 

2.3              LOAN SYNDICATION IN IMB

          Loan syndication in IMB is as a result of the policy and the type loan and advances that is been implemented by the bank, following the banking guidelines of central bank of Nigeria (CBN).

IMB as a profit making organization will always look for investment that will yield not just profit but maximize profit at the expense of a minimum cost. An investment that requires a huge sum of money that is too much for an individual or a bank to generate as a result of the huge nature or the risk involve can be syndicated for by more than one bank. IMB as one of the merchant banks in Nigeria is highly favoured because it is only the merchant bank that undertakes a wholesale banking on loan syndication.

2.4 EVOLUTION AND DEVELOPMENT OF MERCHANT BANKS

          The banking (amendment) Act No 88 of 1979, defined merchant bank to mean any person in Nigeria who is engaged in wholesale banking, medium and long term financing, equipment leasing, debt factoring, loan syndication management, issue and acceptance of bills and the management of units trust.

Merchant banks specialize primarily in the provisions of corporate finance service and banking services as well, which range from provision of long term loan through rendering of foreign services to equipment leasing, debt factoring, loan syndication and rendering of advisory services among others.

(Ibid.) Observed that:

“Although merchant banks act primarily as intermediaries                        between interested parties in financial transactions. They also                       take extensive stake in commercial ventures themselves, either                         by extending medium and long term loan or by subscribing or                            underwriting issues of securities”

In Nigeria, the role of merchant bank is not precisely defined. It is due to the fact that it is difficult to define their specific roles in developing economy like Nigeria, where the money and capital market are not yet fully developed. As a result merchant banks had for a long time be performing virtually the same function as commercial banks.

Clay and wheable (1983) observed that:

Their activities (merchant banks) were originally and still are connected with foreign trade and with international movement of goods and services but the motive of their business once, often that of the merchant venture and therefore concerned primarily with merchandizing for their own account has changed.

According to innocent Iyalla Itary (1997): Merchant banks were defined as wholesale banking which involves the mobilization of fund from big time depositor for lending to fund seekers mainly on medium and long term basin.

Attempting a function definition of what a merchant is, Ojih (1996) defined merchant banking as banks that are engaged in the following activities:

  1. Corporate financial adv.
  2. Issuing of shares and debenture
  3. Securities under – writing
  4. Private placing of securities
  5. Investment advice and portfolio management
  6. Mergers and acquisition ‘
  7. Medium and long term loan
  8. Equipment leasing
  9. Acceptance of credit
  10. Hire purchase.

From the above functional definition, there appeared to be clear – cuff demarcation between the activities of commercial banks and that of merchant banks especially in the areas of service and application of fund.

Charlay (1974) considered merchant banks as a subsystem of commercial banks of depositor (or deposit banks) and merchant banks? In banks generally, and especially in Nigeria, merchant banks are distinguishable from commercial banks. Ojo and Adewunmi (Ibid.) argued that;

“In contrast with commercial banks, merchant banks remain a                            small organization. Offering wholesale banking concentrate on                           business involving large sums and the use of expertise. Learning                   small transaction retail banking and subsequent routine clerical                        work involved, to the commercial banks”.

Chanon also observed that competition has made it increasingly difficult for the banks to maintain their role as the key log term and corporate financial advisor institution. In fact this is owing to their small scale and possible vulnerability, which in turn has led to the difficult in obtaining long-term deposits.

In recent times, therefore the operation of merchant banks and commercial banks tend to overlap while commercial banks are shifting their operation more to the provision of medium and to long-term. The merchant banks now carry out short-term operation.

 

2.5              SYNDICATION THEORIES AND MANAGEMENT

          In this section we will look at the theorical overview of loan syndication as

“A package of two or more investment asset held for the benefit of an individual or an institutional investment.

Philipates (1973) defined syndication from the investment point of view “as a composite set of ownership right to financial asset in which the investors wish to invest their fund. Perry (1979) also defined syndication as the securities held by or on behalf of an investor, the list of such securities the holding of bills of exchange by banks or discount houses. He (Ibid.), went further to say that loan syndication management services is the management of banks or financial institution of the quoted securities of a customer these include the safe keeping of securities, dealing with right issues. The collection of dividend and preparation of variation.

Sharpiro (1968) observed that there are choices of syndication management contending that a useful way to visualize the impact of the three economic demands on a bank syndication that is solvency, liquidity and earnings is to trace the process by which an individual bank obtains the implication with respect to earnings and solvency. According to Cohen et al (1977). Loan syndication management is the art of handling a pool of fund so that it is not only to preserve its original worth but also overtime appreciate in value and yield and adequate return consistent with level of risk assumed. Also Ityaes and Bauman (1976) defined syndication management as “a package of two or more investment assets held for the benefit of an individual or institutional investor”.

They further defined syndication management as “the task of combining or packaging two or more individual securities into a syndication which entails a process at integrating separately, through closely related element, intended to lend the construction of an optional syndication for an investor”.

Loan syndication investment has rules, which are designed to build and sustain a loan that maximizes their returns while minimizing risk. It is a general belief and well observed fact that the more the bank tends to shift more of their syndication into long term loans and investment, their prospect for higher earnings improve. But it also well known that aggressive loan and investment policies subject the bank to higher risk.

Basically, loan syndication theories deals with the optimal combination of portfolio i.e. that syndication provide the higher possible returns for any specified degree of risk or the lowest possible risk for the specified level of return. Though loan syndication theories were developed mostly for financial asset like stock and bonds extension of financial assets syndication theories have been useful for investment in physical assets. Theories of syndication management can be divided into two groups, the theory of diversification and the theory of efficiency. Markouiz theory on loan syndication management was the first to dwell on diversification. William (1964) extended Markouitz diversification theory to include efficiency.

2.6     THE FOUNDATION AND CONCEPT OF LOAN SYNDICATION

          The entire business setting is full of risk and because of this most business entrepreneur who engage in production activities in pursuit of some outlined commercial end, are regarded as risk takers.

Risk in investment assumes various forms and shape based on the resultant effect of risk like business loan demand. Investors are subject to various types of risk like business risk, market risk, interested rate risk and political risk.

Business risks are those risks, which affect the profitability of the business or company to pay interest or dividend. The market risk are those risk which cases security prices to decline, irrespective of any truly fundamental changes I the earning power, for example in market psychology of investor.

The purchasing power risks are those risks that reduce the buying or purchasing power of income or the principal. A risk in price level due to inflation is a purchasing power risk. Interest rate risk is those risks, which depress the prices of fixed income type of securities. The risk inherent in the rise of interest is an interest rate risk, because it depresses the prices of fixed income earning securities. The political risks are those risk which result from government policy change, like change in tariff.

Because of these inherent risks in any investment investors develop means of reducing them and at the same time increasing the required returns before venturing into any investment. The means and strategies by which investors respond to risk from the concept of utility theory are multi-dimensional. Given choice between more or less risk taker would prefer the riskier investment. The assumption of risk aversion is basic to many decision model used in syndication management. Given or faced with the same choice the risk averter would select the less risky of the two investments. An investor who is indifferent to risk would not care which investment to venture into. There are people who prefer risk and there are those who are indifference to it. But logic and observation suggest that business managers and stockholders are predominantly has been regarded as the degree of dispersion of future returns from their average expected value, measured as a variance, standard deviation or co-efficient of variation of future returns.

2.7     DIVERSIFICATION THEORY (MARKOWITZ SYNDICATION)

Loan syndication theory is based on simple assumption about investor’s behaviour. Markowitz (1959) in his portfolio theory observes that investors try as from the expected rate of return by diversifying the portfolio holding different issues would not significantly reduce the variability of the expected rate of return.

The work of Markowitz is based on simple assumption that investor exhibit rational behaviour, which reflects the inherent aversion of absorbing increased risk, without compensation by an adequate, increased in expected return. It’s model provided theoretical framework for the systematic selection of optimum syndication combination once the level of risk willing to be assumed by the investor was established. With all it elegance and competence, the Markowitz model cannot be of service without information supplied by security analysis and syndication managers. To determine the composition of the “efficient syndication”, syndication managers or planner require the following information:

Firstly, a projection of expected rate of return including both current income and capital gain or loss, to be earned on each security that might be considered for inclusion in the syndication. Secondly they make an estimate of the possible range or error of each return projection. Thirdly, it is necessary to derive an indication of an inter – relationship of the error range among securities. Fourthly, we have to analyze the constraint placed upon the syndication managers, such as the maximum number of different securities to be included in the syndication.

From what has been said so far, it is evident that Markowitz model could not be estimated manually, but only with the use of adequate computer programme packaged. Markowitz and others following the same line of reasoning recognized the function of loan syndication management as one of the composition and not of individual stock selection, as it is more commonly practice decision as to individual security addition or selection. Will have on the delicate diversification balance. It is important to note that Markowitz emphasized that diversification of investment in itself does not reduce the risk in loan syndication. It is return on securities are perfectly and negatively correlated, diversification can completely eliminating risk. But if the returns on securities are not perfectly and positively correlated then diversification does not reduce the risk in loan syndication. On the other hand, if the returns on securities are uncorrelated, then diversification can reduce risk significantly to zero as the limit. In the real world, perfectly or negative or positive correlation of securities does not exist. Because it is not possible to have two securities that are so related that when the return on security is increasing, the other will be falling with the same proportion, and vice versa. More security are positively correlated, but not perfectly. The degree of correlation among securities depends on economic factors and these factors are usually amendable to analyst.

The use of Markowitz theory is also complicated by the fact that the stock market is always in the state of flux based on new information that enter the stock market. The random work theory explains that different investors are risk and return associated with holding of a particular security in response to new event. The Markowitz diversification model had been criticized by many people.

Valentine (1968) observed that; “if analyst simply provide the same projection that could have been calculated using past return from stocks in question. They are not providing additional useful information. Despite criticism of Markowitz conceptualization of the investor’s rationality in decision-making, his use of variance as a measure of risk has be questioned.

Fisher (1975) questions whether variance is the most appropriate measure of risk. Experience has shown that investors with limited liquidity problems are interested in long-term investment and regard final price realization as more important than current fluctuation. The introduction of variance makes the model more complicated and on this score, management who are easily bared and beaten by mathematical manipulation. This followed a period of active academic concern dealing with the underlying implication for the security markets pricing mechanism. This gives rise to a cohesive body of thought know as capital asset pricing model (CAPM) led by William Sharp (1964).

 

CAPITAL ASSET PRICING MODEL (CAPM)

          The duty of corporate financial management is the measurement of the company’s act of equity or for the investor. The expected return on investment. Estimate of the return causes a lot of fidgeting; often the result is subjective and therefore opens to criticism as a reliable benchmark.

The capital asset pricing model (CAPM) is an ideal portrayal of how financial markets price securities and determine expected return on equity. In details the character of the pricing mechanism or the market when all investors act as if they are governed by the principle of risk aversion the desire to maximize syndication composition through affective diversification. This model tries mastic and unsystematic risk. The following assumption underlines the working of CAPM:

  1. Investors are risk averse in that they prefer smaller variance at comparable levels of return and greater returns at the same level of variance.
  2. Investors seek to optimize their syndication through efficient diversification.
  3. Investors hold similar view as to the variance risk or distribution of future return.
  4. Investors are able to lend and borrow unlimited fund at the prevailing risk rate.

It is true that many of these assumptions cannot be obtained in real life situation of the working day security market pricing mechanism. Sharp acknowledges this, when he said “the proper test of a theory is not the reality of its assumption, but the acceptability of its implication” as such the price of any individual security is seen as the composite of all interest investors. Balance to reflect difference in existing view and preference. The investor can eliminate company specific risk by simply and properly diversifying their portfolios. They are not compensated for bearing systematic risk. And because well – diversified inventors are not exposed only to systematic risk with CAPM, the relevant risk in the financial market risk / return trade-off as the systematic risk rather than total risk. Thus, an investor is rewarded with higher expected return for bearing market related risk.

 

FARRAR’S EFFICIENT SYNDICATION MODEL

Farrar’s model of efficient syndication model is a purely mathematical programming process to investment decision under uncertainty. It is founded in the following assumption;

  1. The investor’s posse’s utility of money function, which is positively stopped and downward.
  2. The investor bases his syndication decision on the principle of utility maximization.

2.9              ASSET PORTFOLIO OF MERCHANT BANK

          Precisely, the assets of a merchant bank constitute its overall syndication since they represent the bank’s application of fund. The assets as well as liabilities (sources of fund) are usually enumerated published in a balance sheet at the end of financial year in line with operative accounting standards. They include the following;

  1. ASSETS (USES OF FUND)
  2. Cash and cash items
  3. Balance held with their banks
  • Loan and advances
  1. Investment
  2. Other assets

Fixed assets

[simple-links category=”3198″]

One Comment on “Loan Syndication In Banks”

Leave a Reply

Your email address will not be published. Required fields are marked *