In firm-commitment underwriting, one or more arrangers commit to provide to a borrower the total amount of a multilateral financing and then organize and syndicate the financing, regardless of the ultimate success of the syndication. If syndication is unsuccessful, the arrangers and underwriters will have to retain a larger amount of the loan (final hold) than they had originally intended to keep.
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A firm-commitment underwriting demonstrates arranger support for the borrower, signals the arranger’s confidence in the deal, and provides greater potential profit for the arranger. However, when funding certainty is essential for the borrower, the lead arranger takes the risk that the market will not accept the deal and that it will then have to hold the entire loan amount on its books.
In practice, approximately 70% of deals are done on an underwritten basis. For “new money” deals—those that provide borrowers with new financing rather than refinance an existing loan—the rate is closer to 90%.
Firm-commitment underwriting is transacted in primary syndication. Depending on the syndication, it is syndicated to participant lenders with or without joint lead arrangers and with or without sub-underwriting.
One or more lead arrangers may initially underwrite the financing commitment and may be joined by co-underwriters in two-stage syndication. Alternatively, sole or joint lead arrangers may take a financing directly into general syndication after its initial underwriting.
The probability (risk) that underwriters must absorb any unallocated amount of a syndicated financing in the event there is insufficient lender/investor interest for the syndication to be successful is syndication risk. The arrangement fee paid by the borrower to the underwriters compensates the underwriter for the syndication risk.
[The participant-lead arranger relationship] plays a more important role in decreasing loan syndication cost and loan syndication risk.
The underwriters (arrangers) – lead arrangers and sub-underwriters – are the only finance parties that assume the risk of successful syndication, where they transfer their commitments to participant lenders in primary syndication. The facility agent acts only as the loan administrator and is not exposed to any syndication risk.