Loan pricing is the process of determining the interest rate for granting a loan, typically as an interest spread (margin) over the base rate, conducted by the bookrunners. The pricing of syndicated loans requires arrangers to evaluate the credit risk inherent in the loans and to gauge lender appetite for that risk.
For market-based loan pricing, banks incorporate credit default spreads as a measure of borrowers’ credit risks. It is standard procedure in loan pricing to benchmark a loan against recent comparable transactions (“comps”) and select the base rate on which the financing costs are pegged. A comparable deal is one with a borrower in the same industry, country and of the same size with the same credit rating, for which a certain market rate of return is required.
A bank’s credit rating has a direct impact on its cost of funding and, thus, the pricing of its loans. Banks with a high credit rating generally have access to lower cost funds in debt markets and low counterparty margins in swap and foreign exchange markets. The lower cost of funds can be passed on to borrowers in the form of lower loan pricing.
Banks compete for lead arranger mandates on syndication strategy and pricing. Some banks are very effective at pricing loans, while others have better bargaining power, are more effective in borrower monitoring, or have better incentive-inducing scheme.
If [every bidding bank were] fully effective in pricing each loan, then every given loan price should be the maximum price and each bank should perform identically. However, in practice we do not expect all banks to be equally effective in setting the loan price.