Question

Define sweep account and a loan syndication and explain how each are used. What is the general structure of a trust?

Answer 1

Define sweep account and a loan syndication and explain how each are used. What is the general structure of a trust?

Sweep Account

A sweep account is a bank or brokerage account that automatically transfers amounts that exceed, or fall short of, a certain level into a higher interest-earning investment option at the close of each business day. Commonly, the excess cash is swept into a money market fund.

How a Sweep Account Works

Using a sweep vehicle like a sweep fund works by providing the customer with the greatest amount of interest with the minimum amount of personal intervention by transferring money at the end of the day into a high-interest account. In a sweep program, a bank's computers analyze customer use of checkable deposits and sweep funds into money market deposit accounts.

As of 2016, some brokerage accounts had similar features that enabled investors to gain some additional return for unused cash. Sweep accounts are simple mechanisms that allow any money above or below a set threshold in a checking account to be swept into a better investment vehicle. Sweep accounts were needed historically because federal banking regulations prohibited interest on checking accounts.

Sweep accounts, whether for business or personal use, provide a way to ensure money is not sitting idly in a low-interest account when it could be earning higher interest rates in better liquid cash investment vehicles. These investment vehicles that provide higher interest rates while still offering liquidity include money market mutual funds, high-interest investment or savings accounts, and even short-term certificates with 30-, 60- or 90-day maturities for known layovers in investments.

Businesses and individuals need to keep an eye on the costs of sweep accounts, as the benefit from higher returns from investment vehicles outside the checking account can be offset by the fees charged for the account. Many brokerages or banking institutions charge flat fees, while others charge a percentage of the yield.

Special Considerations: Personal Sweeps vs. Business Sweeps

Sweep accounts for individual investors are typically used by brokerages to park money waiting to be reinvested such as dividends, incoming cash deposits, and money from sell orders. These funds are typically swept into high-interest holding accounts or into money market funds until an investor makes a decision on future investments or until the broker can execute already standing orders within the portfolio.

Sweep accounts are a typical business tool, especially for small businesses that rely on daily cash flow but want to maximize earning potential on sitting cash reserves. A business sets a minimum balance for its main checking account, over which any funds are swept into a higher-interest investment product. If the balance ever dips below the threshold, the funds are swept back into the checking account from the investment account.

Depending on the institution and investment vehicle, the sweep process is generally set daily from the checking account, while the return of funds can possibly experience delays. With the changes of regulations on checking accounts, some banking institutions also offer high-interest rates on amounts over certain balances.

Loan Syndication

Loan syndication is the process of involving a group of lenders in funding various portions of a loan for a single borrower. Loan syndication most often occurs when a borrower requires an amount too large for a single lender to provide or when the loan is outside the scope of a lender's risk-exposure levels. Thus, multiple lenders form a syndicate to provide the borrower with the requested capital.

The agreements between lending parties and loan recipients often need to be managed by a corporate risk manager to reduce misunderstandings and to enforce contractual obligations. The primary lender conducts most of this due diligence, but lax oversight can increase corporate costs. Company legal counsel may also be engaged to enforce loan covenants and lender obligations.

Loan syndication is often used in corporate financing. Firms seek corporate loans for a variety of business reasons that include funding for mergers, acquisitions, buyouts, and other capital expenditure projects. These types of capital projects often require large amounts of capital that typically exceed a single lender's resource or underwriting capacity.

Loan syndication allows any one lender to provide a large loan while maintaining a more prudent and manageable credit exposure because the associated risks are shared with other lenders. Each lender's liability is limited to their respective share of the loan interest. Generally speaking, with the exception of collateral requirements, most terms are uniform among lenders. Collateral assignments are generally assigned to different assets of the borrower for each lender. Usually, there is only one loan agreement for the entire syndicate.

Financial Institution Coordinates Loan Syndication

For most loan syndications, a lead financial institution is used to coordinate the transaction. The lead financial institution is often known as the syndicate agent. This agent is also often responsible for the initial transaction, fees, compliance reports, repayments throughout the duration of the loan, loan monitoring, and overall reporting for all lending parties.

A third party or additional specialists may be used throughout various points of the loan syndication or repayment process to assist with various aspects of reporting and monitoring. Loan syndications often require high fees because of the vast reporting and coordination required to complete and maintain the loan processing. Fees can be as high as 10% of the loan principal.

In 2015, Charter Communications topped the list of leveraged loan-funded syndications at $13.8 billion for its merger with Time Warner Cable. Credit Suisse was the lead syndicator on the deal. In the United States loan market, Bank of America/Merrill Lynch, JPMorgan, Wells Fargo, and Citi have been the industry’s leading syndicators of loans in recent years.

The Loan Syndications and Trading Association (LSTA) is an established organization within the corporate loan market that seeks to provide resources on loan syndications. It helps to bring together loan market participants, provides market research, and is active in influencing compliance procedures and industry regulations.