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On Loan Sales, Loan Contracting, and Lending Relationships. Steven Drucker Columbia Business School & Manju Puri Fuqua School of Business, Duke University September 2006. Screening. Loan Seller. Upfront Fees. Borrower. Interest Payments. Loan Buyer. Monitoring, Funding.

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on loan sales loan contracting and lending relationships

On Loan Sales, Loan Contracting, and Lending Relationships

Steven Drucker

Columbia Business School

&

Manju Puri

Fuqua School of Business, Duke University

September 2006

motivation

Screening

Loan Seller

Upfront Fees

Borrower

Interest Payments

Loan Buyer

Monitoring, Funding

Screening, Monitoring, Funding

Borrower

Lender

Upfront Fees, Interest Payments

Motivation
  • Loan selling is important for banks and the economy
    • Trading Volume: $154.8 billion in 2004 vs. $8.0 billion in 1991
    • Diversification; Comply with Risk-Adequacy Regulations
    • Allows Origination even when Funding Constrained
  • Loan Selling Fundamentally Alters Lending
main issues
Main Issues
  • Loan Sales Separate Origination from Funding
  • Agency Problems
    • Moral Hazard (Pennacchi 1988; Gorton & Pennacchi 1995)
    • Adverse Selection
    • How do banks overcome these problems?
      • Loan Contracting
  • Access to Loans and Lending Relationships
    • Harm?
      • Reduce interaction that is critical to benefits (Diamond 1991)
    • Help?
      • Increased Capital From Non-Banks
      • Risk-Management  Flexibility in Future Loan Origination
outline
Outline
  • Data, Sample Selection, and Descriptive Statistics
  • Loan Sales and Loan Contracting
    • Secondary Market Sales and Covenants
    • Agency Problems or Signaling?
  • Loan Sales, Access to Loans, and Lending Relationships
    • Current Loans
    • Lending Relationships and Future Loans
  • Summary
data and sample selection
Data and Sample Selection
  • Sample Period: 1999 - 2004
  • Data from four sources with some data matched by hand
    • Loans & Lending Relationships (LPC DealScan)
    • Identify Traded Loans (LSTA Mark-to-Market Pricing)
    • Borrower Financial Characteristics (Compustat)
    • Equity Market Data (CRSP)
  • Sample Sizes (link)
sold loans and information asymmetry
Sold Loans and Information Asymmetry
  • Sold Borrowers are larger and rated (link)
    • Information Transparency
  • Sold Loans are Term Loans instead of Credit Lines
    • Monitoring
  • Lead Lender on Sold Loan has Higher Market Share
    • Reputation
outline7
Outline
  • Data, Sample Selection, and Descriptive Statistics
  • Loan Sales and Loan Contracting
    • Secondary Market Sales and Covenants
    • Agency Problems or Signaling?
  • Loan Sales, Access to Loans, and Lending Relationships
    • Current Loans
    • Lending Relationships and Future Loans
  • Summary
secondary market sales and covenants

Screening

Loan Seller

Upfront Fees

Borrower

Interest Payments

Loan Buyer

Monitoring, Funding

Secondary Market Sales and Covenants
  • Selling Loans Can Induce Agency Problems
  • Financial Covenants Reduce Reliance on Seller’s Information
    • Monitoring Mechanism
    • Buyer Exercises Control When Firm Performs Poorly
secondary market sales and covenants9
Secondary Market Sales and Covenants
  • Univariate Relationship Between Covenants and Loan Sales
  • Multivariate Logit Model (Table 4) (link)
    • Dependent Variable: Indicator for Loan is Sold
  • Key Independent Variables
    • # of Financial Covenants (+)
    • Net Worth Slack (-)
  • Control Variables
    • Lender Market Share; Borrower and Loan Variables
secondary market sales and covenants10
Secondary Market Sales and Covenants
  • Changes in Predicted Probabilities (link)
    • One Std. Dev Change Around the Mean (t-stats in parentheses)
  • Key Results:
    • More Covenants  Increases Probability of Loan Sale
    • Tighter Covenants  Increases Probability of Loan Sale
are loans structured to sell to others
Are Loans Structured to Sell to Others?
  • Sold Loans are Nearly Always Syndicated (Primary Market)
  • Loans are Sold Close to the Loan Origination Date (link)
are loans structured to sell to others12
Are Loans Structured to Sell to Others?
  • Banks are not dumping poorly performing loans
  • Distribution of Initial Sale Prices
  • Performance of Sold Borrowers: Origination to Sale
agency or signaling
Agency or Signaling?
  • Syndication: Primary Market Sales
  • Additional Mechanisms for Mitigating Agency Problems
    • Hold Larger Piece of Loan (e.g. Dennis & Mullineaux 2000)
    • Syndicate Structure and Composition (Lee & Mullineaux 2004; Sufi 2005)
    • Expect Smaller Agency Problems
  • Empirical Prediction
    • # of Covenants / Tighter Covenants have LESS influence on probability of loan syndication (compared to loan sale)
  • Empirical Model: Probability of Syndication (Table 5)link)
  • (
primary market sales and covenants
Primary Market Sales and Covenants
  • Changes in Predicted Probabilities (link)
    • One Std. Dev Change Around the Mean (t-stats in parentheses)
  • Compared to Secondary Market Sales:
    • More Covenants – Similar Effect
    • Tighter Covenants – Weaker Effect

Evidence is consistent with agency view

agency or signaling15
Agency or Signaling?
  • Lower Reputation Lender  Increased Agency Problems
    • Gorton & Haubrich (1987); Pichler & Wilhelm (2001)
  • Empirical Prediction
    • Low Reputation Lender  # of Covenants / Tighter Covenants have LARGER influence on probability of loan selling
  • Modify Loan Sales Model (Table 6)(link)
    • Interact Reputation Indicators with Covenant Variables
lender reputation
Lender Reputation
  • Changes in Predicted Probabilities of Selling Loans (link)
    • One Std. Dev Change Around the Mean (t-stats in parentheses)
  • Key Result:
    • Tighter Covenants  Increases Probability of Loan Sale when lenders have LOW REPUTATION

Evidence is consistent with agency view

agency or signaling17
Agency or Signaling?
  • Does Restrictive Covenant Package Signal Borrower Quality?
  • Empirical Prediction
    • High Risk  Covenants have LARGER influence on probability of loan selling
  • Modify Loan Sales Model (Table 7) (link)
    • Interact Distance-to-Default Indicators with Covenant Variables
  • KEY RESULTS: Largest Effect on Loan Sale Probability
    • # of Financial Covenants: LOW RISK BORROWERS
    • Net Worth Slack: MID RISK BORROWERS

Evidence is NOT consistent with signaling view

outline18
Outline
  • Data, Sample Selection, and Descriptive Statistics
  • Loan Sales and Loan Contracting
    • Secondary Market Sales and Covenants
    • Agency Problems or Signaling?
  • Loan Sales, Access to Loans, and Lending Relationships
    • Current Loans
    • Lending Relationships and Future Loans
  • Summary
loan sales and access to loans
Loan Sales and Access to Loans
  • Restrictive Covenants / Loan Sales Impose Costs on Borrowers
    • Managerial Flexibility
    • Additional Lenders  Renegotiation Costs
  • Why do Borrowers Agree to Restrictive Covenants / Loan Sales?
  • EXPLORE: Access to Private Debt Capital
    • Loan Buyers are Usually NonBanks  Additional Capital
current loans
Current Loans
  • Key Results
    • Sold Borrowers are Growing and Debt-dependent
    • Sold Year: Increase in Private Debt Issuance
loan sales and lending relationships

Screening

Loan Seller

Upfront Fees

Borrower

Interest Payments

Loan Buyer

Monitoring, Funding

Loan Sales and Lending Relationships
  • Loan Sales Separate Origination from Monitoring / Funding
  • Harm Access to Future Credit / Relationships?
    • Reduced Ongoing Interaction(Diamond 1991; Boot & Thakor 1994)
  • Help Access to Future Credit / Relationships?
    • New Source of Capital
    • Reduced Exposure to Individual Borrowers  Flexibility
loan sales and lending relationships22
Loan Sales and Lending Relationships
  • Univariate Results (Table 9)
  • Sold Borrowers are
    • More Likely to Receive Future Loans
    • More Likely to Continue Lending Relationships
loan sales and lending relationships23
Loan Sales and Lending Relationships
  • Explore: Risk Management  Lending Flexibility
    • Do Loan Sales Increase Relationship Durability for High Risk Firms? High Reputation Lenders?
  • Univariate Results (Table 9):
  • Conditional on Receiving Another Loan, % that Keep Same Lead Bank
loan sales and lending relationships24

Don’t BorrowAgain

Borrow Again

Keep

Lender

Don’t Keep

Lender

Loan Sales and Lending Relationships
  • Nested Logit Model (Table 10) (link)
  • Independent Variables: “Borrow Again”
    • Borrower Characteristics; Year Fixed Effects
  • Independent Variables: “Borrow Again” and “Keep Lender”
    • Loan is Sold; Lender Market Share; Prior Lending Relationship
outline25
Outline
  • Data, Sample Selection, and Descriptive Statistics
  • Loan Sales and Loan Contracting
    • Secondary Market Sales and Covenants
    • Agency Problems or Signaling?
  • Loan Sales, Access to Loans, and Lending Relationships
    • Current Loans
    • Lending Relationships and Future Loans
  • Summary
summary
Summary
  • Loan Selling Separates Origination and Funding
    • Agency Problems Loan Contracting
    • Access to Loans and Lending Relationships
  • Sold Loans Have Additional, Tighter Covenants
    • Consistent With Covenants Used When Agency Problems Are Larger
    • Signaling Not Supported
  • Sold Borrowers: Debt-Dependent, Receive Additional Private Debt
    • Benefit to Offset Costs of Restrictive Covenants / Loan Sales
  • Sold Borrowers get Future Loans, Keep Lending Relationships
    • Additional Capital and Flexibility for Lenders