BANK LOAN SALES: A NEW LOOK AT THE MOTIVATIONS FOR SECONDARY MARKET ACTIVITY

Bank lending traditionally involves the extension of credit that is held by the originating bank until maturity. Loan sales allow banks to deviate from this pattern by transferring loans in part or in their entirety from their own books to those of another institution. I use a new methodology to test the validity of two hypotheses regarding banks' motivations for selling and buying loans: (1) the comparative advantage hypothesis, that banks with a comparative advantage in originating loans sell and those with a comparative advantage in funding loans buy; and (2) the diversification hypothesis, that banks lacking the ability to diversify internally use loan sales and purchases to achieve diversification. I also address the possibility that information asymmetries may increase the cost of participating in secondary markets. Particular attention is paid to the importance of affiliate relationships in overcoming informational barriers to participation. The empirical evidence presented here helps clarify the benefits of an active secondary loan market and generates predictions regarding the future of that market in a world of rapid consolidation and disappearing barriers to geographical expansion.     

Competition,financial innovation and commercial bank loan portfolios

I examine how US commercial bank loan portfolios change in response to the rise of securitization markets and banking market deregulations over 1976–2003. Banks increasingly tilt their portfolios toward real-estate-backed loans. However, there are significant differences across banks. Larger banks and younger banks disproportionately shift their lending toward real-estate-backed loans, particularly commercial real-estate-backed loans, whereas smaller banks and older banks maintain greater shares of their loan portfolios in commercial and personal loans. When larger banks make more real-estate-backed loans, they charge lower interest rates, consistent with these banks lowering the costs of lending and expanding credit for borrowers. In contrast, smaller banks charge higher interest rates, consistent with these banks restricting lending to a select group of borrowers.     

Bank Funding,Securitization, and Loan Terms: Evidence from Foreign Currency Lending

We examine how bank funding structure and securitization activities affect the currency denomination of business loans. We analyze a unique data set that includes information on the requested and granted loan currency for 99,490 loans granted to 57,464 firms by a Bulgarian bank. Our findings document that foreign currency lending is at least partially driven by bank eagerness to match the currency structure of assets with that of liabilities. Our results also show that loan currency, as well as loan amount and maturity, are adjusted to make loans eligible for securitization.     

Monetary policy,bank lending and corporate investment

The purpose of this study is to shed light on the chain of causality from macroeconomic financial policy to the microeconomic investment function. Concretely, we aim to provide an in-depth analysis of the relationships between the monetary policy of central banks, the loan policy of commercial banks, and the investment behavior of firms. We focus on countries that conduct their monetary policy under the inflation-targeting framework. Our empirical analysis with data from Germany, Switzerland and Thailand provides several new insights. First, after controlling for the US monetary policy, the monetary policy in Germany and Thailand appears to influence the banks' lending rate in the short run (i.e. within two months), whereas the monetary policy in Switzerland seems to be ineffective at influencing the banks' lending rate in the short run. Second, our results show that the banks' lending rate has a negative effect on their loans and that this negative effect is weakened by their growth opportunities. Third, we find that the supply of bank loans plays a more pivotal role in determining firms' investment than the lending rate. Last but not least, we document that neither the lending rate nor the loan-to-assets ratio moderates the sensitivity of the firms' investment to growth opportunities.     

Securitization without adverse selection: The case of CLOs

In this paper, we investigate whether securitization was associated with risky lending in the corporate loan market by examining the performance of individual loans held by collateralized loan obligations. We employ two different data sets that identify loan holdings for a large set of CLOs and find that adverse selection problems in corporate loan securitizations are less severe than commonly believed. Using a battery of performance tests, we find that loans securitized before 2005 performed no worse than comparable unsecuritized loans originated by the same bank. Even loans originated by the bank that acts as the CLO underwriter do not show under-performance relative to the rest of the CLO portfolio. While some evidence exists of under-performance for securitized loans originated between 2005 and 2007, it is not consistent across samples, performance measures, and horizons. Overall, we argue that the securitization of corporate loans is fundamentally different from securitization of other assets classes because securitized loans are fractions of syndicated loans. Therefore, mechanisms used to align incentives in a lending syndicate are likely to reduce adverse selection in the choice of CLO collateral.     

Liquidity creation and funding ability during the interbank lending crunch

This study examines the portfolio response of US banks to the interbank lending collapse during the global financial crisis. The paper documents that a bank's response to the collapse of interbank markets is related to whether or not the bank was a net borrower or lender of funds. In particular, we find that typical borrowers had lower loan growth than typical lenders, but that the crisis did not differentially affect borrowers and lenders with respect to loan growth. However, borrowing and lending banks were differentially affected by the crisis in terms of their liquid asset growth. The typical borrowers reduced their liquid asset growth relative to lending banks during the crisis. We interpret this finding as saying that borrowing banks had to reduce their risky asset holdings because access to interbank funds had been reduced. The paper presents analogous analyses of the possible differential response of borrowers and lenders to changes in counterparty risk and lending through the Fed's TAF facility.     

Distance, Lending Relationships, and Competition

We study the effect on loan conditions of geographical distance between firms, the lending bank, and all other banks in the vicinity. For our study, we employ detailed contract information from more than 15,000 bank loans to small firms comprising the entire loan portfolio of a large Belgian bank. We report the first comprehensive evidence on the occurrence of spatial price discrimination in bank lending. Loan rates decrease with the distance between the firm and the lending bank and increase with the distance between the firm and competing banks. Transportation costs cause the spatial price discrimination we observe.     

Sentiment volatility and bank lending behavior

Using a panel of commercial, co-operative and savings banks from G7 countries, we investigate whether the changes in sentiment and its volatility affect banks' lending behavior. We show that the changes in economic agents' sentiment and its volatility affect bank lending negatively, while the impact sizes differ across indicators. We also examine volatility effects on banks' loan growth as uncertainty reaches excessive levels. We highlight the role that several bank-specific variables play on bank lending and discuss to what extent uncertainty effects are transmitted on credit growth through them.     

Global Banks and Synthetic Funding: The Benefits of Foreign Relatives

This paper examines the effect of dislocations in foreign currency (FX) swap markets (“CIP deviations”) on bank lending. Using data from UK banks we show that when the cost of obtaining swap-based funds in a particular foreign currency increases, banks reduce the supply of cross-border credit in that currency. This effect is increasing in the degree of banks' reliance on swap-based FX funding. Access to foreign relatives matters as banks employ internal capital markets to shield their cross-border FX lending supply from the described channel. Partial substitution occurs from banks outside the UK not affected by changes in synthetic funding costs.     

Youth,adolescence, and maturity of banks: Credit availability to small business in an era of banking consolidation

This paper addresses the relationship between the aging process at new and relatively young banks and the tendency of banks to make loans to small businesses. Defining small business loans as C&I loans that are under $1 million in size, we analyze a sample of banks that had assets of less than $500 million in assets for the years 1993–1996 and that were 25 years of age or younger. We find, as have earlier studies, that banks' proclivities for small business lending are negatively related to their age and to their size. We proceed much farther, however, by introducing a number of additional explanatory variables, including the start-up year of the bank. We find that small business lending is negatively related to its being part of a MBHC. Also, small business lending is positively related to higher concentration rates in urban areas but is negatively related to higher concentration in rural areas. Despite the inclusion of these additional variables and a number of alternative specifications, the negative effects of a bank's age on its small business lending persist.     

Government guarantees of loans to small businesses: Effects on banks’ risk-taking and non-guaranteed lending

We analyzed the loan guarantees that the Japanese government provided for banks’ loans to small and medium-sized enterprises (SMEs). We modeled and estimated how much and under what conditions loan guarantees affected banks’ risk-taking and banks’ non-guaranteed lending.In the presence of controls for bank capital and other factors that might affect supplies of bank credit, our estimates supported our model's implications that loan guarantees increased banks’ risk-taking.Consistent with our model, our estimates imply that, when banks initially had fewer guaranteed loans and then got more guaranteed loans, guaranteed loans were complements to, rather than substitutes for, non-guaranteed loans. As complements, loan guarantees could be “high-powered” in that they generated increases not only in guaranteed loans, but also increases in non-guaranteed loans that were a multiple of the increases in guaranteed loans. In addition, banks’ having more capital was associated with doing more non-guaranteed lending.     

Branching,lending and competition in Italian banking

With the liberalization of legal barriers to the opening of bank branches in 1990, both market structure and competitive conditions in Italy changed profoundly as banks expanded their branching networks. This paper provides novel empirical evidence on how changes of the branch network structure at the province level affect the performance and lending activity of banks across the period 1993–2011. In particular, we adopt two modes of analysis. The first focuses on the impact of diversification strategies on performance, lending and funding strategies at the province level. The second one examines how the increase of big banks' local presence affects single-market bank performance and lending strategies. Our results show that geographical diversification strategies can reduce performance, the adjusted Lerner Index of banks and lending activities, but increase the Lerner Index in deposit markets. Furthermore, we find that the expansion of branches by large-medium sized banks in concentrated markets can reduce the Lerner Index for the deposit market and the amount of loans offered by single-market banks.     

Loan Sales and the Cost of Corporate Borrowing

When a loan is sold, it goes to a lower-cost financing sourcethan its originator. Yet, lending markets are less than perfectlycompetitive. Despite the lower funding cost, therefore, theloan price is not necessarily more favorable to the borrower.However, corporate borrowers are averse to the participationof their loans to other lenders because of the complexity ofdealing with multiple banks and the potential information costsof the sale announcement. Consequently, I conjecture that theborrower extracts a price concession in exchange for allowingthe bank to sell participations in the loan. Using a hand-matcheddataset of loans, borrowers, and lenders, I find that the averageyield spread on loans originated by active loan sellers is about20 basis points lower than the average spread on loans originatedby moderate loan sellers.     

It takes more than two to tango: Multiple bank lending,asset commonality and risk

Multiple-bank lending is the most prevalent form of bank-firm credit relationships in nearly all countries. It results in high asset commonality and interconnectedness, allows idiosyncratic risks to become systemic, and makes the banking system more fragile and vulnerable to shocks. Using detailed, granular-level, supervisory data on large corporate loans, we show that multiple bank lending is driven, inter alia, by regulatory limits on large credit exposures. These limits, aimed at mitigating an individual bank's concentration risk, force firms to explore alternative sources of funding, making the common borrowers' phenomenon more prominent. We find that multiple bank lending is determined endogenously, and its likelihood increases with the level of portfolio similarity between lenders. The size of the original lender and its systemic importance magnifies this effect. We argue that banks do not internalize the systemic effect of their lending decisions and that multiple bank lending constitutes an insurance mechanism related to an implicit "too-many-to-fail" guarantee. Its externalities are suboptimal and should be reinforced with better monitoring by the related authorities.     

Bringing the environment into bank lending: implications for environmental reporting

In recent years, it has come to be recognised that banks' lending operations affect, and are affected by, the state of the natural environment. In particular, rising public concern about the state of the natural environment, as reflected in legislation and consumer attitudes, poses risks for the state of a bank's lending portfolio. Even if they are not directly concerned about the environment, banks therefore have an incentive to understand the environmental implications of their lending decisions. This generates a potential demand for environmental information on companies.This paper reports on empirical research conducted to explore the interface between bank lending and the demand for environmental information. Based on a postal questionnaire survey of banks engaged in corporate lending in the UK, supplemented by a programme of semi-structured interviews, it reports on: the extent to which UK banks incorporate environmental considerations into their corporate lending decisions; the sources of information used by banks when making corporate lending decisions which involve environmental considerations; and lending bankers' views on developments in environmental reporting.The results indicate, inter alia, the importance that bankers attach to the annual report, notwithstanding its traditional limitations as a source of information on corporate environmental impact, and some desire for extensions to environmental disclosure. However, those desired developments are relatively narrow in scope, mirroring banks' principal interest in protecting their loans, and tend not to extend to more comprehensive forms of environmental disclosure such as might be expected to be found in a separate corporate environmental report.     

Does bank lending affect output? Evidence from the U.S. states

This paper uses a panel of state-level data to test whether changes in bank loan supply affect output. Since the U.S. states are small open economies with fixed exchange rates, state-specific shocks to money demand are automatically accommodated, leading to changes in lending if banks rely on deposits as a source of funding. Using these shocks as an instrumental variable, I find that shocks to money demand have large and statistically significant effects on the supply of bank loans, but loans have small, often negative and statistically insignificant effects on output.     

Asymmetric information and price competition in small business lending

This paper examines the relationship between bank lending rates and their cost of funds in New Zealand. Our results show that on average mortgage rates respond more quickly to changes in the cost of funds than base business lending rates. We also find an asymmetry in the initial (short-run) response of banks to changes in funding costs; in particular, our results show banks adjust mortgage rates downwards faster than upwards. The speed to which lending rates revert back to their equilibrium relationship with funding costs varies across the lending markets. We find the adjustment speed is faster when mortgage rates are below equilibrium, whereas it is slower when business lending rates are above long-run levels in relation to funding costs. Our analysis suggests that banks prefer the plain-vanilla type of lending such as mortgages in comparison to small business lending consistent with asymmetric information associated with business loans.     

Securitization,Ratings, and Credit Supply

We develop a framework to explore the effect of credit ratings on loan origination. We show that ratings endogenously shift the economy from a signaling equilibrium, in which banks inefficiently retain loans to signal quality, toward an originate-to-distribute equilibrium with zero retention and inefficiently low lending standards. Ratings increase overall efficiency, provided that the reduction in costly retention more than compensates for the origination of some negative net present value loans. We study how banks' ability to screen loans affects these predictions and use the model to analyze commonly proposed policies such as mandatory “skin in the game.”     

Credit risk transfer in U.S. commercial banks: What changed during the 2007–2009 crisis?

Following the debate on the role of credit risk transfer (CRT) in exacerbating the 2007–2009 crisis, this paper investigates the usage and effects of loan sales, securitization, and credit derivatives in U.S. commercial banks over the last decade, with special emphasis on the financial crisis. We find that in times of severe funding constraints, the need to raise financial resources becomes the principal incentive behind CRT. We document some beneficial effects of CRT on the economy, since the funds released through CRT are subsequently invested by banks to sustain credit supply, also in recession. However, we report higher overall riskiness in banks that engage intensively in loans sales and securitization, which translates into higher default rates during the crisis. Interestingly, the benefits and drawbacks of CRT are much stronger for loan sales and securitization than for credit derivatives.     

The performance of banks around the receipt and repayment of TARP funds: Over-achievers versus under-achievers

In this paper, we look at how the pre-crisis health of banks is related to the probability of receiving and repaying TARP capital. We find that financial performance characteristics that are related to the probability of receiving TARP funds differ for the healthiest (“over-achiever”) versus the least healthy (“under-achiever”) banks. We find that TARP under-achievers have some, but not consistent, weaknesses in income production. These banks also are experiencing liquidity issues as customers, shut out of public debt markets, get bank loans through drawdowns of loan commitments. Unlike TARP under-achievers, TARP over-achievers’ loans are performing well. Yet, liquidity issues (from low levels of liquid assets and core deposits and drawdowns of loan commitments) hurt the abilities of these banks to continue their lending. Differences between under-achiever and over-achiever banks are also found for repayment and deadbeat TARP banks.