Credit Reporting, Relationship Banking, and Loan Repayment

How does information sharing between lenders affect borrowers repayment behavior? We show—in a laboratory credit market—that information sharing increases repayment rates, as borrowers anticipate that a good credit record improves their access to credit. This incentive effect of information sharing is substantial when repayment is not third‐party enforceable and lending is dominated by one‐shot transactions. If, however, repeat interaction between borrowers and lenders is feasible, the incentive effect of credit reporting is negligible, as bilateral banking relationships discipline borrowers. Information sharing nevertheless affects market outcome by weakening lenders' ability to extract rents from relationships.     

Strategic loan defaults and coordination: An experimental analysis

This paper experimentally studies the impact of bank and borrower fundamentals on loan repayment. We find that solvent borrowers are more likely to default strategically when the bank’s expected strength is low, although loan repayment is a Pareto dominant Nash equilibrium. Borrowers are also less likely to repay when other borrowers’ expected repayment capacity is low, regardless of banks’ fundamentals. We show that changes in expectations about bank and borrower fundamentals change the risk dominance properties of the borrowers’ coordination problem, and that these changes subsequently explain strategic defaults. For the individual borrower, loss aversion and negative past experiences reduce repayment, suggesting that bank failure can be contagious in times of distress.     

UNDERWRITER REPUTATION AND AFTERMARKET PERFORMANCE OF CLOSED‐END FUNDS

I find a positive relation between underwriter reputation and the initial and long‐run aftermarket performance of closed‐end funds. This relation persists even after controlling for fund characteristics, types, and investment strategies. The positive relation between underwriter reputation and initial returns supports the notion that prestigious investment bankers tend to promote a price run‐up in the immediate aftermarket to enhance their reputation with the issuers and the investors. The better long‐run performance for funds underwritten by prestigious underwriters suggests that prestigious underwriters protect their reputation by underwriting only high‐quality issues that will perform well in the long run.     

Are good or bad borrowers discouraged from applying for loans? Evidence from US small business credit markets

This paper takes the concept of a discouraged borrower originally formulated by Kon and Storey [Kon, Y., Storey, D.J., 2003. A theory of discouraged borrowers. Small Business Economics 21, 37–49] and examines whether discouragement is an efficient self-rationing mechanism. Using US data it finds riskier borrowers have higher probabilities of discouragement, which increase with longer financial relationships, suggesting discouragement is an efficient self-rationing mechanism. It also finds low risk borrowers are less likely to be discouraged in concentrated markets than in competitive markets and that, in concentrated markets, high risk borrowers are more likely to be discouraged the longer their financial relationships. We conclude discouragement is more efficient in concentrated, than in competitive, markets.     

North-South : The implications for multinational banking

International finance should be of great value to developing countries because their potential growth paths are ‘out of step’ with the world economy and because the gambles they must take to develop are much more diversifiable in the context of the world economy than locally. However, the actual benefits of North-South finance have been limited by an overreliance on non-specific bank credit with the inherent limitations and by errors in judgement by both borrowers and lenders. In fact, the current crisis threatens to reverse many of the earlier gains. While the current crisis is primarily the result of the world recession, the severity of its effects on lenders and borrowers reflects three key aspects of bank credits: (1) its perverse real repayment patterns, (2) its specific nature which implies that risks are transferred only through generalized non-performance with its attendant deadweight costs, and (3) its concentration in a small but critical segment of capital markets. These characteristics would be serious even with ideal behavior by lenders and borrowers, but they also can lend to inappropriate and possibly erratic behavior. Specific suggestion for restructuring the system of North-South finance are given including (1) smoothing repayment patterns, (2) increasing repayment flexibility, (3) increasing risk-bearing non-specific finance, (4) increasing non-recourse financing, and (5) increasing project-specific risk capital.     

TARP announcement,bank health,and borrowers’ credit risk

Theory suggests that unhealthy banks exhibit more pronounced flight-to-quality behavior during financial crises and, hence, the infusion of capital through unhealthy banks is less effective in relieving the liquidity shocks of vulnerable borrowers. We test these predictions by investigating how the financial health of leading US banks influenced their borrowers’ credit risk surrounding the announcement of the Troubled Asset Relief Program (TARP). Changes in borrower credit risk, measured by credit default swap (CDS) spreads, should reflect the expected relief from liquidity shocks and other benefits of rescuing banks, such as maintaining the existing lending relationships. Consistent with the theory, prior to the TARP capital infusions, unhealthy banks’ borrowers with high leverage experienced a greater increase in their credit risk relative to similar healthy banks’ borrowers. Following the event, the CDS market anticipated less liquidity relief to these vulnerable unhealthy banks’ borrowers, but more liquidity relief to the vulnerable healthy banks’ borrowers.     

Financial Ratio Covenants in UK Bank Loan Contracts and Accounting Policy Choice

The attitudes of lending bankers to the use of restrictive ratio covenants in loan contracts are of importance to both corporate management and accounting policy makers. Such attitudes also underly research linking costly contracting with accounting policy choices. This paper reports a survey of 33 UK lending bankers. It analyses their views on (a) the extent of ratio covenants in UK bank loan contracts and factors with which their presence is most likely to be associated; (b) costs that may be imposed on borrowers violating such covenants or expecting to do so; and (c) the ability of borrowers to avoid such costs by appropriate choice of accounting methods. Respondents indicated that ratio covenants are widely used, particularly for loans in excess of £1 million and with companies that are relatively highly geared. ‘High cost’ penalties such as loan acceleration are most likely to be adopted where no prior warning has been given of a covenant breach. Where prior warning has been given, or where a breach is due to an acquisition, waivers and contract renegotiation are more likely responses. Breaches caused by new SSAPs cause few real costs to borrowers, while just under 60% of respondents indicate they may take no action in response to a voluntary accounting method change.     

DO BANK RELATIONSHIPS MATTER IN PUBLIC DEBT OFFERINGS?

Finance theorists have argued that banks have a comparative advantage over public debtholders and other suppliers of debt both in gathering information about and in monitoring corporate borrowers. Although underwriters of public debt issues and private placements have access to inside information when executing specific transactions, commercial bankers have ongoing relationships with their corporate borrowers that have often been built up over years. Perhaps more important, banks are also often in a better position and have stronger incentives than a dispersed collection of bondholders to keep tabs on what the borrowers do after receiving the capital.
This theoretical argument received striking empirical support from a study by Chris James published in 1987 in the Journal of Financial Economics. Entitled "Some Evidence on the Uniqueness of Bank Loans," the study documented that announcements of new bank lending aggreements by public firms are received positively, on average (and in a large majority of cases) by the stock market. This finding offered a pointed contrast to the neutral to sharply negative stock-price responses that accompany announcements of almost all other kinds of securities offerings, including private placements of debt and public offerings of straight debt.
In this article, the authors discuss their own recently published study that provides another piece of evidence of the value added by banking relationships. Specifically, the authors report that the first public debt offerings of companies with bank relationships carry spreads that are 85 basis points less than the spreads of initial debt issues by comparable firms without bank relationships. As the authors interpret their findings, a banking relationship not only helps to "certify" the value of corporate borrowers to their stockholders, but also provides other lenders with valuable "cross-monitoring" benefits that are reflected in lower borrowing costs.     

Lock‐In Effects in Relationship Lending: Evidence from DIP Loans

Do prior lending relationships result in pass‐through savings (lower interest rates) for borrowers, or do they lock in higher costs for borrowers? Theoretical models suggest that when borrowers experience greater information asymmetry, higher switching costs, and limited access to capital markets, they become locked into higher costs from their existing lenders. Firms in Chapter 11 seeking debtor‐in‐possession (DIP) financing often fit this profile. We investigate the presence of lock‐in effects using a sample of 348 DIP loans. We account for endogeneity using the instrument variable (IV) approach and the Heckman selection model and find consistent evidence that prior lending relationship is associated with higher interest costs and the effect is more severe for stronger existing relationships. Our study provides direct evidence that prior lending relationships do create a lock‐in effect under certain circumstances, such as DIP financing.     

Maturity and Corporate Loan Pricing

We investigate the relation between corporate loan spreads and maturity to test whether lenders are compensated for longer maturity loans (tradeoff hypothesis) or limit their exposure by forcing riskier borrowers to take short‐term loans (credit‐quality hypothesis). Earlier studies reject the tradeoff hypothesis. We use the LPC DealScan database to create a matched sample of pairs of loans to the same borrower on the same day holding credit quality constant. We perform mean of difference tests and cross‐sectional and regression analyses, and find evidence supporting both the tradeoff and credit quality hypotheses.     

The role of bankers in the U.S. syndicated loan market

I construct a novel dataset of individual bankers in the U.S. syndicated loan market to analyze the impact of bankers for the largest, most transparent borrowers. Bankers exhibit time-invariant preferences for specific loan characteristics, or styles. In addition, exploiting within-borrower variation in personal relationship strength from banker turnover, I find that stronger relationships lead to significantly lower interest rates. This effect is stronger if borrowers lack a credit rating or issue less frequent and shorter horizon management reports. Relationship loans are associated with fewer bankruptcies and fewer favorable modifications in renegotiations.     

The American keiretsu and universal banks: Investing,voting and sitting on nonfinancials’ corporate boards

This paper investigates the equity investments and voting rights that American banks control through their trust business. The paper also studies whether the voting rights American banks control through their trust business help explain their presence on firms’ corporate boards. We find that on average the largest 100 American banks control 10% of the voting rights of S&P 500 firms. We also find that there are several firms in the S&P 500 index in which the top banks control more than 20% of their voting rights, and several firms in the country in which these banks control more than 60% of their voting rights. Our investigation into the presence of American bankers on corporate boards shows that bankers are more likely to join the boards of firms in which they control a large voting stake. We also find that banks’ lending relationships help explain bankers’ board memberships. Our results further show that bankers who have both a voting stake in a firm and a lending relationship with it have a higher likelihood of joining the firm's board of directors.     

How do lending relationships affect access to credit and loan conditions in microlending?

A key problem facing microlenders is the high level of information asymmetry between them and their borrowers. In this paper, we analyze whether the relationship intensity between microlenders and borrowers helps to overcome existing information asymmetries and how this impacts access to credit and loan contract terms. Using a rich loan-level data set provided by a microlender in Mozambique for the years 2000-2006, we find that access to credit improves and that the loan approval process takes less time when relationships become more intense. Borrowers further profit from a more intense relationship through lower guarantee requirements. All effects are more pronounced the more opaque the borrowers are. These results suggest that longer lending relationships indeed help to reduce information asymmetries and that this is beneficial for microborrowers.     

Bank lending during the financial crisis of 2008

This paper shows that new loans to large borrowers fell by 47% during the peak period of the financial crisis (fourth quarter of 2008) relative to the prior quarter and by 79% relative to the peak of the credit boom (second quarter of 2007). New lending for real investment (such as working capital and capital expenditures) fell by only 14% in the last quarter of 2008, but contracted nearly as much as new lending for restructuring (LBOs, M&As, share repurchases) relative to the peak of the credit boom. After the failure of Lehman Brothers in September 2008, there was a run by short-term bank creditors, making it difficult for banks to roll over their short term debt. We find that there was a simultaneous run by borrowers who drew down their credit lines, leading to a spike in commercial and industrial loans reported on bank balance sheets. We examine whether these two stresses on bank liquidity led them to cut lending. In particular, we show that banks cut their lending less if they had better access to deposit financing and thus, they were not as reliant on short-term debt. We also show that banks that were more vulnerable to credit-line drawdowns because they co-syndicated more of their credit lines with Lehman Brothers reduced their lending to a greater extent.     

Consumer Default,Credit Reporting,and Borrowing Constraints

Why do negative credit events lead to long‐term borrowing constraints? Exploiting banking regulations in Peru and utilizing currency movements, we show that consumers who face a credit rating downgrade due to bad luck experience a three‐year reduction in financing. Consumers respond to the shock by paying down their most troubled loans, but nonetheless end up more likely to exit the credit market. For a set of borrowers who experience severe delinquency, we find that the associated credit reporting downgrade itself accounts for 25% to 65% of their observed decline in borrowing at various horizons over the following several years.     

The impacts of emotions and personality on borrowers’ abilities to manage their debts

This paper examines the impacts of retail borrowers’ emotions and personality traits on their abilities to engage in appropriate responses when things unexpectedly go wrong and they get into debt repayment difficulties. We establish several scenarios where borrowers are hit with unforeseen circumstances that affect their abilities to make their loan payments and we classify and evaluate the riskiness of the strategies they state that they would adopt in those situations. Via an extensive on-line survey conducted in the UK, we show that borrowers who were most comfortable about taking on debts in the first place, those who show neurotic tendencies, and those who believe that they have control over events rather than being controlled by them, are more likely to undertake high risk strategies when faced with unforeseen issues that affect their ability to meet their debt interest and repayment costs. We also find that respondents who identify as feeling excited, alert or guilty, as well as younger borrowers and those who are single or renters, are more likely to opt for risky approaches. Our findings have potentially important implications for lenders, regulators and debt counselling services regarding the types of people who are most likely to get into debt troubles.     

So what do I get? The bank's view of lending relationships

While many empirical studies document borrower benefits of lending relationships, less is known about lender benefits. A relationship lender's informational advantage over a non-relationship lender may generate a higher probability of selling information-sensitive products to its borrowers. Our results show that the probability of a relationship lender providing a future loan is 42%, while for a non-relationship lender, this probability is 3%. Consistent with theory, we find that borrowers with greater information asymmetries are significantly likely to obtain future loans from their relationship lenders. Relationship lenders are likely to be chosen to provide debt/equity underwriting services, but this effect is economically small.     

Why do large shareholders adopt a short‐term versus a long‐term investment horizon in different firms?

I ask why the same large shareholders have different investment horizons. Using data for 1998–2013, I examine four fundamental firm policies for their potential influence on blockholders’ investments with different time horizons. The panel ordinary least squares, difference‐in‐difference (using the Sarbanes‐Oxley Act), logistic, and dynamic generalized method of moments regression analyses reveal that blockholders adopt a short‐term horizon in smaller firms with a less independent board, high leverage, and high dividends while the same blockholders keep their investments longer in firms with a more independent board and low dividends. Under various economic conditions, different firm characteristics gain importance in blockholders’ decision on short‐term versus long‐term investments.     

Are Expected Inflation Rates and Expected Real Rates Negatively Correlated? A Long‐Run Test of the Mundell‐Tobin Hypothesis

Some empirical evidence suggests that the expected real interest and expected inflation rates are negatively correlated. This hypothesis of negative correlation is sometimes known as the Mundell‐Tobin hypothesis. In this article we reinvestigate this negative relation from a long‐term point of view using cointegration analysis. The data on the historical interest rate on T‐bills and the inflation rate indicate that the Mundell‐Tobin hypothesis does not hold in the long run for the United States, the United Kingdom, and Canada. We also obtain similar results using the real interest rate on index‐linked gilt traded in the United Kingdom.     

Bank Heterogeneity and Interest Rate Setting: What Lessons Have We Learned since Lehman Brothers?

A substantial literature has investigated the role of relationship lending in shielding borrowers from idiosyncratic shocks. Much less is known about how lending relationships and bank‐specific characteristics affect the functioning of the credit market in an economy‐wide crisis. We investigate how bank and bank–firm relationship characteristics have influenced interest rate setting since the collapse of Lehman Brothers. We find that interest rate spreads increased by less for those borrowers having closer lending relationships. Furthermore, firms borrowing from banks endowed with large capital and liquidity buffers and from banks engaged mainly in traditional lending were kept more insulated from the financial crisis.