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The Total Cost of Corporate Borrowing in the Loan Market: Don't Ignore the Fees
Abstract
Fees are an important part of the total cost of corporate borrowing. More than 80% of US syndicated loans contain at least one fee type and payments from fees can easily exceed interest payments. We find that the scope of relationship benefits extend beyond spreads, in particular, relationship loans are associated with lower upfront fees and lower letter of credit fees and these relationship benefits are similar in magnitude to those observed for spreads. We also find evidence consistent with a liquidity insurance view of lines of credit where relationship banking facilitates the smoothing of payments between no-liquidity-shock states and liquidity-shock states. Importantly, we propose a new measure for the total cost of corporate borrowing that accounts for fees and the fact that most loans are not immediately drawn down at origination. This measure produces higher costs of borrowing than has hitherto been recognized in the academic literature to date.
... This is important in our context since CLOs are never lead arrangers of loan packages. 14 Second, a voluminous literature in finance looks at loan pricing by taking the DealScan variable All-In-Spread-Drawn (AISD) as a proxy for total borrowing costs (see Berg et al. (2016a) and Berg et al. (2016b) for recent notable exceptions). One important underlying assumption is that loans are issued at par. ...
... In other words, although we rely on buyout data to identify the sponsor-borrower relation we do not restrict ourselves to a pure sample of LBO loans. Furthermore, credit lines as defined in Berg et al. (2016a) are almost non-existent in our sample. The primary facilities bought by CLOs are institutional loan facilities (i.e., term loans B, C, and D). ...
... The purchase amount of each CLO is inflation adjusted. FollowingBerg et al. (2016aBerg et al. ( , p. 1382) facilities of LoanType "Revolver/Line < 1 Yr.", "Revolver/Line ≥ 1 Yr.", "364-Day Facility", "Limited Line", or "Revolver/Term Loan". Dummy variable that is one if the LoanType of the facility contains the word "Term Loan" and is not of LoanType "Term Loan A" or "Re-Division belonging to the two-digit SIC Code as stated on the website of the U.S. Department of Labor.Effective spread, defined as the sum of AISD and the price discount distributed over four years: Effective Spread = AISD in % + (100 − price)/4. ...
... 9 For more information on the syndicated loan market's institutional setting see Berg, Saunders and Steffen (2016 drawn from the State aid Cases. In case of unknown end dates, the nationalizations will take value one for the full sample period. ...
... For more information on the syndicated loan market's institutional setting seeBerg, Saunders and Steffen (2016). ...
Diese Dissertation untersucht die Auswirkungen von Bankenkrisen auf die Realwirtschaft in drei unabhängigen Kapiteln. Kapitel 1 klassifiziert die geografische Diversifikation einer Großzahl von Banken, anhand deren international syndizierten Kreditportfolios. Ergebnisse zeigen ein höheres Kreditangebot durch diversifizierte Banken während Bankenkrisen die sich in Kreditnehmerländern ereignen. Dieses relativ stabilere Kreditangebot führt zu höherem Investitions- und Beschäftigungswachstum von Unternehmen. Eine weiterführende Unterteilung von Banken anhand derer Nationalität zeigt eine Rangfolge auf: diversifizierte inländische Banken erweisen sich als die stabilste und ausländische Banken mit geringer Diversifikation als die instabilste Finanzierungsquelle. In Kapitel 2 analysiere ich die Rolle der industriellen Spezialisierung von Banken in der Transmission von Finanzierungsshocks. Anhand der Ergebnisse schützen Banken Unternehmen die Teil ihrer spezialisierten Industrien sind vor der Bankenkrise und reduzieren ihre Kreditvergabe hingegen am stärksten an Industrien, in welchen sie weniger spezialisiert sind. Darüber hinaus finde ich Evidenz für Übertragungseffekte durch reduzierte Kreditvergabe auch in Nicht-Krisenländern. Dieser Übertragungseffekt ist jedoch gedämpft für Unternehmen aus spezialisierten Industrien. Kapitel 3 untersucht die Effekte von Bankenrettungen in Europa auf die globalen Kreditströme. Gerettete Banken weisen einen höheren Anstieg des Anteils an inländischen Unternehmen in der Kreditvergabe auf als nicht-gerettete Banken. Das negative Kreditangebot für ausländische Unternehmen führt zu einer Verringerung des Absatz- und Beschäftigungswachstums. Im inländischen Markt hingegen führt die Bankenrettung zu einer Verzerrung der Kreditallokation, hin zu größeren und weniger innovativen Unternehmen. Darüber hinaus dokumentiere ich eine stärkere politische Einflussnahme, da Kontrollrechte im Zuge der Bankenrettung an die Regierung übertragen werden.
... The resulting dataset contains the volume of outstanding and maturing loan facilities at the firm-quarter level. 16 For term loans and credit lines, I follow the definition of Berg, Saunders, and Steffen (2016). 17 I define investment as the four-quarter moving average of the ratio of quarterly capital expenditures to the fourth lag of quarterly PPE assets. ...
I study the long-run effects of credit market disruptions on real firm outcomes and how these effects depend on nominal wage rigidity at the firm level. Exploiting variation in firms' refinancing needs during the global financial crisis, I trace out firms' investment and growth trajectories in response to a credit supply shock. Financially shocked firms exhibit a temporary investment gap for two years, resulting in a persistent accumulated growth gap six years after the crisis. Shocked firms with rigid wages exhibit a significantly steeper drop in investment and an additional long-run growth gap relative to shocked firms with flexible wages.
... The conditional feature of credit lines makes them imperfect substitutes for cash holdings as a source of corporate liquidity, especially for firms with low cash flows (e.g., Demiroglu and James, 2011;Nikolov, Schmid and Steri, 2019). 2 Banks charge firms for the option to draw down a credit line (liquidity insurance). Berg, Saunders, and Steffen (2015) find that almost all credit lines contain either a commitment fee (paid on unused credit line) or a facility fee (paid on entire committed amount regardless of usage), similar to insurance contracts that require fees for coverage. Acharya et al. (2014) develop a theory of credit lines where banks provide monitored liquidity insurance to firms. ...
Hand-collecting credit line drawdowns that firms classify as long-term debt, we first document how long-term drawdowns rise with high investment needs or weak external capital market conditions. Nearly all drawdown proceeds finance long-term investment, including M&A activity. Unrated and lower-rated firms rely more on long-term drawdowns than high or very poorly rated firms. We further find that credit lines have tighter covenants than terms loans. Drawdowns are repaid fairly quickly and often refinanced with other long-term debt. Our findings support the monitored liquidity insurance theory of credit lines and highlight that long-term drawdowns act as a valuable bridge financing mechanism.
... While the upfront fee does not correlate with the interest rate in this regression, a ten basis point higher annual fee is associated with a nine basis point higher interest rate, suggesting that lenders include annual fees in riskier loans. See Berg, Saunders, and Steffen (2015) for a discussion of the importance of fees in loan contracts. the negative EBITDA dummy drops from 78 to 37 basis points and is no longer statistically significant. ...
... The log of the all-in-drawn spread is the main dependent variable in our tests. We also analyze the log of the time to maturity, and the log of the loan amount as dependent variables, and for a small fraction of the observations (in unreported results), we estimate the TCB as defined by Berg, Saunders, and Steffen (2016) as dependent variables. To show that lenders' creditor rights matter in loan contracts, we control for borrower country creditor rights as well as borrower risk characteristics, loan purpose, industry effects, and year effects. ...
The multinational syndicated loan market has crossed the $7 trillion threshold. Prior literature argues that weak borrower country's creditor rights is the main limiting factor to cross‐border lending. We find that lender country's creditor rights can partly substitute for weak borrower creditor rights if a lender is from a better creditor rights country. Our results are robust to controlling for a borrower's country laws, its foreign assets, the loan guarantees provided by its foreign parent, and its choice set of lenders.
... Sufi (2009) andBerg et al. (2016) provide direct empirical evidence. ...
Using a comprehensive dataset of Italian SMEs, we find that differences between private and public information on creditworthiness affect firms' decisions to issue debt securities. Surprisingly, our evidence supports positive (rather than adverse) selection. Holding public information constant, firms with better private fundamentals are more likely to access bond markets. Additionally, credit conditions improve for issuers following the bond placement, compared with a matched sample of non-issuers. These results are consistent with a model where banks offer more flexibility than markets during financial distress and firms may use market lending to signal credit quality to outside stakeholders. JEL Classification: G10, G21, G23, G32.
... У уређивању тих односа полази се од основних принципа облигационог права као што су аутономија воље, ограничена принудним прописима, јавним поретком и добрим обичајима, затим начела савјесности и поштења, те равноправности уговорних страна. 2 Полазећи од наведених принципа, креира се и садржај облигационог односа који као крајњи резултат има уоквирен уговор. Тај уговор има релативно дејство само између уговорних страна 3 и не односи се на трећа лица, а његове основне особине су да се ради о имовинскоправном односу, да су његови субјекти одређена лица и да има одређену садржину. ...
... For term loans and credit lines, we follow the variable definition ofBerg, Saunders, and Steffen (2016). ...
We study the impact of higher capital requirements on banks' balance sheets and its transmission to the real economy. The 2011 EBA capital exercise provides an almost ideal quasi-natural experiment, which allows us to identify the effect of higher capital requirements using a difference-in-differences matching estimator. We find that treated banks increase their capital ratios not by raising their levels of equity, but by reducing their credit supply. We also show that this reduction in credit supply results in lower firm-, investment-, and sales growth for firms which obtain a larger share of their bank credit from the treated banks.
... The increase in annual fees implies that the bank intends to expend greater monitoring efforts after the auditor switch because of the higher probability of financial misreporting. The additional combined cost associated with the above two fees, approximately $1.5 million for the average loan in our sample, is substantial and reflects the sentiment of recent work that fees should not be ignored as they form an important part of loan contracting (Berg, Saunders, and Steffen 2015). ...
We examine the response of informed market participants to the informational signal of auditor changes. Using propensity score matching and difference-in-differences research designs, we document that loan spreads increase by 22 percent on bank loans initiated within a year after auditor changes, increasing direct loan costs by approximately $6.6 million. We also find a significant increase in upfront and annual fees and the probability of pledging collateral, consistent with an increase in screening and monitoring by banks. The increase in spreads is significant for client-initiated auditor changes, with or without disagreements with the auditor, as well as for auditor resignations. Further, the significant increase in loan spreads is documented for upward, lateral, and downward auditor changes. Our results are robust to other proxies for financial reporting quality. Finally, we find no effect resulting from the forced auditor changes due to Arthur Andersen. Collectively, these results suggest that voluntary auditor changes increase information risk, which is priced in private credit markets.
JEL Classifications: G20; G21; G32; K22.
... The increase in annual fees implies that the bank intends to expend greater monitoring efforts after the auditor switch because of the higher probability of financial misreporting. The additional combined cost associated with the above two fees, approximately $1.5 million for the average loan in our sample, is substantial and reflects the sentiment of recent work that fees should not be ignored as they form an important part of loan contracting (Berg, Saunders, and Steffen 2015). ...
Using a sample of state pension funds' equity holdings, we find evidence of not only local bias, but also bias towards politically-connected stocks. Political bias is detrimental to fund performance. State pension funds have longer holding durations of politically-connected local firms and display disposition behavior in these positions. Political bias is positively related to the percentage of politically-affiliated trustees on the board and Congressional connections. The more politically-affiliated trustees on the board, the more the fund shifts toward risky asset allocations. Overall, our results imply that political bias is likely costly to taxpayers and pension beneficiaries.
... As such, we expect a negative relationship between Loan Commitment and Credit Risk. Berg et al. (2013) show that credit lines act as insurance for borrowers against liquidity shocks and the related fees including commitment fees smooth borrowing costs across different scenarios (namely, the presence and absence of liquidity shocks). As such, higher ...
This paper investigates the impact of non-interest income businesses on bank lending. Using quarterly data on 9,066 U.S. commercial banks over 2003-2010, we find that non-interest income activities of banks with total assets ranging between $100 million and $1 billion influence credit risk. In particular, banks that have higher income from fiduciary activities have lower credit risk. For this size range of banks our findings suggest that fiduciary activities induce managers to behave more prudently in lending because such activities are found to increase banks’ franchise value. Micro banks (assets less than $100 million) suffer from diseconomies in joint production of non-interest income activities and lending. Non-interest activities of large (assets $1bn to $50bn), systemically important (assets greater than $50bn) and distressed banks have no impact on credit risk.
... The use of publicly traded bonds enables us to be less sensitive to the problem of reverse causality since the majority of public bondholders, such as mutual funds, pension funds, insurance companies, government agencies, and foreign institutions, are generally not the sellers of derivatives . Additionally, our cost of debt measure based on market transactions is less likely to be subject to the underestimation problem in private loans data uncovered by Berg et al. (2013). Second, most of the existing research on hedging focuses on specific industries (e.g., the oil and airline industries) using a limited sample period. ...
For a large sample of U.S. Firms from 1994 to 2009, we empirically examines the impact of corporate hedging on the cost of public debt. We find strong evidence that hedging is associated with a lower cost of debt. The negative effect of hedging on the cost of debt is consistent across industries, and remains economically and statistically significant under various controls and econometric specifications. A cross-sectional analysis based on propensity score matching suggests that hedging initiation firms experience a drop in cost of debt, while suspension firms sustain a jump. We confirm our findings after employing an extensive array of models to address potential endogeneity. The influence of hedging on cost of debt is mainly through the lowering of bankruptcy risk and agency cost, and the reduction in information asymmetry. Finally, hedging mitigates the negative effect of rising borrowing costs on capital expenditure and firm value.
U.S. bank supervisors conduct frequent and comprehensive loan‐level exams of the syndicated loan market. These exams are costly as adverse exam loan ratings may increase supervisory scrutiny and reduce bank capital. Relying on an unexpected change in supervisory coverage in 1998, we estimate that the cost of bank credit for borrowers excluded from supervision decreases by approximately 18%. We show that large lenders use the coverage change to exclude deals from supervision, especially riskier deals. Strikingly, small lenders shift their lending to increase supervisory coverage, suggesting the potential importance of supervision in reducing information asymmetries within lending syndicates.
We show that U.S. dollar movements affect syndicated loan terms for U.S. borrowers, even for those without trade exposure. We identify the effect of dollar movements using spread and loan amount adjustments during the syndication process. Using this high-frequency, within loan variation, we find that a one standard deviation increase in the dollar index increases spreads by up to 15 basis points and reduces loan amounts and underpricing by up to 2 percent and 7 basis points, respectively. These effects are concentrated in dollar appreciations. Our results suggest that global factors reflected in the dollar affect U.S. borrowing costs.
This paper investigates the pricing of bank loans relative to capital market debt. The analysis uses a novel sample of loans matched with bond spreads from the same firm on the same date. After accounting for seniority, lenders earn a large premium relative to the bond‐implied credit spread. In a sample of secured term loans to noninvestment‐grade firms, the average premium is 140 to 170 bps or about half of the all‐in‐drawn spread. This is the first direct evidence of firms' willingness to pay for bank credit and raises questions about the nature of competition in the loan market. This article is protected by copyright. All rights reserved.
This paper examines the impact of borrowers’ managerial ability on lenders’ bank-loan pricing and the channels through which managerial ability affects bank-loan pricing. Using a large sample of U.S. bank loans, we provide evidence that higher managerial ability is associated with lower bank-loan prices. This effect is stronger in firms with high information risk, suggesting that an important channel for managerial ability to affect bank-loan pricing is through improved financial disclosure to mitigate information asymmetry. The relation is also stronger for firms with weak business fundamentals, implying that another channel is through improved business performance. Of these two mechanisms, path analysis suggests that the business-fundamentals mechanism is the more important channel through which managerial ability affects bank-loan pricing. This article is protected by copyright. All rights reserved
Using a sample of syndicated loan facilities granted to US corporate borrowers from 1987 to 2013, we directly gauge the lead banks’ market power, and test its effects on both price and non-price terms in loan contracts. We find that bank market power is positively correlated with loan spreads, and the positive relation holds for both non-relationship loans and relationship loans. In particular, we report that, for relationship loans, lending banks charge lower loan price for borrowing firms with lower switching cost. We further employ a framework accommodating the joint determination of loan contractual terms, and document that the lead banks’ market power is positively correlated with collateral and negatively correlated with loan maturity. In addition, we report a significant and negative relationship between banking power and the number of covenants in loan contracts, and the negative relationship is stronger for relationship loans.
Based on U.S. 10-K filings, we investigate the use of lines of credit as sources of long-term finance. We find that long-term debt representing drawdowns of credit lines constitutes 11% of a typical listed firm’s book value of assets. Consistent with credit lines serving as liquidity buffers and financing sources of last resort, long-term drawdowns are more likely when other sources of external capital are not easily accessible due to unfavorable external equity and long term bond market conditions. They are also more likely when firms are expected to spend more on capital expenditures and acquisitions (consistent with maturity matching).
We examine the differential impacts of lending relationships on firm outcomes depending on individual bank health. We find that the information benefit dominates when the relationship bank is healthy but is swamped by hold up costs when it is not. We study this differential benefit of relationships on loan availability, loan terms, and firm outcomes. Our empirical strategy employs an instrument for endogenous relationships using heteroskedasticity of independent regressors and a new measure of bank health to overcome endogeneity of the standard measures. Results suggest that the decline of lending relationships in recent decades has conflicting effects on loan availability and terms due to the changing health of the relationship banks.
JEL Classifications: G21, G30, E24.
This paper investigates the impact of non-interest income businesses on bank lending. Using quarterly data on 9,066 U.S. commercial banks over 2003-2010, we find that non-interest income activities of banks with total assets ranging between $100 million and $1 billion influence credit risk. In particular, banks that have higher income from fiduciary activities have lower credit risk. For this size range of banks our findings suggest that fiduciary activities induce managers to behave more prudently in lending because such activities are found to increase banks’ franchise value. Micro banks (assets less than $100 million) suffer from diseconomies in joint production of non-interest income activities and lending. Non-interest activities of large (assets $1bn to $50bn), systemically important (assets greater than $50bn) and distressed banks have no impact on credit risk.
This paper investigates the impact of non-interest income businesses on bank lending. Using quarterly data on 9,066 U.S. commercial banks over 2003-2010, we find that non-interest income activities of banks with total assets ranging between $100 million and $1 billion influence credit risk. In particular, banks that have higher income from fiduciary activities have lower credit risk. For this size range of banks our findings suggest that fiduciary activities induce managers to behave more prudently in lending because such activities are found to increase banks’ franchise value. Micro banks (assets less than $100 million) suffer from diseconomies in joint production of non-interest income activities and lending. Non-interest activities of large (assets $1bn to $50bn), systemically important (assets greater than $50bn) and distressed banks have no impact on credit risk.
We investigate how the introduction of market-based pricing, the practice of tying loan interest rates to credit default swaps, has affected borrowing costs. We find that CDS-based loans are associated with lower interest rates, both at origination and during the life of the loan. Our results also indicate that banks simplify the covenant structure of market-based pricing loans, suggesting that the decline in the cost of bank debt is explained, at least in part, by a reduction in monitoring costs. Market-based pricing, therefore, besides reducing the cost of bank debt, may also have adverse consequences resulting from the decline in bank monitoring.
This article is mainly concerned with Walter Oi's Disneyland problem: pricing a fixed input (admission to the park or Polaroid cameras) and a variable input (individual rides or Polaroid film) to maximize profit, though profit-constrained welfare maximization is also treated. The structure of demand in such situations is fully described when customers are either households or competitive firms. The implications of customer diversity and other market attributes for optimal policies are presented. The welfare properties of single-price and two-part tariff monopoly equilibria are compared, and potential welfare gains from tying contracts are discussed.
I empirically examine the factors that determine whether firms use bank lines of credit or cash in corporate liquidity management.
I find that bank lines of credit, also known as revolving credit facilities, are a viable liquidity substitute only for firms
that maintain high cash flow. In contrast, firms with low cash flow are less likely to obtain a line of credit, and they rely
more heavily on cash in their corporate liquidity management. An important channel for this correlation is the use of cash
flow-based financial covenants by banks that supply credit lines. I find that firms must maintain high cash flow to remain
compliant with covenants, and banks restrict firm access to credit facilities in response to covenant violations. Using the
cash-flow sensitivity of cash as a measure of financial constraints, I provide evidence that lack of access to a line of credit
is a more statistically powerful measure of financial constraints than traditional measures used in the literature.
Customer relationships arise between banks and firms because, in the process of lending, a bank learns more than others about its own customers. This information asymmetry allows lenders to capture some of the rents generated by their older customers; competition, thus, drives banks to lend to new firms at interest rates that initially generate expected losses. As a result, the allocation of capital is shifted toward lower quality and inexperienced firms. This inefficiency is eliminated if complete contingent contracts are written or, when this is costly, if banks can make nonbinding commitments that, in equilibrium, are backed by reputation. Copyright 1990 by American Finance Association.
We offer evidence that interest rate spreads on syndicated loans to corporate borrowers are economically significantly smaller in Europe than in the United States, other things equal. Differences in borrower, loan, and lender characteristics do not appear to explain this phenomenon. Borrowers overwhelmingly issue in their natural home market and bank portfolios display home bias. This may explain why pricing discrepancies are not competed away, though their causes remain a puzzle. Thus, important determinants of loan origination market outcomes remain to be identified, home bias appears to be material for pricing, and corporate financing costs differ across Europe and the United States. Copyright 2007 by The American Finance Association.
Using a large sample of private credit agreements between U.S. publicly traded firms and financial institutions, we show that over 90% of long-term debt contracts are renegotiated prior to their stated maturity. Renegotiations result in large changes to the amount, maturity, and pricing of the contract, occur relatively early in the life of the contract, and are rarely a consequence of distress or default. The accrual of new information concerning the credit quality, investment opportunities, and collateral of the borrower, as well as macroeconomic fluctuations in credit and equity market conditions, are the primary determinants of renegotiation and its outcomes. The terms of the initial contract (e.g., contingencies) also play an important role in renegotiations; by altering the structure of the contract in a state contingent manner, renegotiation is partially controlled by the contractual assignment of bargaining power.
We propose and test a theory of corporate liquidity management in which credit lines provided by banks to firms are a form of monitored liquidity insurance. Bank monitoring and resulting credit line revocations help control illiquidity-seeking behavior by firms. Firms with high liquidity risk are likely to use cash rather than credit lines for liquidity management because the cost of monitored liquidity insurance increases with liquidity risk. We exploit a quasi-experiment around the downgrade of General Motors (GM) and Ford in 2005 and find that firms that experienced an exogenous increase in liquidity risk (specifically, firms that relied on bonds for financing in the pre-downgrade period) moved out of credit lines and into cash holdings in the aftermath of the downgrade. We observe a similar effect for firms whose ability to raise equity financing is compromised by pricing pressure caused by mutual fund redemptions. Finally, we find support for the model's other novel empirical implication that firms with low hedging needs (high correlation between cash flows and investment opportunities) are more likely to use credit lines relative to cash, and are also less likely to face covenants and revocations when using credit lines.
We examine the link between ex ante contractual contingencies and ex post renegotiation in a random sample of 1,000 private credit agreements between U.S. publicly traded firms and financial institutions. While most every ex ante contract specifies several explicit contingencies (e.g., flexible borrowing bases, performance pricing, financial covenants), over 90% of these long-term contracts are renegotiated prior to the stated maturity. These renegotiations lead to material changes in the terms of the contract (e.g., pricing, principal, maturity), as well as an average effective maturity of approximately one year, less than one third that of the average stated maturity of three and a half years. Renegotiations, and their eventual outcomes, are governed by specific features of the ex ante contract, the evolution of the borrower's credit quality and investment opportunities, and the macroeconomic environment. The implications of our findings are threefold. First the large majority of corporate debt is best viewed as dynamic, state contingent contracts - ever-changing through a combination of ex ante contingencies and ex post renegotiation. Second, inferences based on stated maturities should be treated with caution in light of the difference between the effective and stated maturities. The fact that loans are so frequently and quickly modified has significant implications for understanding maturity structure, as well as for the valuation and risk management of these securities. Finally, lenders appear to use ex ante contingencies as a means to induce renegotiation and allocate bargaining power between the contracting parties, as opposed to a means for completing contracts and reducing renegotiation.
Using a novel measure of contract strictness based on the ex-ante probability of a covenant violation, I investigate how lender-specific shocks impact the strictness of the loan contract that a borrower receives. Exploiting between-bank variation in recent portfolio performance, I find evidence that banks write tighter contracts than their peers after suffering payment defaults to their own loan portfolios, even when defaulting borrowers are in different industries and geographic regions than the current borrower. The effects of recent defaults persist after controlling for bank capitalization, although compression in bank equity is also strongly associated with tighter contracts. The evidence is most consistent with lenders using their default experience to make inference about their screening ability and adjusting contracts accordingly. Finally, contract tightening is most pronounced for borrowers who are dependent on a relatively small circle of lenders, with a one standard deviation increase in lender defaults implying covenant tightening nearly equivalent to that of a two-notch downgrade in the borrower's own credit rating.
We investigate the effect of poor performance on financial intermediary reputation by estimating the effect of large-scale bankruptcies among a lead arranger's borrowers on its subsequent syndication activity. Consistent with reputation damage, such lead arrangers retain larger fractions of the loans they syndicate, are less likely to syndicate loans, and are less likely to attract participant lenders. The consequences are more severe when borrower bankruptcies suggest inadequate screening or monitoring by the lead arranger. However, borrower bankruptcies have little effect on syndication activity of the most dominant lead arrangers, and in years in which many lead arrangers experience borrower bankruptcies.
Using hand-collected data from SEC filings, we show that bank loans are repeatedly renegotiated in order to modify contractual constraints designed to mitigate information related problems. The typical loan is renegotiated every eight months, or four times during the life of the contract. The financial health of the contracting parties, the uncertainty of the borrower’s credit quality, and the purpose of the renegotiation govern the timing of these renegotiations. However, the relative importance of these factors depends critically on when in the relationship the renegotiation occurs. This temporal dependence reflects a decline in information asymmetry during the lending relationship such that lenders can write more efficient contracts and rely more heavily on observable signals of borrower credit quality when amending the contracts.
This article examines the impact of leveraged buyout firms' bank relationships on the terms of their syndicated loans. We
examine a sample of 1,590 loans financing private equity sponsored leveraged buyouts between 1993 and 2005, and find that
private equity firms' bank relationships are an important factor in cross-sectional variation in the loan interest rate and
covenant structure. Our results indicate that bank relationships formed through repeated interactions reduce inefficiencies
from information asymmetry and allow leveraged buyouts sponsored by private equity firms to occur on favorable loan terms.
A one-standard-deviation increase in bank relationship strength is associated with an 8-basis-point (3%) decrease in the spread
and a 0.21-basis-point (4%) increase in the maximum debt to EBITDA covenant. We also find evidence that banks price loans
to cross-sell other fee business. A one-standard-deviation increase in both bank relationship strength and cross-selling potential
translates into as much as a 4-percentage-point increase in equity return to the leveraged buyout firm.
We find that repeated borrowing from the same lender translates into a 10--17 bps lowering of loan spreads and that relationships are especially valuable when borrower transparency is low. These results hold using multiple approaches (propensity score matching, instrumental variables, and treatment effects model) that control for the endogeneity of relationships. We also provide a demarcation line between relationship and transactional lending. Spreads charged for relationship loans and nonrelationship loans are statistically identical if the borrower is in the largest 30% by asset size; has public rated debt; or is part of the S&P 500 index. Past relationships reduce collateral requirements and are also associated with obtaining larger loans. Our results imply that, even for firms that have multiple sources of outside financing, borrowing from a prior lender obtains better loan terms. The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.
The volume of global syndicated loans has increased from $413 billion in 1990 to $2.195 trillion in 2000, making it not only the largest source of corporate funds in the world but also one of the fastest growing. Yet despite the size of this market and its importance as a source of corporate funds, there has been relatively little research on syndicated lending and little understanding of the structuring intricacies underlying these deals.
In this article, the author analyzes the process by which Hongkong International Theme Parks Limited (HKTP), an entity jointly owned by The Walt Disney Company and the Hong Kong Government, raised HK $3.3 billion (approximately US $425 million) in the syndicated loan market to finance part of the construction and operation of its Hong Kong Disneyland theme park and resort complex. Using this case study of the HKTP financing, the article moves beyond the overly simplistic (albeit theoretically tractable) models of debt choice favored by academics and begins to explore the dynamics and consequences of various real-world debt structures. Rather than focusing on the credit analysis or documentation issues, the author focuses on the structuring and distribution issues because they are both less well understood and provide interesting insights into debt management.
We rationalize fixed rate loan commitments (forward credit contracting with options) in a competitive credit market with universal risk neutrality. Future interest rates are random, but there are no transactions costs. Borrowers finance projects with bank loans and choose ex post unobservable actions that affect project payoffs. Credit contract design by the bank is the outcome of a (non-cooperative) Nash game between the bank and the borrower. The initial formal analysis is basically in two steps. First, we show that the only spot credit market Nash equilibria that exist are inefficient in the sense that they result in welfare losses for borrowers due to the bank's informational handicap. Second, we show that loan commitments, because of their ability to weaken the link between the offering bank's expected profit and the loan interest rate, enable the complete elimination of informationally induced welfare losses and thus produce an outcome that strictly Pareto dominates any spot market equilibrium. Perhaps our most surprising result is that, if the borrower has some initial liquidity, it is better for the borrower to use it now to pay a commitment fee and buy a loan commitment that entitles it to borrow in the future rather than save it for use as inside equity in conjunction with spot borrowing.
Between 2001 and 2007, annual institutional funding in highly leveraged loans went up from $32 billion to $426 billion, accounting for nearly 70% of the jump in total syndicated loan issuance over the same period. Did the inflow of institutional funding in the syndicated loan market lead to mispricing of credit? To understand this relation, we look at the institutional demand pressure defined as the number of days a loan remains in syndication. Using market-level and cross-sectional variation in time-on-the-market, we find that a shorter syndication period is associated with a lower final interest rate. The relation is robust to the use of institutional fund flow as an instrument. Furthermore, we find significant price differences between institutional investors’ tranches and banks’ tranches of the same loans, even though they share the same underlying fundamentals. Increasing demand pressure causes the interest rate on institutional tranches to fall below the interest rate on bank tranches. Overall, a one-standard-deviation reduction in average time-on-the-market decreases the interest rate for institutional loans by over 30 basis points per annum. While this effect is significantly larger for loan tranches bought by collateralized debt obligations (CDOs), it is not fully explained by their role.
We present novel empirical evidence that conflicts of interest between creditors and their borrowers have a significant impact on firm investment policy. We examine a large sample of private credit agreements between banks and public firms and find that 32% of the agreements contain an explicit restriction on the firm's capital expenditures. Creditors are more likely to impose a capital expenditure restriction as a borrower's credit quality deteriorates, and the use of a restriction appears at least as sensitive to borrower credit quality as other contractual terms, such as interest rates, collateral requirements, or the use of financial covenants. We find that capital expenditure restrictions cause a reduction in firm investment and that firms obtaining contracts with a new restriction experience subsequent increases in their market value and operating performance.
This paper estimates the cost arising from information asymmetry between the lead bank and members of the lending syndicate. In a lending syndicate, the lead bank retains only a fraction of the loan but acts as the intermediary between the borrower and the syndicate participants. Theory predicts that asymmetric information will cause participants to demand a higher interest rate and that a large loan ownership by the lead bank should reduce this effect. In equilibrium, however, the asymmetric information premium demanded by participants is offset by the diversification premium demanded by the lead. Using shifts in the idiosyncratic credit risk of the lead bank's loan portfolio as an instrument, I measure the asymmetric information effect of the lead's share on the loan spread and find that it accounts for approximately 4% of the total cost of credit.
I. Two-part tariffs and a discriminating monopoly, 78.—II. Determination of a uniform two-part tariff, 81.—III. Applications
of two-part tariffs, 88.—Appendix: Mathematical derivation of a uniform two-part tariff, 93.
The unique characteristics of bank loans emerge endogenously to enhance efficiency in a model of renegotiation between a borrower
and a lender in which there is the potential for moral hazard on each side of the relationship. Firm risk is endogenous and
renegotiated interest rates on the debt need not be monotone in firm risk. The initial terms of the debt are not set to price
default risk but rather are set to efficiently balance bargaining power in later renegotiation. Loan pricing may be nonlinear,
involving initial transfers either from the borrower to the bank or from the bank to the borrower.
Forecasts are an inherent part of economic science and the quest for perfect foresight occupies economists and researchers in multiple fields. The release of economic forecasts (and its revisions) is a popular and often publicized event, with a multitude of institutions and think-tanks devoted almost exclusively to that task. The European Central Bank (ECB) also publishes its forecasts for the euro area, however ECB’s forecast accuracy is not a deeply researched theme. The ECB forecasts’ accuracy is the main point developed in this paper, which tries to contribute to understand the nature of the errors committed by the ECB forecasts and its main differences compared to other projections. What we try to infer is whether the ECB is accurate in its projections, making less errors than the others, maybe due to some informational advantage. We conclude that the ECB seems to consistently underestimate the HICP inflation rate and overestimate GDP growth. Comparing it with the others, the ECB shows a superior performance, committing almost always fewer errors. So, this signals a possible informational advantage from the ECB. Since the forecasting errors could jeopardize ECB’s credibility public criticism could be avoided if the ECB simply let forecasts for the others. Naturally, this change should be weighted against the benefits of publishing forecasts.
Over 80 per cent of all commercial bank lending to corporations in the U.S. is done via bank loan commitments. Yet the authors have little empirical knowledge of loan commitment contracts. In this paper they describe the rich contractual structure of bank loan commitments based on data pertaining to over 2,500 contracts. The authors then develop a model which demonstrates that the observed complex structure of bank loan commitment contracts (which typically include multiple fee structures borrower-specific contracting variables, and the standard 'material adverse change clause') is important when the bank faces borrower adverse selection and moral hazard problems. Finally, the authors verify the robustness of their model by confronting its additional testable predictions with the data. Copyright 1997 by Ohio State University Press.
When loan needs are uncertain and bankruptcy is costly, contracts resembling bank credit commitments dominate ordinary debt contracts. The fees charged on commitments reduce bankruptcy risk by smoothing out borrowers' loan payments. Reduced bankruptcy risk entitles borrowers to larger loans, thereby reducing the risk of quantity rationing. Even if commitments reduce rationing risk, monetary policy is not necessarily weaker under commitment finance. A rise in lenders' cost of funds, perhaps reflecting a monetary contraction, can reduce the expected value of a project more under a commitment than under an ordinary debt contract. Copyright 1994 by Ohio State University Press.
Since bank credit lines are a major source of corporate funding, we examine the determinants of their usage with a comprehensive
database of Spanish corporate credit lines. A line's default status is a key factor driving its usage, which increases as
firm financial conditions worsen. Firms with prior defaults access their credit lines less, suggesting that bank monitoring
influences firms’ usage decisions. Line usage has an aging effect that causes it to decrease by roughly 10% per year of its
life. Lender characteristics, such as the length of a firm's banking relationships, as well as macroeconomic conditions, affect
usage decisions.
While the benefits of bank financing are relatively well understood, the costs are not. This paper argues that while informed banks make flexible financial decisions which prevent a firm's projects from going awry, the cost of this credit is that banks have bargaining power over the firm's profit once projects have begun. The firm's portfolio choice of borrowing source and the choice of priority for its debt claims attempt to optimally circumscribe the powers of banks. Copyright 1992 by American Finance Association.
Competiton and Two-Part Tariffs, Discussion paper no. 601, Center for Mathematical Studies in Economics and Management Science
- Beth Hayes
Hayes, Beth, 1964, Competiton and Two-Part Tariffs, Discussion paper no. 601, Center for
Mathematical Studies in Economics and Management Science, March (Northwestern University,
Evanston, IL).
Shared National Credits (SNC) Program, 2012, Shared National Credit Program
Shared National Credits (SNC) Program, 2012, Shared National Credit Program 2012 Review,
August 2012.
An Empirical Analysis of Exposure at Default, Working Paper
- Michael Jacobs
- Jr
Jacobs, Michael Jr., 2008. An Empirical Analysis of Exposure at Default, Working Paper, Office
of the Comptroller of the Currency.