Syndicated loans, lending relationships and the business cycle

The syndicated loan market, as a hybrid between public and private debt markets, comprises financial institutions with access to valuable private information about borrowers as a result of close bank-borrower relationships. In this paper, we seek empirical evidence for the costs of these relationships in a sample of UK syndicated loan contracts for the time period 1996 through 2005. Using detailed financial data for both borrowers (private and public companies) and for financial institutions, we find that undercapitalized banks charge higher loan spreads for loans to opaque borrowers using various measures for borrower opaqueness and controlling for bank, borrower and loan characteristics. We further analyze this hold-up effect over the business cycle and find that it only prevails during recessions. In expansion phases, however, we do not find evidence for banks exploiting their information monopoly. This finding is consistent with theories on bank reputation in bank loan commitments. Ambiguity about borrower financial health, which induces the information monopoly in the first place, also gives banks the discretion to exploit or not exploit informational captured borrowers. Our findings are both statistically and economically significant and robust to alternative bank and macroeconomic risk proxies. We address potential concerns about unobserved borrower heterogeneity exploiting the panel data nature of our sample. Using firm-bank fixed effect regressions, we find supporting evidence for our theoretical framework. JEL Classifications: G14, G21, G22, G23, G24 Keywords: Syndicated loans; Hold-up; Lending relationships; Business cycl

Capital markets union in Europe : why other unions must lead the way

In 2016, the Eurozone is still coping with the consequences of two financial crises that revealed the shortcomings of an incomplete monetary union. The European economy suffered two severe recessions and a sustainable growth path is still elusive. Risks in the banking system and a severe banking sector debt-overhang played a major role in both crises as Eurozone firms are heavily reliant on bank financing. To foster economic growth in the Eurozone, the European Commission suggested the creation of a capital markets union, in which local capital markets are developed further and integrated across borders as alternative sources for corporate finance. In this paper, we argue that a capital markets union cannot work without a banking union and fiscal union in place

The zero risk fallacy? : banks' sovereign exposure and sovereign risk spillovers

European banks are exposed to a substantial amount of risky sovereign debt. The “missing bank capital” resulting from the zero-risk weight exemption for European banks for European sovereign debt amplifies the co-movement between sovereign CDS spreads and facilitates cross-border financial-crisis spillovers. Risks spill over from risky periphery sovereigns to safer core countries, but not in the opposite direction nor for exposures to countries not exempted from risk-weighting. We consider the trade-off of benefits of sovereign debt (for banks and sovereigns) and spillover risk when applying risk-weights. More bank capital as well as positive risk-weighting for sovereign exposures mitigates spillovers

The total costs of corporate borrowing in the loan market : don't ignore the fees

More than 80% of US syndicated loans contain at least one fee type and contracts typically specify a menu of spread and different types of fees. We test the predictions of existing theories about the main purposes of fees and provide supporting evidence that: (1) fees are used to price options embedded in loan contracts such as the draw-down option for credit lines and the cancellation option in term loans; and (2) fees are used to screen borrowers about the likelihood of exercising these options. We also propose a new total-cost-of-borrowing measure that includes various fees charged by lenders

Lender of last resort versus buyer of last resort - the impact of the European Central Bank actions on the bank-sovereign nexus

In summer 2011, elevated sovereign risk in Eurozone peripheral countries increased the solvency risk of Eurozone banks, precipitating a run on their short-term debt. We assess the effectiveness of different European Central Bank (ECB) interventions that followed – lender of last resort vs. buyer of last resort – in stabilizing the European financial sector. We find that (i) by being lender of last resort to banks via the long-term refinancing operations (LTRO), ECB temporarily reduced funding pressure for banks, but did not help to contain sovereign risk. In fact, banks of the peripheral countries used the public funds to increase their exposure to risky domestic debt, so that when solvency risk in the Eurozone worsened the run of private short-term investors from Eurozone banks intensified. (ii) In contrast, ECB’s announcement of being a potential buyer of last resort via the Outright Monetary Transaction program (OMT) significantly reduced the bank-sovereign nexus. The OMT increased the market prices of sovereign bonds, leading to a permanent reversal of private funding flows to Eurozone banks holding these bonds

Global retail lending in the aftermath of the US financial crisis: Distinguishing between supply and demand effects

This paper examines the broader effects of the US financial crisis on global lending to retail customers. In particular we examine retail bank lending in Germany using a unique data set of German savings banks during the period 2006 through 2008 for which we have the universe of loan applications and loans granted. Our experimental setting allows us to distinguish between savings banks affected by the US financial crisis through their holdings in Landesbanken with substantial subprime exposure and unaffected savings banks. The data enable us to distinguish between demand and supply side effects of bank lending and find that the US financial crisis induced a contraction in the supply of retail lending in Germany. While demand for loans goes down, it is not substantially different for the affected and nonaffected banks. More important, we find evidence of a significant supply side effect in that the affected banks reject substantially more loan applications than nonaffected banks. This result is particularly strong for smaller and more liquidity-constrained banks as well as for mortgage as compared with consumer loans. We also find that bank-depositor relationships help mitigate these supply side effects.

Covenant Violations, Loan Contracting, and Default Risk of Bank Borrowers

Are borrowers rewarded for repaying their loans? This paper investigates the consequences of covenant violations on subsequent loans to the same borrower using a hand-collected sample of US syndicated loans during the 1996 to 2010 period. We find that covenant violations have substantial negative effects for borrowers in subsequent loans. Our results show that the loan spread increases by 22 basis points in the loan following the violation. We also find that the new contract includes more financial covenants which are also more restrictive. Switching banks after a violation does not reduce these effects and even leads to a further increase in loan spreads. We also provide empirical evidence that borrowers who have violated covenants in the previous contract are significantly more likely to violate covenants again in the next loan. Moreover, they violate earlier compared to borrowers who have not violated covenants before. Most importantly, these borrowers also exhibit a substantially higher likelihood to default, particularly in the first 100 days after a violation. Our results suggest that there is an important role for covenants in monitoring borrowers and that covenant violations provide an early warning signal for a severe deterioration of borrower credit quality