Wednesday, November 19, 2008
Do Sold-Off Corporate Loans Do Worse?
Corporate bank loans sliced and sold to outside buyers perform far less well than loans kept by the lender, according to a new study that could have an impact on coming reform of U.S. financial markets. The study by Anurag Gupta of Case Western Reserve University and Antje Berndt of Carnegie Mellon University concludes that syndicated loans underperform nonsyndicated issues by 8% to 14% in trading in the secondary markets. The findings, set to be presented Wednesday to Federal Reserve officials, show that either banks and Wall Street firms "are using inside information and selling off only the bad loans" or that the loan-syndication process diminishes the ability to monitor loan quality, Dr. Gupta said. Study of 1,054 Loans The study sampled 1,054 corporate loans made between 2000 and 2007. "What surprised me was the magnitude of the result," said Dr. Gupta, also a visiting scholar at New York University. The findings don't include this year's performance, which would make the results "even worse." The Study: A new report shows that when bank loans are sold to other investors, they underperform loans held exclusively by issuing banks. Key Findings: The study suggests that banks are either selling off subpar credits or that syndicated-loan buyers can't monitor loan quality. The Impact: The study, to be presented Wednesday to the Fed, could change the bank lending market, forcing banks to keep more loans they make. Syndicated loans typically are sold to dozens or hundreds of buyers. During the seven years included in the study, loan syndication became a vital part of corporate finance. Banks were able to underwrite loans and sell portions to other buyers, notably hedge funds and specialized investment vehicles known as collateralized loan obligations, or CLOs. This created a vast new pool of buyers, expanding the ability of corporations to issue debt necessary for building new plants, launching new products or buying back stock. Yet in selling off these loans, sometimes in pieces as small as $1 million each, some buyers worried that they were getting inferior merchandise. Placing the Blame More broadly, many in the financial community and in Congress blame such risk-dispersal techniques for poor oversight in battered credit markets, both in corporate loans and mortgage-backed bonds. "The banks may indeed be selling lemons based on their unobservable private information about the borrower," concludes the study, which is titled "Moral Hazard and Adverse Selection in the Originate-to-Distribute Model of Bank Credit." The study suggests three steps for improving the performance of syndicated loans: forcing banks to hold a significant portion of the loans they originate, more disclosure about which banks are lending to which corporate buyers, and establishing a loan-trading exchange and clearinghouse that would bring more transparency and accountability to the secondary market for such loans.