John
L. Collins
Chair in Finance
Carroll School of Management
Boston College
324b Fulton Hall
140 Commonwealth Avenue
Chestnut Hill, MA 02467
(617) 552-6430
philip.strahan@bc.edu
We decompose syndicated loan risk into credit, market and liquidity risk and test how these shape syndicate structure. Commercial banks dominate relative to non-banks loan syndicates that expose lenders to liquidity risk. This dominance is most pronounced when borrowers have high levels of credit or market risk. We then tie commercial banks’ advantage in liquidity risk to access to transactions deposits by comparing investments across banks. The results suggest that risk-management considerations matter most for participants relative to lead arrangers. Links from transactions deposits to liquidity exposure, for instance, are more than 50% larger at participants than at lead arrangers.
Relaxation of geographical restrictions on bank expansion was ‘completed’ in 1997 when Federal legislation permitted banks and bank holding companies to expand across state lines. This legislation, however, allowed states the right to erect road blocks to branch expansion. We show that these differences in states’ branching restrictions affect credit supply. In states more open to branching, small firms borrow at interest rates 80 to 100 basis points lower than firms operating in less open states. Firms in open states also are more likely to borrow from banks. These results cannot be explained by states’ choices about how tightly to restrict branching. Despite this evidence that interstate branch openness expands credit supply, we find no effect of variation in state restrictions on branching on the amount that small firms borrow.
Using the September 15, 2008 bankruptcy of Lehman Brothers as an exogenous shock to funding costs, we show that hedge funds act as liquidity providers. Hedge funds using Lehman as prime broker could not trade after the bankruptcy, and these funds failed twice as often as otherwise-similar funds after September 15 (but not before). Stocks traded by the Lehman-connected hedge funds in turn experienced greater declines in market liquidity following the bankruptcy than other stocks; and, the effect was larger for ex ante illiquid stocks. We conclude that shocks to traders’ funding liquidity reduce the market liquidity of the assets that they trade.
We show that mortgage lenders that concentrate in a few markets invest in more information than diversified lenders. First, concentrated lenders focus on the jumbo-loan market, where returns to information production are highest. Second, they ration credit less and retain more mortgages than diversified lenders. Third, they have higher profits than diversified lenders, their profits vary less systematically, and their stock prices fell much less during the 2007-08 credit crisis. Both across markets and over time, the share of concentrated lending - that is, the share of informed lending - is negatively related to the recent housing price run-up. We therefore conclude that inadequate information production played a key role in the 2001-2008 real estate bubble and crash.
In February 2003, the SEC officially certified a fourth credit rating agency, Dominion Bond Rating Service (“DBRS”), for use in bond investment regulations. After DBRS certification, bond yields change in the direction implied by the firm’s DBRS rating relative to its ratings from other certified rating agencies. A one notch better DBRS rating corresponds to a 39 basis point reduction in a firm’s debt cost of capital. The impact on yields is driven by cases where the DBRS rating is better than other ratings and is larger among bonds rated near the investment-grade cutoff. These findings indicate that ratings-based regulations on bond investment affect a firm’s cost of debt capital.
This paper considers banks’ role in provide funding liquidity (the ability to raise cash on demand) and market liquidity (the ability to trade assets at low cost), and how these roles have evolved. Traditional banks made illiquid loans funded with liquid deposits, thus producing funding liquidity on the liability side of the balance sheet. Deposits are less important in 21st century banks, but funding liquidity from lines of credit and loan commitments has become more important. Banks also provide market liquidity as broker-dealers and traders in securities and derivatives markets, in loan syndication and sales, and in loan securitization. Many institutions besides banks provide market liquidity in similar ways, but banks dominate in producing funding liquidity because of their comparative advantage in managing funding liquidity risk. This advantage, which came to the fore during the Fall of 2008, stems from the structure of bank balance sheets as well as their access to government-guaranteed deposits and central-bank liquidity.