Bank Reputation in the Private Debt Market

Abstract

Abstract:We examine the impact of lead arranger's reputation on the design of loan contracts such as spread, fees and the inclusion of restrictive covenants. We evidence that the loan market differs from the public bond market in many ways. It seems to be much more concentrated, in particular the last few years. Controlling for the non-randomness of the lender-borrower match (selfselection bias), we find that reputation of top tier arrangers leads to higher spreads, and that top tier arrangers retain smaller fractions of their loans in the syndicate. These larger spreads are especially pronounced for borrowers without credit rating that have most to gain from top tier arranger certification. Top tier arrangers are able to select the best deals and therefore to sell larger portions of their loans to junior banks by negotiating better terms with borrowers. This is consistent with the market power hypothesis for more established banks, but not the signaling hypothesis for which empirical support has been found in public markets (Fang, 2005). Interestingly, the effect is strongest for transactions done after the changes in banking regulations (including the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994) that led to significant consolidations in the banking industry, also among the largest commercial banks. Top tier arrangers offer lower arranger fees only to borrowers with credit ratings that have little need for additional certification by lenders.