Bankers extract rents on syndicated loans
A few weeks back in Banking Day I wrote about the increasing confidence among corporate borrowers concerning the ability of the corporate bond market to meet their term debt-funding needs. That article cited my PhD research, which shows that syndicated loan borrowers that have also issued corporate bonds achieve a lower cost of debt on their syndicated loans than borrowers that have not sold bonds.The difference in pricing can be largely explained by bank "hold-up" effects.Combining the words "bank" and "hold-up" usually conjures up images of someone terrifying a teller. However, when finance academics use these words together they are talking about almost the exact opposite.While the banker may not be waving a gun in front of their customer, the banker can hold them up.When lending to a customer, a banker can extract rents, to use economic terminology. In other words, the bank can make excessive or greater than normal profits.How does the bank get away with this and why does the borrower let the bank do it?The answer lies with the possession of information. Information is power.The bank uses information it has on its customer that is not readily available to other potential lenders to charge a higher cost for the debt provided. If other debt providers had the same information about the borrower, then competition would exist to lend to the borrower and the cost of debt to the borrower would be lower. At least, that is the theory.Does it occur in practice? Yes, it does.Working with the sample (used in the earlier article) of Australian public companies that used syndicated loans between 1996 and 2007, I tested for evidence of bank hold-up effects.The first test undertaken looked for differences in the pricing of syndicated loans for companies that had issued corporate bonds, relative to those that had not. After controlling for differences in credit quality, issue size and term to maturity, a dummy variable was used to signify those syndicated loan borrowers that had also used corporate bonds.Syndicated loan borrowers that have issued corporate bonds are known to other potential lenders. The bankers that provide the syndicated loans are put on notice that the borrower has alternative sources of term debt-funding available.The dummy variable used in the test was found to be statistically significant. It indicates an average credit spread reduction of 29 basis points for syndicated loan borrowers that have issued corporate bonds. This equates to an annual saving of A$2 million on the average size of the syndicated loan for this group, of A$680 million.A second test was undertaken to verify the results of the first.In the second test, a dummy variable was used to indicate those syndicated loan borrowers that do not have a credit rating. Credit ratings convey information to the market at large about the credit quality of a borrower - the information is no longer known exclusively to a borrower's banker.Moreover, credit ratings provide access to debt markets, regardless of whether the rating is investment grade or not. Again, the banker