Bank Borrowers and Loan Sales: New Evidence on the Uniqueness of Bank Loans

Abstract

This paper examines the information content of the announcement of the sale of a borrower's loan by its bank. A large body of research has documented the positive impact on a firm's stock price around the announcement of formation and renewal of bank lending relationships. In light of these findings it would seem natural that when a bank chooses to sell off its loans, the stock returns of the borrower would be adversely affected. Our paper is the first study to test this hypothesis. We find that the stock returns of these borrowers are significantly negatively impacted on average for the period surrounding the announcement of a loan sale. The post-loan sale period is also marked by a large incidence of bankruptcy filings by the borrowers whose loans are sold. Overall, the evidence supports the hypothesis that the news of a bank loan sale has a negative certification impact, which is validated by the subsequent performance of the firm whose loan is sold. We conduct similar event study tests for those banks that engage in loan sales and find that the stock returns of the selling banks are not significantly impacted on average. Cross-sectional tests reveal that loan sales were made by banks that emphasized trading income and had relatively large Commercial and Industrial loan portfolios. For our sample period, a bank's capital adequacy position did not appear to have a material effect on a bank's decision to sell its loans.

Liquidity in the pricing of syndicated loans

“…The originating institutions traditionally sell portions of some of their loans to other banks and financial institutions via individually negotiated deals, for a variety of reasons that are outlined in Pennacchi (1988), Gorton and Pennacchi (1995), Haubrich and Thomson (1996), Dahiya, Puri, and Saunders (2003), and others. However, over the last fifteen years, an active dealer-driven secondary market has emerged, which has led to these loans being traded, much like debt or equity securities, on an over-thecounter market.…”

Constraints on Loan Sales and the Price of Liquidity

“…Constraining the capacity to sell a loan could be a method for preventing a relationship from depreciating in quality. As noted above, Dahiya et al (2003) find that loan sales have negative consequences for borrowers, especially lowquality firms. We hypothesize that "relationship loans" are more likely to involve resale constraints than "transaction loans."…”

“…Dahiya et al (2003) find that an announcement of a sale of a subpar loans is associated with a decline in the stock prices of the relevant borrower, which presumably reflects, in part, the declining value of the borrower-lender relationship. The capacity to constrain resales could serve as a device to prevent depreciation in "relationship assets."…”

Mortgage loan securitization and personal consumption smoothening

“…Thirdly, our study contributes to the continuing debate over the role that asset securitization plays in the economy. Before the 2007-2009 financial crisis, some policy makers and researchers argue that securitization allows banks to disperse credit risk, reduce information asymmetry, and therefore enhance financial stability (e.g., Hill 1997;Greenspan 2005), 2 while other studies suggest that securitization created another layer of agency problems and distorted incentives (e.g., Dahiya et al 2003). Some studies even argue that the recent 2007-2009 financial crisis was caused by mortgage securitization for allowing assets of poor credit quality to spread to unsophisticated and unprotected investors, and eventually leading to the historical financial turmoil (Bank for International Settlements 2008;Brunnermeier 2009;Taylor 2009).…”

“…For example, Dahiya, Puri and Saunders (2003) show that stock market responded negatively to firms whose loans were sold by lending banks. They also find that a large portion of these firms even filed for bankruptcy a few years after the loan sales, suggesting that banks may have prior information about the potentially poor performance and therefore sold these loans to avoid future losses.…”