Ownership Concentration and Performance of Deteriorating Syndicated Loans

Abstract

Regulation and capital constraints may force banks and collateralized loan obligations (CLOs) to sell deteriorating loans, potentially hampering renegotiation and amplifying the initial negative shock to the borrower. We show that banks and CLOs sell downgraded loans to mutual funds and hedge funds. The reallocation of loan shares favors the syndicate's concentration, increasing lenders' incentives to renegotiate. However, syndicates remain less concentrated when potential buyers experience financial constraints and subsequently loans are less likely to be amended and more likely to be downgraded even further. Our findings indicate that existing regulations may amplify shocks to credit quality during periods of generalized distress in the financial system.

Essays in Financial Markets and Beliefs

“…44 We compare loan spreads of non-O&G firms held in US CLOs that differ solely in the extent to which their investor base was exposed to the shock. The idea is similar to the Lehman shock discussed above: a shock to the constraints of a firm's investor base (orthogonal to firm fundamentals and loan demand) can affect credit conditions for firms, e.g., because firms have a harder time getting new credit or renegotiating or rolling over their existing debt as, e.g., documented by Giannetti and Meisenzahl (2023). Consistently, Fleckenstein (2024) documents that frictions in the CLO sector can have real consequences for CLO-dependent borrowers.…”