Location: New York
Author: Jessica Neville
Date: Monday, November 24, 2008
In evaluating 1,054 loan-seeking corporations, NYU Stern Visiting Professor of Finance Anurag Gupta reveals that borrowing firms whose loans are sold by banks in the secondary loan market underperform other corporate bank borrowers by between 8% and 14% per year (on a risk-adjusted basis) in the three years after the loan sale.
Key findings:
* Collectively, firms just in his sample suffered a total corporate value destruction of $237 billion (about 15% of their Total Assets), further threatening the stability of the financial markets in a recession environment.
* The current "originate-to-distribute" model of bank credit may not be entirely desirable.
* Investors should value loan sales as a signal for the deteriorating quality of a company, which could form the basis for a trading strategy for hedge funds.
Proposed policy solutions:
* Institute regulatory restrictions on loan sales by banks
* Increase disclosure of participants and trades in the loan sales market
* Create a loan trading exchange to alleviate these problems
“Banks could be cherry picking – they keep the good loans for themselves, while selling off bad loans based on insider information,” suggests Gupta, "quite similar to the chain of events characterizing the subprime mortgage sector.”
“The practice of originating and selling bad loans in the corporate loan market could be part of the next wave of shocks to Main Street because real economy companies are the ones that borrow in this market.”
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