Bank Reputation in the Private Debt Market

Abstract

We examine the impact of lead arrangers' reputation on the design of loan contracts such as spread, fees and the inclusion of restrictive covenants. Controlling for the non-randomness of the lender-borrower match (self-selection bias), we find that the reputation of top tier arrangers leads to higher spreads, and that top tier arrangers retain larger fractions of their loans in their syndicates. These larger spreads are especially pronounced for borrowers without credit rating that have the most to gain from the certification assumed by virtue of a loan contract with a top tier arranger. Top tier arrangers are able to select the best deals and thereby sell larger portions of their loans to syndicate banks. This certification channel differs from the one found in public markets (Fang, 2005), where certification leads to a reduced spread offered to the best clients. In the private syndicated loan market, certification seems to be through the higher retention of loans by the lead arranger-however, only for borrowers without credit rating. We find no evidence of certification for rated borrowers. These differences between public and private markets can be explained by differences in the way they operate and are structured. Interestingly, the effect is strongest for transactions done after the changes in the banking regulations (including the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994) that led to significant consolidations in the banking industry, including among the largest commercial banks. Consistent with the overall results on spreads, top tier arrangers charge lower arranger fees only to borrowers with credit ratings that have little need for additional certification by lenders.