Corporate Bonds Underwritten by Commercial and Investment Banks: Analyzing the Default Risk

Abstract

Starting in the early 1990s, banks began to slowly make their way into securities underwriting using their Section 20 subsidiaries. With the enactment of the Gram-Leach-Bliley Act of 1999, the long-standing restrictions between commercial- and investment-banking activities were formally removed. Banks have not wasted any time utilizing these new powers, making significant inroads in bond and equity underwriting over the last few years. In 2003, banks accounted for 53 percent of the IPO volume and 61 percent of corporate bond underwriting. The rapid ascendancy of many large banks in the underwriting league tables has renewed the debate concerning the gains (private information certification benefits) and costs (conflicts-of-interest costs) of combining commercial and investment banking. This paper examines these competing views on bank entry by analyzing the post-issue performance of corporate bond issues managed by investment and commercial banks during 1990-2003. We find that both commercial banks and investment banks underwrote the same quality of high-yield bonds. Investment-grade bonds underwritten by banks exhibited higher default rates than investment bank issues. Bank-advised unrated bonds had a lower default rate, suggesting that banks may be better at certifying unrated opaque firms where private information is more critical. Moreover, we find that the aftermarket performance of bonds was not adversely influenced by pre-existing syndicated loan relationships between bank underwriters and issuers.