Non-bank Lenders Research Articles

Did technology contribute to the housing boom? Evidence from MERS

We examine the effects of the Mortgage Electronic Registration System, or MERS, on mortgage origination volumes and foreclosure rates prior to the Great Recession. MERS was introduced in the late 1990s and significantly reduced the cost and time associated with secondary mortgage sales. Using novel data from the Massachusetts Registry of Deeds, we show that the introduction of MERS led to an expansion in mortgage credit supply that was primarily fueled by nonbank lenders originating mortgages to low-income borrowers. We also find that foreclosure rates were higher on these mortgages. Our paper provides a new explanation for the credit supply increases observed prior to the 2008 financial crisis and for the disproportionate supply increase observed in low-income areas.

Blood Money: The Financial Implications of Plasma Sales for Individuals and Non-Bank Lenders

In the United States, households donate plasma for compensation at a higher rate than they use payday, auto-title, rent-to-own, or pawn loans. Our paper is the first to explore the financial implications for households of plasma donation. Plasma donors tend to be younger and less educated with lower incomes and credit scores; they are also more reliant on non-bank credit. We use dramatic growth in plasma centers between 2014 and 2021 to study the causal effect of the ability to donate plasma on non-bank credit. We find that access to a plasma donation center reduces demand (inquiries) for payday and installment loans by 6.5% and 8.1%, respectively, with larger effects (13.1% and 15.7%, respectively) on younger borrowers. Moreover, foot traffic increases by 7-10% at essential and non-essential goods establishments when a new plasma center opens nearby. Our findings suggest that plasma donation helps households smooth consumption without appealing to high-cost debt.

Do Lenders Still Monitor? Leveraged Lending and the Search for Covenants

It was once conventional wisdom that lenders routinely influenced corporate managers’ decision making. Covenants constrained borrower risk taking and compelled specific affirmative obligations to protect lenders. Recent policy discussion, however, laments loan markets’ turn to various forms of high-risk lending. So-called leveraged loans — relatively risky, below-investment-grade loans — more than doubled in outstanding dollar terms, growing from about $550 billion in 2010 to $1.2 trillion by 2019. These risky loans have taken up a larger and larger share of the loan markets over time. More leveraged loans are also “covenant-lite,” issued without traditional financial maintenance covenants. And regulators worry about “add-backs” — borrowers’ growing practice of making upward adjustments to projected earnings that tend to weaken leverage constraints. Moreover, bank regulatory changes have incentivized “originate-to-distribute” loan syndications that enable non-bank lenders to hold and trade leveraged loans too risky for banks to keep. Syndicated lending now involves greater and greater participation by nonbank or “institutional” lenders like hedge funds, CLOs (collateralized loan obligations), and mutual funds. Commentators worry about the new species of risky loans, with their dearth of traditional covenants and the fewer instances of lender intervention, which may portend instability in debt markets. At the same time, weakened covenant protections may lead to weakened corporate governance. In this Article, I respond to these fears, arguing that they may be overblown. The increasing share of leveraged and covenant-lite loans may not necessarily evidence undisciplined debt issuance. Many seemingly troublesome loans are issued as subparts of deals that include loans with traditional covenants and cross-default provisions, which effectively constrain borrower behavior. Though add-backs may increase firm leverage, they may also improve the informativeness of earnings-based financial covenants. In addition, while the incidence of loan covenant violations has dropped dramatically across U.S. public firms, recent research suggests that covenants have become more efficient. In effect, covenants are doing more with less. Financial covenants have generally become less restrictive and more discriminating in differentiating distress from non-distress situations.

Timely “Gain Recognition” in Debt Contracting – Evidence from Cost Savings and Synergy Add-backs

In this paper, I study the inclusion of cost savings and synergy add-backs (cost-synergy add-backs hereafter) in loan contracts. Such add-backs allow borrowers to add unrealized cost savings and synergy gains into contractual earnings calculations and thus reflect timely gain recognition in debt contracting. I find that the implications of cost-synergy add-backs depend on lender incentives, which vary with loan market segments. In the non-leveraged loan market where banks perform monitoring, lenders include cost-synergy add-backs to enhance earnings informativeness. By contrast, in the leveraged loan market where non-bank lenders tend to reach for yield and banks may lack monitoring incentives, lenders take on hidden risks through cost-synergy add-backs in an overheated market. Taken together, my results suggest that timely gain recognition in the form of cost-synergy add-backs enhances contract efficiency in non-leveraged loans and distorts contract efficiency in leveraged loans.

Do Lenders Still Monitor? Leveraged Lending and the Search for Covenants

It was once conventional wisdom that lenders routinely influenced corporate managers’ decision making. Covenants constrained borrower risk taking and compelled specific affirmative obligations to protect lenders. Recent policy discussion, however, laments loan markets’ turn to various forms of high-risk lending. So-called leveraged loans — relatively risky, below-investment-grade loans — more than doubled in outstanding dollar terms, growing from about $550 billion in 2010 to $1.2 trillion by 2019. These risky loans have taken up a larger and larger share of the loan markets over time. More leveraged loans are also “covenant-lite,” issued without traditional financial maintenance covenants. And regulators worry about “add-backs” — borrowers’ growing practice of making upward adjustments to projected earnings that tend to weaken leverage constraints. Moreover, bank regulatory changes have incentivized “originate-to-distribute” loan syndications that enable non-bank lenders to hold and trade leveraged loans too risky for banks to keep. Syndicated lending now involves greater and greater participation by nonbank or “institutional” lenders like hedge funds, CLOs (collateralized loan obligations), and mutual funds. Commentators worry about the new species of risky loans, with their dearth of traditional covenants and the fewer instances of lender intervention, which may portend instability in debt markets. At the same time, weakened covenant protections may lead to weakened corporate governance. In this Article, I respond to these fears, arguing that they may be overblown. The increasing share of leveraged and covenant-lite loans may not necessarily evidence undisciplined debt issuance. Many seemingly troublesome loans are issued as subparts of deals that include loans with traditional covenants and cross-default provisions, which effectively constrain borrower behavior. Though add-backs may increase firm leverage, they may also improve the informativeness of earnings-based financial covenants. In addition, while the incidence of loan covenant violations has dropped dramatically across U.S. public firms, recent research suggests that covenants have become more efficient. In effect, covenants are doing more with less. Financial covenants have generally become less restrictive and more discriminating in differentiating distress from non-distress situations.

Fintech Lending and Mortgage Credit Access

Following the 2008 financial crisis, mortgage credit tightened and banks lost significant mortgage market share to nonbank lenders, including to fintech firms recently. Have fintech firms expanded credit access, or are their customers similar to those of traditional lenders? Unlike in small business and unsecured consumers lending, fintech mortgage lenders do not have the same incentives or flexibility to use alternative data for credit decisions because of stringent mortgage origination requirements. Fintech loans are broadly similar to those made by traditional lenders, despite innovations in the marketing and the application process. However, nonbanks market to consumers with weaker credit scores than do banks, and fintech lenders have greater market shares in areas with lower credit scores and higher mortgage denial rates.

The impacts of fintech on small business borrowing

Consolidation in banking raise concerns about exclusion and predatory practices in small-business lending. Fintech lenders, largely unregulated credit providers with lending decisions and loan terms determined primarily by algorithm, have rapidly increased their lending to small businesses. I analyze loan-level data on consumer and small business loans from Fintech lenders and a comparison sample of small-business loans from regulated bank lenders. Fintech small-business loans charge average annual interest rates 3 percentage points higher than consumer loans from the same lender and 4 to 7 percentage points higher than small business loans from regulated banking entities. The large interest-rate premium points to the need for regulatory clarity and additional supervision to protect this crucial market segment from predatory non-bank lenders.

Creditors' governance, information asymmetry and debt diversification: evidence from India

PurposeThe governing role of bank-appointed directors (BADs) on the boards of non-financial firms has a potential to reduce information asymmetry between the firm and non-bank lenders. This should increase the confidence of other creditors in firm activities, thus performing the certification role. Therefore, the purpose of this paper is to empirically examine the certification role of BADs.Design/methodology/approachThe authors test their hypotheses by using a panel of Indian non-financial firms. Our approach involves examining whether there is a significant difference in the number of different debt sources, the dispersion of debt among different debt sources, and leverage for BAD and Non_BAD Firms. The authors use univariate analysis and multivariate regression models to test the difference.FindingsThe authors find that firms with BADs on their board have (1) access to a higher number of different debt sources, (2) debt distributed evenly among different sources and (3) a higher debt ratio. Overall, our study provides supporting evidence for the certification role that BADs play on the boards of non-financial firms.Originality/valueThe authors contribute to the literature in two aspects. First, to the best of our knowledge, this is the only study that examines the effect of the governing role of banks on the lending decisions of non-bank lenders. Second, our study is associated with the growing body of the governance literature in the emerging markets context by examining the interaction of financial policies and governance in an institutional framework, which is very different from that of the developed world.

Concentration of control rights in leveraged loan syndicates

We find that corporate loan contracts frequently concentrate control rights with a subset of lenders. Despite the rise in term loans without financial covenants—so-called covenant-lite loans—borrowing firms’ revolving lines of credit almost always retain traditional financial covenants. This split structure gives revolving lenders the exclusive right and ability to monitor and to renegotiate the financial covenants, and we confirm that loans with split control rights are still subject to the discipline of financial covenants. We provide evidence that split control rights are designed to mitigate bargaining frictions that have arisen with the entry of nonbank lenders and became apparent during the financial crisis.

The Effects of Information on Credit Market Competition: Evidence from Credit Cards

We show empirically that public credit information increases competition in credit markets. We access data that cover all credit card borrowers in Chile and include details about relationship borrowers have with each lender. We exploit a natural experiment whereby a non-bank lender’s portfolio was sold to a bank. Because of this transaction, the lender’s borrowers, who were previously not identifiable unless in default, become observable by banks through the credit bureau but remain unobservable to other non-bank lenders. Using a difference-in-differences strategy, we find that after the transaction the lender’s borrowers receive higher credit limits from other banks relative to other non-bank borrowers. This result is mediated by individuals whose predicted probability of bank default drops as a result of the change to banks’ information set. After the transaction, the lender shifts originations to safer borrowers with higher initial limits, a result that is consistent with cross-sectional evidence that banks tend to lend to safer borrowers. Our results imply that by increasing competition, public credit information can reduce lenders’ incentive to “learn by lending”, potentially excluding riskier populations from access to credit.

Comment Letter In Opposition to the OCC's Proposed "True Lender" Rule

This comment letter opposes the adoption of a proposed rule published by the Office of the Comptroller of the Currency (“OCC”) on July 22, 2020. 85 Fed. Reg. 44223 (2020). The proposed rule would determine whether a national bank or federal savings association “makes a loan and is the ‘true lender’ in the context of a partnership between a bank and a third party, such as a marketplace lender.” Id. The proposed rule – to be codified at 12 C.F.R. 7.1031 – would provide that a national bank or federal savings association is deemed to “make” a loan if the institution, “as of the date of origination: (a) Is named as the lender in the loan agreement; or (b) Funds the loan.” Id. at 44228. The proposed rule is designed to operate in combination with the OCC’s recently-adopted “Madden-fix rule.” 85 Fed. Reg. 33530 (2020). Under the Madden-fix rule, a loan that is “made” by a national bank or federal savings association will retain its preemptive immunity from state usury laws under 12 U.S.C. 85 or 1463(g) if the loan is “subsequently sold, assigned, or otherwise transferred” to a nonbank. The proposed rule – in tandem with the Madden-fix rule – would allow a national bank or federal savings association to form “partnerships” with nonbank lenders, including payday lenders and auto title lenders. The two rules would allow a national bank or federal savings association to be treated as the “lender” under 12 U.S.C. 85 or 1463(g) for loans that are originated in its name or that it funds, even if it sells those loans to a nonbank “partner” one day after the loans are originated. 85 Fed. Reg. at 44225. The proposed rule would preempt state “true lender” laws, under which courts apply a substance-over-form analysis and consider several fact-specific issues in determining whether a loan is “made” by a bank as opposed to its nonbank “partner.” The two rules would permit a nonbank “partner” of a national bank or federal savings association to claim preemptive immunity from state usury laws under 12 U.S.C. 85 or 1463(g). The national bank or federal thrift could act as a mere conduit by quickly transferring loans to the nonbank “partner,” which could assume all of the economic risks and control the terms and enforcement of the loans. Such “partnerships” would amount to “rent-a-charter” schemes, which the OCC has barred national banks from entering since the early 2000s. In addition, the proposed rule evidently seeks to preempt a wide range of other state laws – including state licensing, examination, and consumer protection laws – that would otherwise apply to nonbank lenders that establish “partnerships” with national banks or federal savings associations. Thus, the proposed rule’s scope of preemption is not limited to state usury laws and potentially affects a far broader range of state laws. This comment letter argues that the OCC’s proposed rule is unlawful, invalid, and contrary to the public interest for the following reasons: (1) The proposed rule does not comply with 12 U.S.C. 25b, which governs the OCC’s authority to issue rules that seek to preempt state consumer financial laws. (2) The proposed rule unlawfully seeks to override state “true lender” laws without congressional authorization and in contravention of applicable court decisions. (3) The proposed rule is contrary to the public interest because it would allow national banks and federal savings associations to establish “rent-a-charter” schemes with nonbank lenders, thereby encouraging predatory lending and other abusive practices that would inflict very serious injuries on consumers and small businesses. (4) The proposed rule violates the Administrative Procedure Act because the OCC has not provided the required public notice of its intention to reverse the agency’s existing policy banning “rent-a-charter” schemes, as well as the OCC’s factual, legal, and policy reasons for reversing that policy. Accordingly, the OCC may not adopt the proposed rule unless the agency first provides to the public: (A) notice of the OCC’s intention to reverse its existing policy banning “rent-a-charter” schemes and an explanation of the agency’s reasons for doing so, and (B) a reasonable opportunity to submit comments on the OCC’s proposal to reverse that policy and its stated reasons for doing so. This comment letter contends that the OCC should withdraw the proposed rule and should not issue any other rule or order that would (1) override state “true lender” laws, or (2) allow national banks to establish “rent-a-charter” schemes with nonbank lenders.

Macroprudential Capital Requirements with Non-Bank Finance

I analyze the impact of raising capital requirements on the quantity, composition, and riskiness of aggregate investment in a model in which firms borrow from both bank and non-bank lenders. The bank funds loans with insured deposits and costly equity, monitors borrowers, and must maintain a minimum capital to asset ratio. Non-banks have deep pockets and competitively price loans. A tight capital requirement on the bank reduces risk-shifting and decreases bank leverage, reducing the risk of costly bank failure. In response, though, the bank can change both price and non-price contract terms. This may induce firms to substitute out of bank finance, leading to a theoretically ambiguous effect on the profile of aggregate investment. Quantitatively, I find that the bank's incentive to insure itself against issuing costly equity and competition from the non-bank sector mutes the long run impact of raising capital requirements. Increasing the capital requirement from 8% to 26% eliminates bank failures with effectively no change in the quantity or riskiness of aggregate investment.

Distance Effects in CMBS Loan Pricing: Banks versus Non-Banks

Comparing banks to non-bank lenders, we investigate whether the geographical distance between lenders, borrowers and their properties is reflected in the pricing of US mortgages that were included in US CMBS pools during the 2000 to 2017 period. The difference in loan spread when bank-borrower distance increases from zero to the median of about 900 miles is 17 basis points, and this effect is more pronounced if the loan is collateralized by a riskier property. On the contrary, geographical distance does not seem to have any effect on the loan spread of mortgages granted by non-bank lenders. Moreover, loans granted to distant borrowers by both bank and non-bank lenders are more likely to default. Our results contribute to the emerging literature on non-bank lender behavior.

Is the Community Reinvestment Act Still Relevant to Mortgage Lending?

ABSTRACTThe market share of conforming-size, home purchase mortgage originations has shifted from banking institutions to nonbank lenders. In 2017, nonbanks originated more than 1.8 million purchase mortgages (53% of the market), compared with 1.4 million by banks. Nonbanks originated 30% of purchase-money mortgages in 2000 and 24% in 2007. Does the declining role of banking institutions imply that the Community Reinvestment Act (CRA) is becoming less relevant to mortgage lending, since only they are subject to the requirements of the CRA? We address this question by exploring the changing composition of home purchase mortgage originations since 2000. We focus on the share of FHA and conforming-sized conventional loans to low- or moderate-income (LMI) households or to finance properties in LMI neighborhoods, and provide a more detailed examination of shifts in market composition than previous studies. Our analysis suggests that the CRA continues to be relevant to maintaining broad access to mortgage credit. We find that the overall share of loans to LMI borrowers has decreased compared with pre-2004, which we view as a reasonable benchmark period. However, this decrease has mostly been offset by an increased share to borrowers (broadly distributed by income) purchasing properties in LMI neighborhoods.

Nonbanks, Banks, and Monetary Policy: U.S. Loan-Level Evidence since the 1990s

We analyze the effects of monetary policy on nonbank and bank credit supply to firms and households, in particular the associated real effects and the distribution of risk. For identification, we use exhaustive loan-level data since the 1990s and Gertler-Karadi (2015) monetary policy shocks. First, different from the literature showing that low monetary policy rates increase risk-taking in bank loans, we find that higher monetary policy rates lead to an expansion of credit supply and more risk-taking by nonbank lenders. During monetary contractions, credit supply for corporates, mortgages, and consumers shifts from regulated banks to less regulated, more fragile nonbanks. Moreover, this shift is more pronounced for ex-ante riskier borrowers. Second, nonbanks reduce the effectiveness of the bank lending channel of monetary policy at the loan-level. However, this reduction varies substantially by borrower type. Total credit and real effects are largely neutralized in consumer loans and the associated consumption, but not in corporate loans and investment.

Is the CRA Still Relevant to Mortgage Lending?

Market share of conforming-size, home purchase mortgage originations has steadily and substantially shifted from banking institutions to nonbank lenders over recent years. In 2017, nonbanks originated more than 1.8 million conventional and FHA purchase mortgages (53% of the market), as compared to 1.4 million by banks. In contrast, nonbanks originated 30% of purchase-money mortgages (by volume) in 2000 and 24% in 2007. Does the declining role of banking institutions imply that the Community Reinvestment Act (CRA) is becoming less relevant to mortgage lending, since only they are subject to the requirements of the CRA? We address this question by exploring the changing composition of home purchase mortgage originations since 2000. We focus on the share of FHA and conforming-sized conventional loans to low- or moderate income households or to finance properties in low- or moderate-income neighborhoods, and provide a more detailed examination of the shifts in market composition than previous studies. Our analysis points to a conclusion that the CRA continues to be relevant to maintaining broad access to mortgage credit. We find that the overall share of loans to low-or moderate-income borrowers has decreased compared to pre-2004, which we view as a reasonable benchmark period. However, this decrease has mostly been offset by an increased share to borrowers (broadly distributed by income) purchasing properties in low- or moderate-income neighborhoods.

Funding Shocks and Competition in the Mortgage Market

How do primary and secondary mortgage markets interact? This paper shows that funding shocks to mortgage originators interact with the degree of local credit market competition to increase lending growth. Specifically, I use a shift-share approach to estimate the causal effect of the growth in private-label securitization related funding. This effect is stronger in more competitive mortgage markets; with less-regulated non-bank lenders being most responsive to this competition channel. The results emphasize the interaction between the two layers of the mortgage market and document how credit market structure can amplify, or dampen, shocks to the economy.

Mortgage Lending Regulatory Arbitrage: A Cross-Sectional Analysis of Nonbank Lenders

We provide new insights about less regulated nonbank lenders, major originators of risky subprime mortgages prior to 2008. We document significant cross-sectional variations in lending practices and show that nonbank lenders who entered the industry via less-regulated states are associated with riskier loan originations. We also show that states with lower entry barriers have not significantly increased homeownership rates nor reduced poverty rates. Consistent with the traditional banking literature, our findings suggest that while low industry entry barriers encourage more risk taking by new financial institutions, they do not necessarily translate into long-term economic benefits.

Risk taking and low longer-term interest rates: Evidence from the U.S. syndicated term loan market

We use supervisory data to investigate the ex-ante credit risk taken by different types of lenders in the U.S. syndicated term loan market during the LSAPs period. We find that nonbank lenders, mutual funds and structured-finance vehicles, take higher risk when longer-term interest rates decrease. The results are stronger for mutual funds that charge higher fees. Banks accommodate other lenders’ investment choices by originating riskier loans and selling them off. These results are consistent with “search for yield” by nonbanks and with a risk-taking channel of monetary policy. Over the sample we study, lower longer-term interest rates appear to have only a minimal effect on loan spreads.

Banking Deregulation and Discrimination in Mortgage Lending

This paper examines how interstate banking deregulation affects mortgage lending to minorities. I find that the mortgage approval rates for African Americans, compared with other borrowers, decrease after interstate banking deregulation. I also find that the effect is only present in out-of-state banks, but not in in-state banks or non-bank lenders, suggesting that the effect is driven by the strengthening of the bank balance sheet after deregulation, but not by the increased competition. Further analyses show that the effect is stronger for banks with weaker balance sheets before deregulation.