Did the Rise of CLOs Lead to Riskier Lending?

Abstract:     
There is growing evidence that securitization adversely affected the screening incentives of mortgage lenders, contributing to a large increase in delinquencies in the U.S. subprime housing market during the crisis.

In this paper we investigate whether the growth of securitization had also affected corporate lending. We find that during the boom years of the CLO business, loans sold to CLOs at the time of their origination underperform similar unsecuritized loans originated by the same bank.

Banks account for this difference in performance because they charge higher interest rates on the loans they sell to CLOs than on their unsecuritized loans. The difference in performance between CLO credits and non-CLO credits appear to have resulted from banks' use of laxer standards to underwrite the loans they sell to CLOs. Banks also retain lower "skin in the game'' when they sell loans to CLOs, and it appears this too contributed for the underperformance of CLO credits.

Number of Pages in PDF File: 52

Keywords: Securitization, CLOs, Loan Performance, Loan Spreads

JEL Classification: G21, G23

working papers series