Business Aggression, Institutional Loans, and Credit Crisis: Evidence from Lending Practices in Leveraged Buyouts
Joseph R. Mason
Louisiana State University - Ourso School of Business; University of Pennsylvania - Wharton Financial Institutions Center
Louisiana State University
Singapore Management University - Lee Kong Chian School of Business
March 8, 2009
This paper investigates the lending practices related to leverage buyouts (LBOs) market between high and low write-down institutions. The write-downs, which are a proxy for business aggression of institutions, are mainly related to credit crisis from the beginning of 2007 to August 10, 2008. We find that high (low) write-down institutions increase (decrease) loan market share dramatically during the period of 2001-2006. The increase is mainly driven by the segment of loans sold to institutional investors, such as collateralized loan obligations vehicle, hedge fund, and insurance companies. Institutional loans originated by high write-down institutions carry significantly fewer covenants and higher interest spread than those by low write-down institutions during 2001-2006. However, there are no such differences during 1995-2000. The aggressive lending practice by high write-down institutions to lower quality borrowers during 2001-2006 appeared to be mitigated by reputable private equity (PE) investors. High write-down institutions arranged loans with more covenants and lower interest spread for borrowers with investments from more reputable private equity investors.
We contribute to extant literature in the area of financial crisis by providing empirical evidence that both business aggression of some institutions and the increase demand for institutional loans drive the peculiar lending practice during the easy credit period, which subsequently leads to declines in values of assets associated with these loans. Our focus on the role of PE reputation in mitigating aggressive lending practice complements recent studies in the area of LBO loans market and PE reputation, such as Demiroglu and James (2008) and Ivashina and Kovner (2008). The findings of demand pressure (credit supply) from institutional loans add to the analyses of Ivashina and Sun (2008) and Wang (2008). We provide additional evidence that such increase in institutional loans demand is filled by some aggressive financial institutions, which ex post incur high write-downs during the credit crisis. Many such institutions pay horrendous prices for their business aggression and have ceased to exist in the market.
Number of Pages in PDF File: 36
Keywords: Credit crisis, Leveraged buyouts, bank loans, collateralized loan obligations, private equity
JEL Classification: G21, G24, G34
Date posted: April 2, 2009