The Effect of Credit Rationing, Creditworthiness, and Commitments on Commercial Loan Pricing: Theory and Empirical Evidence

Abstract

This paper examines whether U.S. commercial lenders are appropriately compensated on commitment loans under a constant spread, variable rate formula, during recessions. Using the Loan Pricing Corporation (LPC) DealScan database, for periods preceding, during, and following the 1990/91 and 2001 recessions, we test whether lenders employing constant spreads on loan commitments cover their credit risk. During recessions, we find that constant loan spreads do not adequately compensate lenders for exposure to weak creditworthy borrowers and that to maintain their risk-reward objectives, lenders rein in risk by raising rates on new borrowers and by reconstituting loan portfolios.

Keywords: commercial loan pricing, recessions