Originate-to-Distribute Lending Relationships and Market Making in the Secondary Loan Market

Abstract

This paper investigates why originate-to-distribute commercial lenders make markets for the loans that they sell on the secondary market. Using loan-level data, I find that origination lenders with extensive borrower relationships and higher reputations are more likely to serve as market makers. Greater participation of origination lenders as market makers is associated with lower trading costs for their borrowers' loans. The reduction in trading costs is most pronounced during conditions of low liquidity, such as when there are few market makers and during market-wide liquidity shocks. I find little evidence that origination lenders reduce secondary market information asymmetry. Lenders benefit from being market makers by maintaining strong subsequent lending relationships with their borrowers. Collectively, this evidence is consistent with lenders providing an important source of liquidity for their borrowers’ loans traded in the secondary market and inconsistent with moral hazard in originate-to-distribute commercial lending markets.

Keywords: originate-to-distribute lending, lending relationships, lending reputation, secondary loan market, liquidity, information asymmetry