Are Banks Still Special When There is a Secondary Market for Loans?

Abstract

When a borrowing firm's existing loans trade for the first time in the secondary loan market, it elicits a significant positive stock price response by the borrowing firm's equity investors. We show that underlying this response is the impact of loan sales in alleviating a borrowing firm's financial constraints. In particular, we show in a differences-in-differences framework that firms that are smaller, younger, without a bond rating or that are distressed are more likely to benefit from loan sales as compared to other borrowers. We also find that new loan announcements are associated with a positive stock price announcement effect even when prior loans made to the same borrower already trade on the secondary market. Overall, we conclude that the role of banks, in terms of their specialness to borrowers, has changed due to their ability to create an active secondary loan market while simultaneously maintaining their traditional specialness as monitors and information producers for outside agents.

Keywords: alleviation of financial constraints, bank loans, monitoring, risk-shifting, stocks

JEL Classification: G14, G21, G22, G23, G24