On Loan Sales, Loan Contracting, and Lending Relationships
FDIC Center for Financial Research Working Paper No. WP 2007-04
46 Pages Posted: 3 Aug 2006
Date Written: March 2007
This paper examines the secondary market for loan sales, focusing on whether loan contract design can reduce agency problems in loan sales and the benefits and costs to corporate borrowers. We argue that covenants aid loan sales by protecting the loan buyer from potential losses caused by informationally-advantaged borrowers and loan sellers. Using loan-level data, we find that sold loans contain more restrictive covenant packages, particularly when agency problems are more severe. Why do borrowers agree to incur the additional costs associated with loan sales? We show that borrowers whose loans are sold have high leverage ratios, and loan sales increase their access to loans. Also, contrary to concerns that loan sales weaken lending relationships, we find more durable lending relationships when loans are sold.
Keywords: Loan Sales, Covenants, Financial Contracting, Lending
JEL Classification: G21, G32
Suggested Citation: Suggested Citation