Institutional Investors and Loan Dynamics: Evidence from Loan Renegotiations Mehdi Beyhaghi, Ca Nguyen, John Wald University of Texas - San Antonio American Finance Association 2018 PhD Student Poster Session

Overview The new regulations in the US and Worldwide puts tougher restrictions on banks’ credit extension both in terms of involvement in loan origination and in loan securitization. Taking into the account the rise in demand for credit after the crisis, it means that nonbank institutions’ participation is expected to rise at a faster pace. About one quarter of all US loan commitments in 2016 were made by nonbanks. (report by Shared National Credit program) Our goal is to study how the participation of nonbank institutions affects the loan renegotiation process and renegotiation results.

Participation of Nonbanks in Lending Syndicates Bank 1 Bank 2 Bank 3 Mutual Fund Insurance Hedge Fund Company Loan Arranger $ Borrower

Types of Nonbank Lenders We consider the following types of nonbank investors: Finance companies Investment banks Hedge fund/private equity funds Open-end mutual funds Closed-end funds Insurance companies Collateralized loan obligations Other

Contributions Extend the literature on the role of lenders in corporate finance and on the disciplining role of debt. Provide new insights on how nonbank lenders differ from bank lenders in the context of loan renegotiation. Results: Nonbank lenders, particularly CLOs, closed-end funds, open-end mutual funds, and hedge funds, are more likely to exit the syndicate rather than engaging in the renegotiated loan. Addition of nonbank lenders into a syndicate implies higher cost of debt. Addition of bank lenders is associated with tighter covenants. Potential interpretations: Funding liquidity risk Less diversified loan portfolio Less adept in information processing and monitoring

Why Loan Ownership Structure Matters? Loan pricing (Ivashina, 2009; Ivashina and Sun, 2011a; Nadauld and Weisbach, 2012; Lim, Minton and Weisbach, 2014) Cost of financial distress and bankruptcy outcomes (Jiang, Li and Wang, 2010; Ivashina, Iverson, and Smith, 2016) Future financing, investment, and payout policies (Roberts and Sufi, 2009; Demiroglu and James, 2010; Nini, Smith, and Sufi, 2012; Bradley and Roberts, 2015) Transmission of private information (Massoud et al., 2010; Ivashina and Sun, 2011b)

Importance of Loan Renegotiations An average syndicated loan is renegotiated multiple times throughout its life (Roberts, 2015). Most of renegotiations occur outside of financial distress (Roberts and Sufi, 2009; Dennis and Wang, 2014). Renegotiation is an effective mechanism to complete contracts and transfer control rights (Grossman and Hart, 1986, Hart and Moore, 1988; Aghion and Bolton, 1992; Preece and Mullineuax, 2009). Through loan renegotiation, we can observe not only the changes in loan contracts, but also the changes in lending structure.

Data Loan characteristics: LPC DealScan Lender identification: LPC Dealscan, CapitalIQ, Moody’s, Bloomberg, and SEC filings Firm data: Compustat Macroeconomic conditions: GDP: US Bureau of Economic Analysis Stock market return: CRSP Banking sector leverage: FDIC Aggregate credit spread: FRED

A Demonstration of How Loan Paths Are Created This figure demonstrates a 5-year $100 million revolving credit facility as it goes through three rounds of renegotiations. The loan facility was granted to NaviSite, a provider of hosting, application management and managed cloud services for enterprises on June 8, 2007. Renegotiation Round 1 Round 2 Round 3 First renegotiation (time 1) Second renegotiation (time2) Origination (time 0) Third renegotiation (time 3) 06/08/2007 09/12/2007 06/01/2008 10/30/2008

Loan Path Construction We manually cross-check two sources of renegotiations: Loan amendments collected by Dealscan. Loan refinancing by matching similar loans with respect to borrowing firm, loan type, lead arranger, and issue date. Final sample: 4,369 loan paths 7,408 renegotiation rounds Loan path construction allows us to address selection issues regarding the loan type and borrowing firm

Example 1: Loan Path – No change A 60-month $750 million term loan was granted to Dean Foods Co, a food and beverage company on August 29, 2003. The lending syndicate structure does not change the next time lenders negotiate with the borrower.   August 29, 2003 December 31, 2003 Lead Bank Wachovia Bank Banks SunTrust Bank Fleet Bank Bank of Tokyo-Mitsubishi Bank One Nonbanks General Electric Capital Corp

Example 2: Loan Path – Addition A 60-month $75 million revolving credit was granted to Cross Country HealthCare Inc., a provider of healthcare recruiting and workforce solutions on November 10, 2005. In the next negotiation with the borrower a new nonbank is added.   October 11, 2005 September 9, 2008 Lead Bank Wachovia Bank Banks Bank of America Carolina First Bank Commercia Bank LaSalle Bank National City Bank US Bank Nonbanks General Electric Capital Corp Siemens Credit Corp

Example 3: Loan Path – Leaving A 15-month $22.44 million term loan was granted to Ducommun Inc, a provider of transportation services on November 9, 2001. In the next negotiation with the borrower, a nonbank is removed.   November 9, 2001 September 27, 2002 Lead Bank Bank of America Banks Fleet Bank Bank of Nova Scotia Bank Austria Bank One Nonbanks Alpine Enterprises Ltd

Probability of Exit: Model L: lender B: borrowing company C: current renegotiation round i: one of the nine lender types Standard errors are clustered at loan level. Continuous variables are winsorized at 0.5% level. Fixed effects: year, borrowing firm industry, borrowing firm credit rating, loan type, and loan purpose.

Probability of Exit: Results (1)

Probability of Exit of Open-end Mutual Funds

Renegotiation Outcome: Model Transition: Number of lender type: i: loan term referring spread, amount, maturity and covenant tightness r: renegotiation round Standard errors are clustered at firm levels.

Change in Amount, Maturity, and Spread (2) (the impact of transition in ownership structure)

Change in Amount, Maturity, and Spread (3) (The impact of change in the number of nonbanks)

Covenant Tightness (3) (The impact of change in the number of each nonbank)

Conclusions Institutional lenders, especially open-end mutual funds, closed-end funds, and CLOs, are more likely than commercial banks to exit loan investments Addition of nonbank investors implies higher cost of debt. Participation of new commercial banks is associated with more restricted covenants. Our results support the following notions: Funding liquidity risk affects lenders’ decision to exit or stay. Renegotiation costs are higher for institutional investors who hold less diversified portfolio and are less adept than banks in information collection.

Institutional Investors and Loan Dynamics Mehdi Beyhaghi, Ca Nguyen, John Wald University of Texas - San Antonio American Finance Association 2018 PhD Student Poster Session