Filippo Ippolito

The Transmission of Monetary Policy through Bank Lending: The Floating Rate Channel

We combine existing balance sheet and stock market data with two new datasets to study whether, how much, and why bank lending to firms matters for the transmission of monetary policy. The first new dataset enables us to quantify the bank dependence of firms precisely, as the ratio of bank debt to total assets. We show that a two standard deviation increase in the bank dependence of a firm makes its stock price about 25% more responsive to monetary policy shocks. We explore the channels through which this effect occurs, and find that the stock prices of bank-dependent firms that borrow from financially weaker banks display a stronger sensitivity to monetary policy shocks. This finding is consistent with the bank lending channel, a theory according to which the strength of bank balance sheets matters for monetary policy transmission. We construct a new database of hedging activities and show that the stock prices of bank-dependent firms that hedge against interest rate risk display a lower sensitivity to monetary policy shocks. This finding is consistent with an interest rate pass-through channel that operates via the direct transmission of policy rates to lending rates associated with the widespread use of floating-rates in bank loans and credit line agreements.We describe and test a mechanism through which outstanding bank loans affect the firm balance sheet channel of monetary policy transmission. Unlike other debt, most bank loans have floating rates mechanically tied to monetary policy rates. Hence, monetary policy-induced changes to floating rates affect the liquidity, balance sheet strength, and investment of financially constrained firms that use bank debt. We show that firms---especially financially constrained firms---with more unhedged bank debt display stronger sensitivity of their stock price, cash holdings, sales, inventory, and fixed capital investment to monetary policy. This effect disappears when policy rates are at the zero lower bound, which further supports the floating rate mechanism and reveals a new limitation of unconventional monetary policy. We argue that the floating rate channel can have a significant macroeconomic effect due to the large size of the aggregate stock of unhedged floating-rate business debt, an effect at least as important as the bank lending channel through new loans.

Corporate Hedging and the Variance of Stock Returns

By means of a difference-in-differences approach (sigma-DID), we investigate the effect that hedging has on corporate risk. Examining the relation between hedging and the idiosyncratic variance of stock returns, we show that when new commodity derivatives are introduced in the Chicago Mercantile Exchange, firms with exposure to the commodities experience up to a 40% drop in the variance of stock returns. The effect is persistent over time and it is associated with real effects: firms that hedge more also experience an increase in profit margins, investment, access to credit lines, and a drop in cash holdings. Our results establish a direct link between corporate risk management policies and stock return behaviour.

Dynamic Leverage Targets

Through the lens of a dynamic trade-off model of capital structure, we reconcile active capital structure rebalancing and slow average adjustment speeds towards target leverage, both of which have been documented by empirical studies. In the model, firms optimally adjust leverage towards a dynamic target, which is firm specific and responds to evolving firm characteristics and investment opportunities. In the presence of investment frictions and capital market imperfections, firms close only partially the gap that separates their current leverage from their target. Thus, targets are relatively less stable than leverage itself. By means of structural estimation, we show that there is convergence towards dynamic targets in the real data, at faster speed the larger the gap from the target. Over horizons ranging from five to thirty years, targets are roughly twenty to forty percent more volatile than leverage. Adjustment speeds exhibit significant heterogeneity across firms and time, and partial adjustment models that assume constant speed largely underestimate average speeds.

Bank Lines of Credit as Contingent Liquidity: Covenant Violations and Their Implications

We examine the relation between the financial health of banks and their willingness to supply capital to borrowers under previously committed credit lines. We show that during the collapse of the Asset Backed Commercial Paper market in the last quarter of 2007 and the first half of 2008, banks with higher exposure to conduits renegotiated significantly tougher conditions on the outstanding credit lines offered to borrowers in violation of a covenant. Looking at the broader period of the financial crisis (2007-2010), we find that a worsening in financial health at banks led to a lower probability of waivers, following a covenant violation on a credit line. Our paper suggests that a worsening in financial conditions of lenders can bear financial implications for firms that use credit lines as an instrument of liquidity management.

Default Penalties in Private Equity Partnerships

Private equity partnerships are commonly regarded as examples of long-term commitment contracts. Limited partners commit the entire capital of the fund up-front and may face expensive default penalties for not honoring a capital call. Commitment, however, may be perceived to be stronger than it actually is, as explicit early termination provisions are often included. We develop a model to show how the degree of commitment can be used to screen general partners according to their managerial ability. Our model generates new predictions on the use of default penalties, on the investment strategy, and on the fee structures of general partners.Default penalties are commonly observed in private equity funds. These penalties are levied on limited partners that miss out on a capital call. We show that default penalties are part of an optimal contract between limited and general partners. Default penalties help limited partners in screening general partners, and in minimizing distortions in investment levels and fees, caused by information asymmetries between general and limited partners. We also show that an optimal fee structure requires management fees that are proportional to capital under management, and transaction fees that are paid during the life of the fund when investments are made.

Syndication and Second Loan Sales

Secondary loan sales give originating banks the opportunity to diversify part of their credit risk by selling loans to other market participants. However, as originating banks are less exposed to risk after secondary loan sales, their incentives to monitor borrowers diminish. Secondary loan sales therefore involve a trade-off between diversification benefits and sub-optimal monitoring. We explore this trade-off within a theoretical model. The results show that in equilibrium loans trade at a discount because monitoring effort is sub-optimally low. We illustrate how this inefficiency is related to lack of transparency in the secondary loan market, and provide policy implications to address this problem.