Sascha Steffen

The Total Cost of Corporate Borrowing in the Loan Market: Don't Ignore the Fees

More than 80% of US syndicated loans contain at least one fee type and contracts typically specify a menu of spread and different types of fees. We test the predictions of existing theories about the main purposes of fees and provide supporting evidence that: (1) fees are used to price options embedded in loan contracts such as the draw-down option for credit lines and the cancellation option in term loans; and (2) fees are used to screen borrowers about the likelihood of exercising these options. We also propose a new total-cost-of-borrowing measure that includes various fees charged by lenders.

Syndication, Interconnectedness, and Systemic Risk

Syndication increases the overlap of bank loan portfolios and makes them more vulnerable to contagious effects. We develop a novel measure of bank interconnectedness using syndicated corporate loan portfolios, overlap based on industry and region, and different weights such as equal weights, size and relationships. We find that interconnectedness is driven mainly by bank diversification, less by bank size or overall loan market size. Interconnectedness is positively correlated with different bank-level systemic risk measures including SRISK, DIP and CoVaR, and such a positive correlation mainly arises from an elevated effect of interconnectedness on systemic risk during recessions. Overall, our results highlight that institution-level risk reduction through diversification ignores the negative externalities of an interconnected financial system.

Analyzing Systemic Risk of the European Banking Sector

Since the summer of 2007, the financial system has faced two major systemic crises. European banks have been at the center of both crises, particularly of the European sovereign debt crisis. This article analyzes systemic risk of European banks across both crises exploiting the specific institutional nature of the European banking system. We employ the “Systemic Expected Shortfall” concept developed in Acharya et al. (2010) which creates a systemic risk index among financial institutions based on their individual contribution to the capital shortfall of the financial system. We analyze what banks are most systemic in Europe using cross-sectional tests. We then construct a ranking of European banks and European countries as of June 2007 and calculate an estimate of the expected capital shortfall at that time. European governments have supported the banking sector with EUR 4.1 trillion using various support schemes and virtually all banks have raised capital, many of them, however, at steep discounts. We find that markets demand more capital from banks with high exposures to particularly peripheral countries in Europe, that is, banks’ sovereign debt holdings are a major contributor to systemic risk. Using hand-collected data of sovereign debt holdings and impairments, we provide estimates how much capital is needed to restore confidence in the banking sector.

Determinants of Bank Liquidity Creation

This paper measures liquidity creation of German savings banks over the period of 1997-2006 and tries to detect possible influence factors thereof. Using two recently developed techniques to measure liquidity creation, the so called “BB-Measure” as developed by Berger and Bouwman in 2009 and the “Liquidity Transformation” (LT) Gap as developed by Deep and Schaefer in 2004, we are able to determine both absolute amounts of liquidity created for the economy as well as relative magnitudes of maturity transformation the observed banks perform to create liquidity. Using a multivariate dynamic panel regression framework we differentiate between two different sets of potential liquidity determinants: macroeconomic factors, such as monetary policy or economic strength indicators, as well as bank characteristic factors, such as size or business focus. We additionally account for most recent legal developments in the German banking sector by measuring the effects of the abolishment of state guarantees in the public banking sector on liquidity creation. Analyzing a proprietary dataset comprised of all 457 German savings banks containing detailed balance sheet as well as profit & loss account variables, we show that over the given period, the total amount of liquidity created by the savings banks increased by 51% (from 120.7 billion Euro in 1997 to 182.2 billion Euro in 2006). In terms of influence factors we find highly significant and robust values for economy and monetary policy indicators. It can be shown that liquidity creation seems to depend strongly negatively on monetary policy tightness: a monetary policy tightening induces a decrease in created liquidity. We do not find any bank specific factors, such as financial performance or size, to have any influence on liquidity creation.

Government Guarantees and Bank Risk Taking Incentives

This paper analyzes the effect of the removal of government guarantees on bank risk taking. We exploit the removal of guarantees for German Landesbanken which results in lower credit ratings, higher funding costs, and a loss in franchise value. This removal was announced in 2001, but Landesbanken were allowed to issue guaranteed bonds until 2005. We find that Landesbanken lend to riskier borrowers after 2001. This effect is most pronounced for Landesbanken with the highest expected decrease in franchise value. Landesbanken also significantly increased their off-balance sheet exposure to the global ABCP market. Our results provide implications for the debate on how to remove guarantees.

Falling Short of Expectations? Stress-Testing the European Banking System

Before the ECB takes over responsibility for overseeing Europe’s largest banks, as foreseen in the establishment of a eurozone banking union, it plans to conduct an Asset Quality Review (AQR) throughout the coming year, which will identify the capital shortfalls of these banks. This study finds that a comprehensive and decisive AQR will most likely reveal a substantial lack of capital in many peripheral and core European banks. The authors provide estimates of the capital shortfalls of banks that will be stress-tested under the AQR using publicly available data and a series of shortfall measures. Their analysis identifies which banks will most likely need capital, where a public back stop is likely to be needed and, since many countries are already highly leveraged, where an EU-wide backstop might be necessary.

Exit Strategies of Buyout Investments: An Empirical Analysis

Although buyout investments represent a considerable proportion of private equity volume, so far little research has been done on the exit strategies of buyout investments. This article takes a step in this direction by investigating buyouts in more detail focusing particularly on the divestment process. Since exiting enables the realization of returns and is thus the most important factor for private equity investors, it is important to understand the motivation behind and the determinants influencing this decision. The authors analyze three main exit routes for exiting buyout investments: initial public offerings (IPO), sales and write-offs, using a unique data set for U.S. and European buyout transactions. They examine the determinants influencing the choice of an exit channel by employing a multinomial logit model. The results strongly support the view that private equity investors write-off investments that turn out to be non-performing early, showing their ability to filter out bad investments. They also analyze how the internal rate of return (IRR) influences which exit route is chosen. The results show that only the most profitable ventures are taken public. The results have implications for exiting buyout investments during financial crises.

Does Lack of Financial Stability Impair the Transmission of Monetary Policy

We investigate the transmission of central bank liquidity to bank deposit and loan spreads of European firms over the January 2006 to June 2010 period. When the European Central Bank (ECB) allocated liquidity to banks in a competitive tender at the beginning of the crisis, higher “aggregate” central bank liquidity (i.e. the total liquidity in the banking system that is held at the ECB) reduces bank deposit rates of low risk banks but has no effect on deposit rates of high risk banks or on corporate loan spreads of high or low risk banks. After the ECB started to fully allot all liquidity requested by banks via its refinancing operations on October 8, 2008, an increase in liquidity decreases deposit rates of both high and low risk banks. While loan spreads of low risk banks decrease, those of high risk banks remain unchanged also under full allotment of liquidity. We find that borrowers of high risk banks refinance term loans drawing down loan commitments. They have lower payouts, lower capital expenditures and lower asset growth compared with borrowers of low risk banks. Our results suggest a differential transmission of central bank liquidity of low versus high risk banks, and an impaired transmission to corporate borrowers of high risk banks.

What Kinds of Bank-Client Relationships Matter in Reducing Loan Defaults and Why?

Using a unique dataset of more than 1 million loans made by 296 German banks, we evaluate the impact of many aspects of customer–bank relationships on loan default rates. Our research suggests a practical solution to reducing loan defaults for new customers: Have the customer open a simple transactions account – savings or checking account. Observe for some time and then decide whether to make a loan. Loans made under this model have lower default, as banks can use historical data about their borrowers to establish a baseline against which new client-related information can be evaluated. Banks assemble this historical information through relationships of different forms. We define relationships in many different ways to capture non-credit relationships, transaction accounts, as well as the depth and intensity of relationships, and find each of these can provide information that helps reduce default – even establishing a simple savings or checking account and observing the activity prior to loan granting can help reduce loan defaults. Our results show that banks with relationship-specific information act differently compared with banks that do not have this information both in screening and subsequent monitoring borrowers which helps reduce loan defaults.

What Do a Million Observations Have to Say About Loan Defaults? Opening the Black Box of Relationships

Using a unique dataset of more than 1 million loans made by 296 German banks, we evaluate the impact of many aspects of customer–bank relationships on loan default rates. Our research suggests a practical solution to reducing loan defaults for new customers: Have the customer open a simple transactions account – savings or checking account. Observe for some time and then decide whether to make a loan. Loans made under this model have lower default, as banks can use historical data about their borrowers to establish a baseline against which new client-related information can be evaluated. Banks assemble this historical information through relationships of different forms. We define relationships in many different ways to capture non-credit relationships, transaction accounts, as well as the depth and intensity of relationships, and find each of these can provide information that helps reduce default – even establishing a simple savings or checking account and observing the activity prior to loan granting can help reduce loan defaults. Our results show that banks with relationship-specific information act differently compared with banks that do not have this information both in screening and subsequent monitoring borrowers which helps reduce loan defaults.