Syndicated Leveraged Loans During and After the Crisis and the Role of the Shadow Banking System
| DOI | http://doi.org/10.1111/jacf.12016 |
| Published date | 01 June 2013 |
| Author | Christopher L. Culp |
| Date | 01 June 2013 |
VOLUME 25 | NUMBER 2 | SPRING 2013
In This Issue: CEO Pay and Capital Markets
CEO Pay and Corporate Governance in the U.S.:
Perceptions, Facts, and Challenges
8Steven N. Kaplan, University of Chicago Booth School
of Business
How “Competitive Pay” Undermines Pay for Performance
(and What Companies Can Do to Avoid That)
26 Stephen F. O’Byrne, Shareholder Value Advisors, and
Mark Gressle, Gressle and McGinley
How to Design a Contingent Convertible Debt Requirement
That Helps Solve Our Too-Big-to-Fail Problem
39 Charles W. Calomiris, Columbia University, and
Richard J. Herring, University of Pennsylvania
Syndicated Leveraged Loans During and After the Crisis
and the Role of the Shadow Banking System
63 Christopher L. Culp, Compass Lexecon and
The University of Chicago Booth School of Business
The Future of International Liquidity and the Role of China 86 Alan M. Taylor, University of Virginia, NBER, and CEPR
Private Equity and Investment in Innovation:
Evidence from Patents
95 Josh Lerner, Harvard Business School,
Morten Sorensen, Columbia University, and
Per Stromberg, Stockholm School of Economics
Two-Sided Matching: How Corporate Issuers and
Their Underwriters Choose Each Other
103 Chitru S. Fernando, University of Oklahoma,
Vladimir A. Gatchev, University of Central Florida, and
Paul A. Spindt, Tulane University
Discounted Cash Flow Valuation for Small Cap M&A Integration 116 Norman Hoffman, Dominion Enterprises, LLC and
College of William & Mary
Journal of Applied Corporate Finance • Volume 25 Number 2 Spring 2013 63
Syndicated Leveraged Loans During and After the Crisis
and the Role of the Shadow Banking System
* I am grateful to Aaron Brown, Paul Forrester, and David Ross for their comments on
earlier drafts. The usual disclaimer applies, and the views expressed herein are mine
alone and do not necessarily represent the views of any organization with which I am
afliated or their clients. Pursuant to the disclosure policy of The University of Chicago
Booth School of Business, I note that I sometimes provide consulting services related to
the issues explored in this article, but this article is an independent work that has not
been specically funded or sponsored by any particular client.
1. M. H. Miller, “Financial Markets and Economic Growth,” Journal of Applied Corpo-
rate Finance Vol. 11, No. 3 (Fall 1998). The genesis of the present article was the editor
Don Chew’s desire to re-print Miller’s 1998 article along with several more recent com-
mentaries on whether Miller’s insights have proven prescient or off-base (or both) in the
context of the nancial crisis that began in 2007.
2. C. W. Calomiris, “A Look Back at Merton Miller’s ‘Financial Markets and Economic
Growth’,” Journal of Applied Corporate Finance Vol. 24, No. 1 (Winter 2012).
I
by Christopher L. Culp, Compass Lexecon and
The University of Chicago Booth School of Business*
n 1998 Nobel laureate Merton H. Miller wrote
in this journal t hat the impact of banking crises
on economic activity can be at tenuated through
relatively greater reliance by ma rket partici-
pants on non-banking na ncial products and struct ures.
1
Although the focus of his article was the ma croeconomic
impacts of the Asia n nancial crisis of 1997, his conclusions
about the causes of liquidity and banking crises—and his
commentary on how regulation addre sses those crises—go
well beyond that specic historica l episode and are equally
relevant today.
In short, Miller viewed traditional commercial banking as
inherently fragile and contended that “having a wide spectrum
of nancial markets available keeps a country from having to
put all its development eggs in one basket…and, in particular,
from relying too heavily on commercial banking.” As 1998
examples of “market substitutes for functions…performed by
banks,” Miller used money market mutual funds (MMMFs)
and high-yield (HY) debt. At the time of his writing, his
characterization was essentially correct. Customers seeking
alternatives to banks for the provision of liquid transaction
accounts could rely instead on MMMFs, and relatively high-
risk companies wishing to raise new funds could issue junk
bonds in lieu of obtaining bank loans.
Yet, as Charles Calomiris pointed out in the Winter 2012
issue of this journal, Miller’s dichotomous characterization of
“bank-based” and “market-based” nance perhaps exaggerated
the degree of separation between the two systems.2 Although
Miller was right to say that the availability of non-bank sources
of nancing can help limit the impact of nancial crises, he
painted a black-and-white picture—though I think a plausible
one, given the time of his article—of bank- and market-based
nancing. e reality, as has become especially clear since the
recent crisis, is that the two work in concert and are strongly
interrelated.
Miller’s description of the commercial banking s ystem
was essential ly based on the traditional orig inate-and-hold
(O&H) business model in which bank s retained all or most
of the loans they originated on their ba lance sheets until
those loans were repaid. Banks nanced those loan assets
primarily with deposits a nd other borrowings—includi ng
unsecured interban k borrowings, institutional certicates
of deposit, commercial paper, and medium-term notes—a s
well as equity.
Beginning in the late 1970s with mortgage lending and
in the 1990s with leveraged bank loa ns to commercial and
industrial (C&I) borrowers, loan orig inators began to shift
toward an originate-and-di stribute (O&D) approach in
which they underwrote and funded the loans but then sold
large portions of their portfolios to non-bank investors. e
cash proceeds received by O&D origi nators through sales to
non-bank investors were used to nance new loa n production.
Essential to the O&D banking business model is the
“parallel” or “shadow” banking system, which can be viewed
as the collection of nancial products and structures that link
banks with non-bank investors. e shadow banking system
exists alongside but is distinct from the traditional commercial
banking system. In 1998 when Miller’s article was published,
syndicated leveraged loans were already beginning to displace
HY debt as the main source of U.S. leveraged nance. But that
apparent shift away from market-based nancing back toward
bank nancing was, in reality, a shift away from pure market-
based nancing toward O&D bank nancing that was heavily
reliant on the shadow banking system. Even in 1998, the
ability of banks to issue leveraged loans was heavily dependent
on the willingness of non-bank investors to purchase some of
those loans from bank originators.
Had the shadow banki ng system been more fully evolved
(outside the mortgage lending space) at the time of Miller’s
writing, he likely would have argued that diversicat ion of
activities like levera ged nance out of the commercial banking
sector into the shadow bankin g sector would also help reduce
the impact of disruptive shocks within the banking s ystem.
And he would have been right. But the shadow ban king
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