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Key definitions:
1) Insolvency
A borrower is said to be a bankrupt, when he is not able to pay his debts taken from financial institution. Or An institution may also be a bankrupt when it cant pay back the principal amount of loan to the financial institution.
2) Loan Syndication:
When a group of financial institutions combine make the advances to the other persons or institutions, it is called the loan syndication. And this market is called loan syndication market.
3) Lead Manager:
An institution, that collects the recourses from participant institutions and grant loans further to customers. Also it works on the behalf of participants.
4) Lead portion:
Lead portion is the portion of amount in percentage that will be contributed by the lead manager, in the full loan amount.
5) Participants:
These are the financial institutions that grant their resources to the lead manager for advancing loans. And these institutions contribute by larger proportion. They give the lead manager the responsibility of screening and evaluating the borrower.
Abstract
In this paper author investigated that what is the effect of large insolvency on the lead managers image? He is taking the group of financial institutions which collectively advance loans to the customers; it is called the loan syndication. Lead manager contributes the smaller portion of the loan, called lead PORTION. And its image and standing depends on the fact that if there are large bankruptcies or smaller. And if there are greater number of bankruptcies, then its status will be affected by greater proportion. Because all farm duties regarding selection and evaluating the customers lie with the lead manager. Author identified that the status of the lead manager is affected severely by the large insolvency. And now the credibility of the lead manager has decreased so he is supposed to contribute the increased amount of lead portion portion. Because when there is a insolvency, other financial institutions will hesitate to contribute with that lead manager. So lead-manager is asked to increase its portion so that its risk may also be increased. Now it will perform complete evaluation process of the customer with great attention. Author also identified that this effect will affect outsized lead manager with less intensity. Because outsized lead manager is supposed to exert control over the market and they have also huge capital. So the participants will not see that lead manager as risky. And its standing will not be affected severely. Author also found that when too many lead managers faces the bankruptcies in same time period, in that time there will be less impact on lead manager standing. Because this
Insolvency is due to the dreadful economic conditions. And all the players in the market know very fine about it. Further he finds that investors give the lead manager all duties of selection and monitoring of the borrower. So lead manager should do this task with due integrity and carefully. If it performs its duties carefully , its image in the market will be good. And there will be less problems like bankruptcies. Otherwise they will have to face serious costs in the near future. But in spite of this statement it is not confirmed that all the lead managers bear the same costs when insolvency occurs. And also this cost is different according to the market conditions of the country. If market is already in crisis, bankruptcy will not affect standing of the lead manager. Because all firms get come to know that market is already in the bad situations, and this is the risky situation. Here in this study author has taken the loan syndication market in his study In which firms combine their resources and advance loans. Author has checked that what is the impact of huge insolvency on the image of the lead manager? Because it is charged with the duty of selection and evaluation of the borrower. Also author is finding that what will be the after effects of a huge insolvency in the coming years of the lead manager firm. Means how its future lending capacity and capacity to attract the financial institution has affected by it. Is his lending capacity decreased or increased? Author is only making the huge bankruptcies the part of his study. And he applied a formula for calculating and classifying a insolvency as large insolvency. It will be discussed later in this summary. He focused on the loan syndication market for the three reasons: group problem: mean that lead manager is working as an agent of the financial institution. So it is a agent of these firms. But if it does not perform its duties carefully agency problem will rise. Wrong selection: the second reason is that it may select the wrong borrower whose credit history is already risky. So when its portion on loan amount is small it will not be cautious about granting loan to a borrower who is risky. Portion of lead manager: its portion in the loan is very small so it is not cautious about risky borrowers.
EXAMPLE is given here of the case study of Enron. In that JP Morgan evaluated the Enron .but its evaluation was not good and Enron committed a world record default in the history. So JP Morgan bank was held responsible for all of this bad event.
Standing hypothesis:
This theory says that if a lead manager loses its standing; its capacity to catch the attention of the participants will be decreased. In other words we can say that as a lead arranger feces a huge insolvency, its image will be decreased. And now it is risky and unreliable for the market participants. So in order to catch them again it will have to contribute larger portion to lead portion. This hypothesis is called the standing hypothesis, because it involves the loss of standing. Besides this loss huge insolvency will also affect the capital of lead arranger. It will be reduced when insolvency occurs. So by this its future lending capacity will be lessening. But if these bankruptcies are due to dreadful economic conditions , then its image will be less affected be bankruptcies. And author has restricted these types of bias in the study very well. First of all he is trying to see impact of huge insolvency on the lead apportion. According to our hypothesis if standing decreased the lead portion should increase. It means now
lead manager will make good evaluation oe the borrowers. Because their own money is involved now with greater proportion.
RESULTS 1) AUTHOR found that owing to huge insolvency , there was 12.8 percent increase in the
lead portion of the lead manager. And this result was consistent with the standing hypothesis. But this increase was not seen in the case of huge lead managers. This increase was found only in the small lead managers. Because huge lead managers are already exerting control over the market due to large capital. They are dominating the market. And moreover they already contribute half amount of loan. This is called the dominant effect. 2) Moreover he found that , the years in which there were economic crisis, in that years there was less effects o lead managers standing. As all market players knew that bankruptcies in those years were due to crisis, not by the lead manager sluggishness. So he excluded this type of strategies from his study.
3) Then he checks the effect of insolvency which occurs immediately after the loan had
been sanctioned. He found that , immediate bankruptcies after giving loans, would more severely affect the lead managers. It means they have not selected the right borrower. Their selection was wrong.
4) And low yield loans, found to be more severe to the standing of the lead manager. He
argued that the low yield loan are that in which borrower business is risky and he is paying low interest rates.
5) And if there large number of participants and financial institutions in the market, they
will affect more the standing of the lead manager. And further he found that whether there is huge or small insolvency , both affect the standing of the lead manager. And both syndicate and sole trader have to keep a large portion of the lead portion after the large insolvency. We have concluded from all discussion in previous that large lead managers are least affected by the large insolvency. There is no considerable effect on their image. And
when there are correlated bankruptcies , means attributed to bad economic conditions there effect would be less on the image of lead manager. He also studied the investment banks. The large investment banks charge higher fee for underwriting services, because their standing is excellent in the market. And investors rely on these.
Alternate hypothesis
This hypothesis says that lead manager also suffers financial loss due to large insolvency. And this loss will be severe when he cant raise new capital. This is all because his equity decreases as he suffers from large insolvency. So by this its trustworthiness will reduce its future lending capacity. So this is conflicting to the standing hypothesis, it says that after large insolvency lead manager will not be able to increase its lead portion. There may also exist a wrong relationship between lead manager and huge insolvency. Meaning that if the lead manager intentionally selects the risky borrower, it will mechanically put in greater portion of the lead allocation. Author has controlled this in this paper. Because it may be a routine of a particular lead manager to grant loan to a riskier borrower.
Conclusions
All things remaining the same author found that after the huge insolvency, a lead manager keeps a greater portion of loan contributed by it. Because its standing was damaged. Further he found that the sudden insolvencies greatly affected the standing of the lead manager. And expected insolvencies did not affect too much. These results were reliable to the reputation theory. He further found a very interesting result that all insolvencies have not same effects on all lead managers. But he found that only small lead managers were affects most. But this effect was too little on the huge lead managers. And when overall market position was bad, huge insolvencies had no noteworthy effect on lead managers standing. Because all the players suffered from that situation.