Direct Lending: The Determinants, Characteristics and Performance of Direct Loans

Abstract

I explore the determinants, characteristics and performance of direct corporate loans, that is, loans originated by nonbank institutional investors without banks’ intermediation. In the aftermath of the financial crisis, direct lending has been the most rapidly growing credit market segment. I document that direct lending activity increases when commercial banks face greater regulatory pressure and during periods of weak bank loan and securitized debt issuance. Direct lenders are particularly active in geographic regions that experience more bank mergers and primarily focus on informationally opaque borrowers with limited credit history and few financing alternatives. Moreover, direct loans have higher interest rate, more flexible covenant structures and are more likely to be secured by borrower’s capital stock compared to institutional loans issued by banks. I further show that direct loans experience similar or somewhat better post-issuance performance compared to bank-originated institutional loans. Overall, I provide evidence consistent with the view that direct lending expanded the credit space without giving rise to adverse selection costs.