CDS Trading and Non-Relationship Lending Dynamics

We investigate how credit default swaps (CDSs) affect lenders' incentives to initiate new lending relationships. We predict that CDSs reduce adverse selection that non-relationship lead arrangers face when competing for loans. Consistently, we find that a loan is more likely to be syndicated by a non-relationship lead arranger following CDS trading initiation on a borrower's debt. We also show that borrowers that obtain loans from non-relationship lead arrangers in the post-CDS trading initiation period are more opaque, in line with the effect of CDSs being more pronounced for borrowers for which adverse selection costs are higher. Further analyses show that relative to relationship lead arrangers, non-relationship lead arrangers have lower monitoring incentives in the post period, as reflected by less restrictive covenants and performance pricing provisions they impose and by the reduced loan shares they retain. Moreover, we find that borrowers of non-relationship lead arrangers following CDS trading initiation have higher growth opportunities and more volatile operations, consistent with such borrowers benefiting to a greater extent from weaker restrictions on their activities imposed by lenders. Lastly, lower monitoring incentives of CDS-protected non-relationship lead arrangers also decrease the propensity of inexperienced participants to join their syndicates. Overall, our findings suggest that CDS trading significantly changes non-relationship lending dynamics