Abstract - Credit Derivatives and Loan Pricing

We examine the impact of credit default swaps (CDS) on the pricing of bank loans to U.S. corporates. We find that changes in CDS spreads have a significantly positive coefficient and explain nearly 25% of the monthly changes in aggregate spreads on new loans during 2000-2005. Moreover, CDS spreads are the dominant factor driving loan spreads, rendering traditional determinants like the credit spreads of bonds insignificant. Furthermore, over time, loan spreads have become significantly more responsive to the price of risk in the CDS market (but not to other measures of credit risk) and that information from the CDS markets is faster incorporated into credit decisions. This has led to a substantial increase in the extent to which loan spread changes can be explained by market risk factors. We conclude that the new markets for credit derivatives have an important impact on actual financing decisions and have contributed to a more market-based (and less relationship based) loan pricing.

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