The Journal of Applied Business Research Volume 19, Number 4

Transcription

1 The Journal of Applied Business Research Volume 19, umber 4 ixed Or Variable Rae Choice In The Commercial Bank Business Loan Marke Manoj Ahavale ( ahavale@bsu.edu), Ball Sae Universiy Rober O. Edmiser ( bedmiser@olemiss.edu), Universiy of Mississippi Absrac We sudy he choice available o business borrowers and lenders beween fixed rae and variable rae bank loans. Unlike previous sudies ha examine residenial morgage loans, his analysis examines commercial and indusrial loans. Business loans differ in aribues from morgage loans and hence provide an opporuniy o es deerminans of he morgage loan choice decision for oher loan ypes. The diversiy of business loans also permis ess of any effec which lender size and borrower size may have on he choice decision. Using a coninuous index of preferences for he variable rae commercial loan, we find ha he deerminans of he business loan choice decision are differen from he deerminans of he morgage loan choice decision. In conras o prior research, we find srong evidence conradicing he proposiion ha variable rae loans are merely a response o high and variable ineres raes. urher, his he firs sudy o reveal size as a deerminan of loan choice. Larger banks and larger borrowers have a greaer preference for variable rae loans. Our resuls combined wih he consolidaion occurring among banks leads o he conclusion ha he observed shif o variable rae bank loans is no ransiory, and poses a significan risk for businesses wih asse reurns uncorrelaed wih shor-erm loan raes. 1. Inroducion V ariable rae loans are conracs ha adjus he ineres rae concurrenly wih an open marke index. Oher conrac erms, including repaymen, remain independen of ineres rae. The variable rae conrac commis he business o an uncerain fuure ineres expense and ransfers ineres rae risk from he lender o he borrower. The alernaive choice, a fixed rae conrac, has exacly he opposie effec on banks and businesses. Thus, he ineresing issues arising from he choice beween fixed and variable rae loans is discerning he deerminans of his choice decision. However, previous empirical ess of he deerminans of he fixed rae versus variable rae loan decision have only analyzed morgage loans. The purpose of his paper is o model and es facors ha deermine he choice for variable rae business loans. Business loans differ from morgage loans wih respec o mauriy erm, repaymen erms, purpose, collaeral, and securiizaion. Morgage loans are for long periods, ofen ranging up o hiry years while business loans exended by banks are for shorer periods. Morgage loans are generally amorized over he life of he loan while business loans ofen remain ousanding for he iniial amoun. The purpose of he loan is fairly sandard in he case of morgage loans bu may vary widely for business loans, inroducing greaer complexiy in he valuaion of collaeral. In he absence of sandardized conracs, he scope for securiizaion of business loans and he creaion of an efficien secondary marke is limied. These and oher differences in he characerisics of morgage and business conracs migh resul in differenial risk assessmens and may influence he fixed rae and variable rae loan choice decision. Paricipans in financial markes do no all have he same abiliy o accep or ransfer risk and his migh influence heir loan choice decision, for example, Berkovec, Kogu and ohaf (21) find ha he marke for Readers wih commens or quesions are encouraged o conac he auhors via . 49

2 The Journal of Applied Business Research Volume 19, umber 4 variable rae jumbo originaion is wo o hree imes he size of he conforming marke, and Balsam and Kim (21) find ha i is he large firms ha are more likely o engage in ineres rae swaps o hedge agains ineres rae risk. We herefore es for segmenaion wihin he marke for variable rae business loans by considering bank size and loan size as deerminans of he fixed and variable rae business loan choice decision. The populariy of he variable rae morgage loans has been aribued o he high and volaile ineres raes of he lae 197s and early 198s and he regulaory changes of 1981, which permied variable rae morgage loans. Brueckner and ollain (1988) observe ha he adjusable rae morgages moved from near obscuriy in 1981 o become he dominan insrumen in 1984, when wo-hirds of all morgages were adjusable rae. Almos as rapidly, hey declined in imporance wih heir marke share falling o near 2 percen in June Goldberg and Heuson (1992) observed ha he proporion of variable rae financing has varied grealy from less han 25 percen in June 1986 o almos 75 percen in December In comparison, variable rae business loans exised long before variable rae morgage loans. We herefore examine he marke share rend of variable rae business loans (as compared o oal business loans) over ime, o assess wheher variable rae business loans are merely responses o volaile ineres raes. The fixed or variable rae choice decision has been sudied in markes oher han he residenial morgage marke. or example, he credi card marke (Sango (2)), he commercial morgage marke (Dhillon, Sa-Aadu and Shilling (1996)), in he marke for fixed or variable rae insurance or reiremen annuiies, in he conex of ineres rae swaps (Balsam and Kim (21)) and prepaymen and defaul in he derivaive marke for asse backed securiies (Calhoun and Deng (22)). Our lieraure search revealed ha his is he firs paper ha addresses he choice decision for business loans. Consequenly, we sar his paper wih a review of heoreical conceps developed for morgage loan conracs, and address he possibiliy ha he business loan conrac choice is deermined by characerisics unique o corporae finance and differen from an individual s morgage loan choice decision. 2. Review of Theoreical and Empirical Lieraure 2.1 The Theoreic Background Baesel and Biger (198) analyzed he implicaions of fixed and variable rae morgages in he conex of he high inflaion and ineres raes of he lae 197s. They assered ha he radiional fixed rae conrac could be hough of as a loan combined wih a be on inflaion. In equilibrium, he lender should be indifferen beween fixed and variable rae loans, so long as he conrac rae is appropriae o he level of risk. urher, heir analysis suggess ha under compeiive condiions and posiive inflaion risk, variable rae morgages will be offered a a lower ineres rae compared o fixed rae morgages. While lenders may no have a preference for fixed versus indexlinked morgages, borrowers may have a preference depending on he covariance of heir income sream wih inflaion. Since no a priori expecaions of borrower preference were possible, he soluion suggesed by Baesel and Biger (198) o resolve he fixed rae and variable rae loan decision, is a flexible package offered by he lender, such ha each borrower decides he proporion of fixed and variable rae financing. The quesion of he opimal proporion of fixed rae and variable rae deb is a specific par of he general problem of he opimal capial srucure of he firm. Agmon, Ofer and Tamir (1981) examined variable rae deb insrumens as par of he deerminaion of he opimal composiion of he deb porfolio for a firm. They heorize ha he paymen schedule should be posiively correlaed wih a firm s operaing income. The soluion suggesed by Agmon, Ofer and Tamir (1981) o deermine he opimal proporion of variable and fixed rae deb is a funcion of boh marke condiions and he naure of he income sream of he firm. In commercial banking srucure research, Sanomero (1983) discussed he naure of fixed rae and variable rae loan conracs and saed ha he uncerainy of funding coss makes he fixed rae loan increasingly less aracive o he bank as i includes boh credi risk and ineres rae risk in he same conrac. However, if a variable rae loan is a greaer credi risk han a fixed rae loan, he opimal loan porfolio balances marginal ineres rae risk 5

3 The Journal of Applied Business Research Volume 19, umber 4 wih marginal credi risk. Sanomero (1983) showed ha an immunized porfolio would no resul in an opimal bank asse and liabiliy srucure. Smih (1987) showed ha he circumsances mos favorable o he selecion of he variable rae insrumen include a wide posiive rae spread beween fixed and variable raes, real income and real asse values ha increased wih boh inflaion and real ineres raes, and a relaively low degree of risk aversion on he par of he borrower. In oher relaed sudies, Chang, Rhee and Wong (1995) examined he opimal mix of fixed and variable rae loans and he spread beween fixed and variable loan raes. They found ha he expeced spread varies direcly wih he volailiy of he funding cos, he banks degree of risk aversion and he compeiive profi margin on variable rae loans. 2.2 The Empirical Evidence Page and Sirmans (1984) examined reasons for differences in yield beween fixed rae and variable rae morgages sold in he convenional secondary marke. The difference in he secondary marke yield beween fixed rae and variable rae morgages was modeled o be a funcion of he defaul risk premium difference, he ineres rae risk premium on a fixed rae morgage, he holding period premium difference, and he opions premium difference. Conrary o expecaions, heir resuls indicae ha during periods when he erm srucure was relaively fla, he secondary marke yield on adjusable rae morgages was higher han fixed rae morgages, suggesing ha he pricing of variable rae morgages needed o be more compeiive. Dhillon, Shilling and Sirmans (1987) used a probi model o conduc an empirical es of he impac of pricing and borrower characerisics on he choice of he morgage conrac and concluded ha, in general, pricing variables play a dominan role while borrower characerisics have a relaively weak influence in he morgage choice decision. These resuls conradic Baesel and Biger (198) who posulaed a srong relaionship beween he characerisics of he borrower s income sream and preferences for fixed rae and variable rae loans. To es he characerisics of he choice decision, Brueckner and ollain (1988) consruced an economeric model of he choice beween fixed and variable rae morgages and confirmed he Dhillon, Shilling and Sirmans (1987) conclusion ha borrower characerisics do no influence he morgage choice decision. The mos imporan variables ha explained he fixed and variable loan choice decision were pricing variables: he differenial beween he fixed and variable rae and he level of he fixed loan rae. A higher differenial beween fixed and variable raes raises he probabiliy of choosing variable rae loans. urher, for a given rae differenial, he level of ineres raes and he probabiliy of choosing an adjusable rae morgage were posiively relaed. By simulaing he presen value cos differenial beween fixed and variable rae morgages, Tucker (1991) showed ha he cos advanage of he adjusable rae morgage depends on he morgage holding period and discoun rae (i.e. expecaions of fuure ineres raes). The resuls of his analysis indicae ha, for shor holding periods, all variable rae morgage borrowers have a presen value advanage; while for longer holding periods, borrowers wih a low discoun rae fare beer wih a fixed rae morgage. A high discoun raes, variable rae borrowers mainain a cos advanage over fixed rae borrowers across all holding periods. Sa-Aadu and Sirmans (1995) examined he impac of price variables and borrower characerisics on he morgage choice decision and found ha he diversiy of conracs observed in he marke can be viewed as a response o he presence of heerogeneous borrowers. Goldberg and Heuson (1992) used a reduced form equaion o model he influence of borrower, lender and marke characerisics in deermining he choice beween fixed and variable rae morgage loans. They found relaive cos, he level and expecaions of ineres raes and defaul risk measures o be significan in explaining he morgage choice decision. In oher relaed sudies, Hendersho and Van Order (1987) and Cunningham and Capone (199) saed ha variable rae morgages have a lower prepaymen risk bu a greaer defaul risk, and suggesed ha he benefi o lenders from variable rae morgages remains quesionable, while Brewer, Jackson and Mondschean (1996) found ha for some lenders, addiional variable rae morgage lending resuls in an increase in credi risk which dominaes he decrease in ineres rae risk associaed wih variable rae morgages. 2.3 Summary of Lieraure Sudies of fixed and variable rae morgages may apply o he business loan choice decision, and hence hese provide a basis for he esable hypoheses. irs, i is a consensus ha variable rae conracs are a reacion o high and volaile ineres raes. Variable rae conracs sabilize he value of he conrac agains changes in ineres 51

4 The Journal of Applied Business Research Volume 19, umber 4 raes. 1 Second, here is considerable empirical evidence ha he level of ineres raes, he spread beween fixed and variable raes, expecaions of fuure condiions and defaul risk, play an imporan role in deermining he choice beween fixed and variable rae loans. Third, he rae on a fixed rae loan will be higher han on a variable rae loan because he borrower is willing o pay a premium for sable payous. A he same ime, variable rae loans presen lower ineres rae risk and hence he lender is able o offer variable rae loans a a lower cos. 3. Mehodology and Daa Consider a model of he business loan choice decision based on expeced cash flows from each loan ype. The presen value of cash flows o he lender (from a loan exension of dollars L wih fixed ineres paymens a he rae for periods) discouned a he rae R can be expressed as- PV L, L* L* L 1 R (1 R) 2 L* (1 R) 3 L*(1 )... (1 R) (1) Similarly, he presen value of cash flows o he lender (from a loan exension of dollars L wih variable ineres paymens a he rae V =1, for periods) discouned a he rae R can be expressed as- PV L, V L* V1 L* V2 L 1 R (1 R) 2 L* V3 (1 R) 3 L*(1 V... (1 R) (2) ) Then, assuming L=$1, D L V1 V2 V3 V PV L, PV L, V... (3) R (1 R) (1 R) (1 R) oice ha by definiion, he loan rae is a funcion of he index o which he loan is linked and he consan markup charged on ha loan relaive o he index. Assuming ha he ineres rae applicable o any given period is deermined a he sar of ha period, we ge- P M (4) V V P 1 M (5) where, P =,-1 is he index (for example, he prime rae) o which he loan is linked, and M and V is he predeermined addiive markup (deermined a he iniiaion of he conrac) charged on he fixed and variable rae loan respecively. Subsiuing equaions 4 and 5 ino equaion 3, i follows ha- D L 1 M M (1 R) V 2 P (1 R) 2 P 1 (1 R) Or D L 1 V 1 (1 R) 2 P (1 R) 2 P 1 (1 R) (6) This line of reasoning suggess ha he spread beween fixed and variable raes a he iniiaion of he conrac, he level of ineres raes a he iniiaion of he conrac, and loan mauriy, would be significan deerminans of he choice decision. We include proxies for ineres rae risk and defaul risk in our analysis since 52

5 The Journal of Applied Business Research Volume 19, umber 4 he exan lieraure has deermined ha variable rae loans reduce ineres rae risk bu increase defaul risk. We es for segmenaion wihin he marke for business loans by considering he effec of originaing bank size and loan size on he choice decision. 2 urher, we es wheher variable rae loans were merely a reacion o high and volaile ineres raes in he lae 197s and early 198s, and have since los appeal Business Loan Daa and Hypoheses The issue of choice beween fixed and variable rae loans is relevan only o long-erm loans. In his analysis, we herefore consider price and volume daa on long-erm business loans from he firs quarer of 1977 o he second quarer of 1996, obained from he Survey of Terms of Bank Lending. 4 The daa comprises all loans made by a sample of 292 small and 48 large commercial banks during he firs full business week in he mid-monh of each quarer. The asses of large banks were a leas seven billion dollars as on Sepember 3, 199. Oher banks are caegorized as small banks. The loans are classified as shor-erm if he saed mauriy was less han one year and long-erm oherwise. Loans are classified as fixed-rae if he rae applicable for he enire period was known wih cerainy and variable-rae oherwise. The four loan size classificaions for long-erm loans are $1-99 housand, $1-499 housand, $5-999 housand and $1 million +. The survey repors he weighed average characerisics of loans exended in each period for each loan ype. The average values repored in he survey represen he characerisics of a represenaive loan of a paricular loan ype. 5 We model he choice decision using seveny-eigh ime-series observaions for each of eigh cross secions (he eigh cross-secions correspond o four loan sizes for each of wo bank sizes). One of he significan shorcomings of earlier sudies of he morgage choice decision was ha while he rae on he ype of loan seleced was observable, he rae on he loan ype no seleced was no known. Boh fixed and variable raes on loans wih similar characerisics and a a poin in ime could no be observed direcly, and hence had o be esimaed. The use of he STBL business loan rae indices provides direc observaions on boh fixed and variable loan raes simulaneously and avoids he problem encounered by Brueckner and ollain (1988). The dependen variable (VARVOL) used in his analysis is he proporion of dollar volume of variable rae loans o he dollar volume of oal (fixed + variable) loan exensions, by each loan size and bank ype caegory. The dependen variable herefore represens a coninuous index of preferences for he variable rae loan. 6 The explanaory variables used in his analysis o explain he proporion of variable rae loans are hose generally found significan in sudies of he morgage choice decision (Brueckner and ollain (1988), and Goldberg and Heuson (1992)). These variables include he level of ineres raes as represened by he level of he prime rae (PRIME) and he difference in ineres raes on fixed rae and variable rae loans (DRATE). Based on exan morgage choice lieraure, we expec he coefficien on PRIME and DRATE o be posiive. 7 When DRATE is posiive and large, fixed rae loans are relaively more expensive, causing borrowers o selec variable rae loans. Expecaions of fuure shor-erm ineres raes, imbedded in he slope of he erm srucure, are proxied by he difference beween he en-year and one-year consan mauriy raes on Treasury securiies. A seep yield curve is indicaive of rising shor-erm ineres raes, hence we expec borrowers o avoid variable rae loans, and he coefficien on TERM is expeced o be negaive. 8 While fuure values of he prime rae are unknown, we calculae he hisoric variance of he prime rae (VARPR) using he curren and eigh prior quarer values of he prime rae. The prevailing level of defaul risk (RISK) is proxied by he difference beween he yield on Moody s BAA and AAA raed bonds. 9 During periods of economic sabiliy we would expec a propensiy o variable rae loans, and hence he coefficiens on boh VARPR and RISK are expeced o be negaive. DMAT is he difference beween he average mauriy on fixed and variable rae loans. Borrowers prefer fixed rae conracs for longer mauriy conracs and hence he coefficien on DMAT is expeced o be negaive. Large banks and small banks operae under differing ses of consrains, economies and risk olerance, which may influence heir respecive preferences for fixed or variable rae loans. Therefore, oher conrol variables used in he analysis are dummy variables for he ineracion of each bank size wih he larges loan size classificaion. SBS4 is he ineracion of a small bank dummy (SB = 1 if he daa perains o a small bank) wih he larges loan size dummy (S4 = 1 if he loan size caegory is $1+ million) and represens large loans a small banks. 53

6 The Journal of Applied Business Research Volume 19, umber 4 Similarly, LBS4 is he ineracion of a large bank dummy (LB = 1 if he daa perains o a large bank) wih he larges loan size dummy (S4) and represens large loans a large banks. The bank size and loan size ineracion proxies for he differenial loan choice decisions based on lender size and borrower size. These variables should equal zero if bank size and loan size does no influence he choice decision. The daa used in his analysis can be separaed ino wo disinc sub-periods: he weny-four quarers from o , and he period afer he high and volaile ineres raes covering fify-four quarers from o The influence of he wo sub-periods is characerized by an ineracion of he sub-period dummy, a rend variable and he bank size dummies, i.e. PRE82S is he ineracion of he firs sub-period (PRE82 = 1 beween and ), he small bank dummy (SB) and he influence of ime (TRED =.25 a and is incremened by.25 a each quarer). POS82S is he ineracion of he second sub-period (POS82 = 1 beween and ), he small bank dummy, and he rend variable. PRE82L is he ineracion of he firs sub-period, he large bank dummy (LB), and he rend variable. POS82L is he ineracion of he second sub-period, he large bank dummy and he rend variable. While banks were generally allowed o exend variable rae morgage loans from 1981, hey did exend variable rae business loans prior o If he propensiy o variable rae loans can be explained by oher variables, he coefficien of hese variables (viz. PRE82S, POS82S, PRE82L, and POS82L) should be zero. Sample saisics for he dependen and explanaory variables used in his analysis are presened in Table 1. Table 1: Sample saisics for he dependen and explanaory variables The dependen variable (VARVOL) represens a coninuous index of preferences for he variable rae loan, covering seveny-eigh quarers from he firs quarer of 1977 o he second quarer of 1996, and eigh cross-secions comprising four loan sizes a large and small banks. Variable Mean Sd. Dev. Min. Max. VARVOL The proporion of variable rae loan volume o oal PRIME (+) The level of he prime rae DRATE (+) ixed less variable ineres rae TERM (-) Slope of he erm srucure VARPR (-) Variance of he prime RISK (-) Yield on BAA less AAA bonds DMAT (-) Average fixed less variable mauriy SBS4 () Ineracion of small bank and larges loan size dummy LBS4 () Ineracion of large bank and larges loan size dummy PRE82S () Ineracion of firs sub-period, small bank and rend POST82S () Ineracion of second sub-period, small bank and rend PRE82L () Ineracion of firs sub-period, large bank and rend POST82L () Ineracion of second sub-period, large bank and rend oe: The hypohesized relaion shown in parenhesis is from he borrower perspecive. Boh borrowers and lenders face he variable loan choice decision, and hence he proporion of variable rae loans is a funcion of he ineracion of boh borrower and lender preferences. 54

7 The Journal of Applied Business Research Volume 19, umber The Esimaion Process Since we uilize ime series and cross secional daa, we chose he single equaion Parks (1967) mehod 1 o esimae he coefficiens of he model, generally specified as- K Yi Xik k i k 1 (7) where, Y represens a vecor of he dependen variable as described earlier, X represens a non-sochasic marix of independen variables as described earlier, represens a vecor of esimaed coefficiens, i represens he cross secional observaions, represens he lengh of he ime series, k represens he number of independen variables, and represens a vecor of error erms. The esimaor is efficien, consisen and has he same asympoic properies as Aiken s GLS esimaor. We assume a firs order auoregressive model wih conemporaneous correlaion beween cross secions. The single equaion can also be inerpreed as he reduced form of borrower and lender preferences where he coefficiens of he reduced form equaion depend on wheher he borrower or lender preference dominaes. The esimaes of he coefficiens of he model are presened in Table 2. Table 2: Regression Resuls for he commercial loan fixed or variable rae choice model The model ess variables suggesed by heory or hose generally found o be significan in previous sudies of he fixed and variable loan choice decision (PRIME, DRATE, TERM, VARPR, RISK, and DMAT). Addiional es variables used o explain he loan choice decision include ineracion variables for lender and borrower size (SBS4, LBS4) and dummy variables for preference shifs beween regimes (PRE82S, POST82S, PRE82L, and POST82L). The dependen variable is he raio of variable rae loans o oal loans in each caegory (muliplied by 1 for ease in presenaion and inerpreaion) and represens a coninuous index of preferences for he variable rae commercial loan. Variable Esimae of Coefficien ITERCEPT -.18 (-.11) PRIME.13 The level of ineres raes (.82) DRATE.13 ixed less variable ineres rae (1.4) TERM year less 1 year consan mauriy raes (-1.49) VARPR.14 Variance of he prime rae (1.18) RISK 2.61** Yields on BAA less AAA raed bonds (2.79) DMAT. Average fixed less variable mauriy (.2) SBS4 2.43** Ineracion of small bank and larges loan size dummy (15.75) LBS ** Ineracion of large bank and larges loan size dummy (38.54) PRE82S -.5 Ineracion of firs sub-period, small bank and rend (-.15) POST82S.59** Ineracion of second sub-period, small bank and rend (7.27) PRE82L.3 Ineracion of firs sub-period, large bank and rend (.12) POST82L.32** Ineracion of second sub-period, large bank and rend (3.8) Regression Diagnosics for he Parks Single Equaion Esimaion Mehod umber of Cross Secions 8 Time Series Lengh 78 DE 611 R-Square 74% ** Significan a he 1% level. The -saisic is placed below he coefficien in parenheses. 55

8 The Journal of Applied Business Research Volume 19, umber 4 We assume an auoregressive process of order one wih conemporaneous correlaion among he crosssecions. See Parks (1967) for deails of he single equaion esimaion mehod. The coefficiens on he level of ineres raes (PRIME), he spread beween he fixed and variable rae (DRATE), he erm srucure (TERM), he variance of he prime rae (VARPR), and he mauriy differences beween fixed and variable rae loans (DMAT) are insignifican. The inclusion of hese variables was suggesed by heoreical models and was consisen wih previous empirical sudies using morgage loan daa. 11 However, none were found o be significan deerminans of he business loan choice decision. A surprising observaion is ha he RISK variable is posiive and significan - implying ha a higher levels of concurren economic risk here is a greaer likelihood of variable rae conracs. The small bank and large loan ineracion dummy variable (SBS4) is posiive and highly significan as is he large bank and large loan ineracion dummy variable (LBS4), indicaing ha large loans are generally variable rae loans. These resuls indicae a clear segmenaion wihin he marke for variable rae loans. Long-erm loans of more han $1 million increase he likelihood of a given loan being variable by abou 2 percen in he case of small banks and by abou 53 percen in he case of large banks. The larger loan sizes show a greaer likelihood of variable raes as compared o smaller loan sizes, and large banks show a greaer propensiy for variable rae loans as compared o smaller banks. This resul is consisen wih he noion ha larger banks and larger borrowers may have a greaer abiliy o manage risk and hence a greaer propensiy oward variable rae loans, and is also consisen wih he Booh and Chua (1995) asserion ha virually all large loans are a variable rae. The rend variables PRE82S and PRE82L are insignifican. However, boh POST82S and POST82L are posiive and significan, indicaing ha he rend owards variable rae loans is coninuing even afer he period of high and volaile ineres raes experienced in he lae 197s and early 198s. 4. Conclusions and Suggesions for uure Research The choice beween fixed and variable rae business loans is clearly differen from he choice beween fixed and variable rae morgage loans. Differences in mauriy, size, repaymen erms, collaeral, secondary markes and securiizaion; are probably only some of he facors ha may influence he deerminaion of he business loan choice decision relaive o he morgage loan choice decision. We have shown ha he deerminans of he business loan choice decision are no he same as he morgage loan choice decision. By inroducing ineracion dummy variables for bank size and loan size we have shown ha he business loan choice decision is also segmened by bank size and loan size. 12 inally, we have also shown ha he propensiy for variable rae business loans has been increasing even afer he period of high and volaile ineres raes. Business managers need o analyze he choice of variable rae loans as par of he general problem of he opimal capial srucure of he firm, while bank managers need o analyze he choice of variable rae loans as par of he general problem of opimal porfolio allocaion. Given he greaer preference of large banks for variable rae loans, consolidaion among banks creaes a secular rend o variable rae loans which poses a significan risk for businesses wih asse reurns uncorrelaed wih shor-erm loan raes. While some businesses may have he capabiliy o bear he uncerainy resuling from ineres rae risk, ohers need o use hedging ools o immunize rae risk. These business borrowers, aware of he risk induced by variable rae loan erms, are a developing marke for derivaive hedging producs ha improve corporae financial managemen. Addiional research is needed o examine firm specific choice decisions and deermine he ineracions of he firm s operaing and financing characerisics, hedging aciviies, and oher economic variables, on he firm specific choice decision. 56

9 The Journal of Applied Business Research Volume 19, umber 4 Endnoes 1. Cox, Ingersoll and Ross (198). 2. Modigliani and Such (1956) considered he exisence of preferred habias, and Culberson (1957) considered he exisence of marke segmenaion in financial markes. 3. See Brueckner and ollain (1988) for a discussion of he relaive imporance of he variable rae morgage loans in he 198s. 4. A quarerly saisical release of he Board of Governors of he ederal Reserve Sysem. 5. The ederal Reserve does no make daa on individual loan ransacions publicly available. The loan rae indices used here provide a coninuous ime series of loan raes and eliminae disconinuiies in loan raes. 6. An increase in he dependen variable can be inerpreed as an increase in preference for he variable rae loans relaive o fixed rae loans. 7. The sign depends on boh borrower and lender preferences - and he dominance of one over he oher is an empirical issue. The hypohesized relaionship shown here is for exposiional purpose only, and is from he borrower s perspecive. 8. Obained from he ederal Reserve Bullein. According o Cox, Ingersoll and Ross (1985) The erm srucure embodies he markes anicipaion of fuure evens. 9. Obained from he ederal Reserve Bullein. 1. This mehod is useful in he analysis of panel daa, is available on SAS as an ETS procedure, and has recenly been used by Brockman and Chung (1999), Shyam-Sunder and Myers (1999), Dewan and Kraemer (2), and Durham (21), o es hypoheses and in ess of robusness. 11. We also used he Mcadden mulinomial logi specificaion for he independen variable. The inerpreaion of hose resuls is similar o he resuls presened, which indicaes ha he resuls are no dependen on specificaion. 12. These resuls can be conrased o ugie (1984, p.22) who saes, There are wo major problems wih variable rae lending. irs, nobody wans i, and second, i's no in he consumer's ineres. References 1. Agmon, T., A. R. Ofer and A. Tamir, 1981, Variable rae deb insrumens and corporae deb policy, The Journal of inance 36, Baesel, Jerome B. and ahum Biger, 198, The allocaion of risk: Some implicaions of fixed versus indexlinked morgages, Journal of inancial and Quaniaive Analysis 15, Balsam, S. and Sungsoo Kim, 21, Effecs of ineres rae swaps, Journal of Economics and Business 53, Berkovec, James A., David J. Kogu and rank E. ohaf, 21, Deerminans of he ARM share of HA and convenional lending, Journal of Real Esae inance and Economics 22, Booh, James R. and Lena Chua, 1995, Srucure and pricing of large bank loans, ederal Reserve Bank of San rancisco Economic Review, Brewer, Elijah, William E. Jackson and Thomas S. Mondschean, 1996, Risk, Regulaion, and S&L diversificaion ino nonradiional asses, Journal of Banking and inance 2, Brockman, Paul and Dennis Y. Chung, 1999, An analysis of deph behavior in an elecronic, order-driven environmen, Journal of Banking and inance 23, Brueckner, Jan K. and James R. ollain, 1988, The rise and fall of he ARM: An economeric evaluaion of morgage choice, The Review of Economics and Saisics 7, Calhoun, Charles A. and Yongheng Deng, 22, A dynamic analysis of fixed- and adjusable-rae morgage erminaions, Journal of Real Esae inance and Economics 24, Chang, Eric, Moon-Whoan Rhee and Ki Pong Wong, 1995, A noe on he spread beween he raes of fixed and variable rae loans, Journal of Banking and inance 19, Cox, John C., Jonahan E. Ingersoll and Sephen A. Ross, 198, An analysis of variable rae loan conracs, The Journal of inance 35, Cox, John C., Jonahan E. Ingersoll and Sephen A. Ross, 1985, A heory of he erm srucure of ineres raes, Economerica 53,

10 The Journal of Applied Business Research Volume 19, umber Culberson J. M, 1957, The erm srucure of ineres raes, Quarerly Journal of Economics 71, Cunningham, Donald. and Charles A. Capone Jr., 199, The relaive erminaion experience of adjusable o fixed-rae morgages, The Journal of inance 45, Dewan, Sanjeev and Kenneh L. Kraemer, 2, Informaion echnology and produciviy: Evidence from counry level daa, Managemen Science 46, Dhillon, Upinder S., James D. Shilling and C.. Sirmans, 1987, Choosing beween fixed and variable rae morgages, Journal of Money, Credi and Banking 19, Dhillon, Upinder S., J. Sa-Aadu and James D. Shilling, 1996, Choosing beween fixed- and adjusable rae morgages: The case of commercial morgages, Journal of Real Esae inance and Economics 12, Durham, J. Benson, 21, Sensiiviy analysis of anomalies in developed sock markes, Journal of Banking and inance 25, ugie, James, 1984, Borrowers do no need or wan variable rae loan, American Banker 149, Goldberg, Lawrence G. and Andrea J Heuson, 1992, ixed versus variable rae financing: The influence of borrower, lender, and marke characerisics, Journal of inancial Services Research 6, Hendersho, P. and R. Van Order, 1987, Pricing morgages: An inerpreaion of he models and resuls, Journal of inancial Services Research 1, Modigliani,. and R. J. Such, 1956, Innovaions in ineres rae policy, American Economic Review 56, Parks, R.W., 1967, Efficien esimaion of a sysem of regression equaions when disurbances are boh serially and conemporaneously Correlaed, Journal of The American Saisical Associaion 62, Page, Daniel E. and C.. Sirmans, 1984, Yield differences on fixed and variable rae morgages, Quarerly Review of Economics and Business 24, Sa-Aadu, J. and C.. Sirmans, 1995, Differeniaed conracs, heerogeneous borrowers, and he morgage choice decision, Journal of Money, Credi and Banking 27, Sanomero, Anhony M., 1983, ixed versus variable rae loans, The Journal of inance 38, SAS Insiue Inc., SAS/ETS Users Guide v.6 second ediion, Cary, C. 28. Shyam-Sunder, Lakshmi and Sewar C. Myers, 1999, Tesing saic radeoff agains pecking order models of capial srucure, Journal of inancial Economics 51, Smih, Donald J., 1987, The borrower s choice beween fixed and variable rae loan conracs, AREUEA Journal 15, Sango, Vicor, 2, Compeiion and pricing in he credi card marke, Review of Economics and Saisics 82, Tucker, Michael, 1991, Comparing presen value cos differenials beween fixed and variable rae loans: A morgage simulaion, The inancial Review 26,