AS ANY fruit enthusiast knows keeping track of the seasons is important. Looking for strawberries in winter or apples come the summer is bound to result in high prices, poor quality or both. Curiously,new researchby Justin Murfin of Yale University and Mitchell Petersen from the Kellogg School of Management, suggests that the same is true of finance.
They examined 30 years of corporate loans and found that the spread (or excess interest rate) that firms pay varied depending on when the debt was issued, with borrowing costs peaking in February and August. Credit is cheapest to obtain in the spring, when it is 19 basis points (19-hundredths of a percentage point) cheaper compared with the peak of the cycle. Why does this pattern persist? Surely once the cycle was observed both sides of the market would have an incentive to arbitrage the price differential away. For example, borrowers could take on loans when spreads were at their seasonal low points, or financial companies might offer more credit when yields are comparatively high. Supply and demand would then adjust to compete away any yearly price cycle. For this seasonal pattern to exist, then, both sides of the market must be unable, or unwilling, to arbitrage the difference.
Indeed some companies are able to take advantage of this seasonal pattern. The authors find that highly rated firms are able to stock up on credit when rates are low to cover their future liquidity needs. However, firms with a lower rating are generally charged a higher interest rate, which makes this strategy unviable. Instead they go to the market when they need additional funds – for example to pay for a new investment which may be time sensitive and thus cannot be deferred. A significant portion of the market is forced to issue debt as their needs arise.
Why lenders do not vary their supply in response to this seasonal pattern is somewhat less clear. The authors theorise that the seasonal pattern may increase banks’ profits by enabling them to price discriminate between firms. According to the theory, the periods when spreads are comparatively small allow lenders to attract companies with a low willingness to pay for credit, as these companies will be able to wait and time the market to get the best price. For the rest of the year, the higher prices increase profits from firms who have a greater need for credit and are unwilling to wait out the cycle. So by varying the price over a regular cycle lenders can charge different prices to different firms to maximise their profits. This meshes with the volumes of loans that are traded over the cycle with banking activity highest when rates are low.
However, this theory only holds for an oligopoly which can avoid being undercut by competitors when prices are high. For this explanation to hold, the lenders must be at least tacitly colluding in order to maintain the price cycle. Testing for implicit collusion between firms is inherently tricky. However, the authors show that there is a positive relationship between the concentration amongst lenders and the size of the seasonal cycle, both between industries and over time. This suggests that when there are fewer banks in the market, and thus collusion is easier to maintain, they are better able to maintain the profitable price cycle. Conveniently, the ‘low activity’ periods also coincides with the winter and summer vacation. Like a good cider, it seems, the best time to take on new loans is in the spring.