Banks are no longer in the business of making and holding corporate loans. In 1994, banks purchased 30% of all primary leveraged loans. In 2018, they purchased 3%. In the mid-1990s, U.S. and foreign banks funded more than 70% of institutional leveraged loans. In the first half of 2019, they funded less than 11%.
The banks have largely been replaced as holders of loans by nonbanks, like collateralized loan obligation vehicles (CLOs) and offshore funds. Banks continue to arrange loans and sell them in an “originate and sell” model. Offshore funds and CLOs often buy these loans. Increasingly, offshore funds are engaging in direct lending activity: The fund (through its manager in the United States) – and not a bank – will originate the loan directly and hold it. Between 2010-2015, 32% of all loans were extended by nonbanks. Altogether the U.S. private debt market was about $700 billion in 2018.
When a U.S. bank, or the U.S. branch of a foreign branch, originates and holds a loan, it pays U.S. income tax on its origination fees, and on the continuing interest income it receives. When banks engaged in this business of making and holding loans, if an offshore fund could engage in the same business through personnel located in the United States and avoid U.S. tax on its interest income could undercut U.S. banks. This is the policy basis behind taxing offshore loan-originating funds that have U.S. managers. However, when banks operate under an “originate and sell” model, they are taxed at the same rate on the same activities as the managers for offshore funds.