Weak Credit Covenants

Victoria  Ivashina; Boris  Vallee

Working Paper | 2020

Weak Credit Covenants

Abstract

Using novel data on 1,240 credit agreements, we investigate sources of contractual complexity in the leveraged loan market. While negative covenants are widespread, carve-out and deductible clauses that weaken them are as frequent. We propose simple measures of contractual weakness, which uniquely explain the market-wide price reaction that followed the 2017 J.Crew restructuring, a high profile use of such contractual elements. Leveraged buyouts have significantly weaker loan agreements, and a larger non-bank funding of a loan is conducive to weaker contractual terms. Weak covenants translate to modestly higher issuance spreads. Overall, our findings are consistent with sophisticated borrowers catering to a reaching-for-yield phenomenon by exploiting contractual complexity.

Keywords: Credit; Agreements and Arrangements;

Language: English

Format: Print

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Citation:

Ivashina, Victoria, and Boris Vallee. "Weak Credit Covenants." NBER Working Paper Series, No. 27316, June 2020.

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Weak Credit Covenants

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