Weak Credit Covenants

Format:Print
| Language:English

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

Loan Contracts; Debt Covenants; Creditor Governance; Credit; Agreements and Arrangements; Leveraged Buyouts

Citation

Ivashina, Victoria, and Boris Vallée. "Weak Credit Covenants." NBER Working Paper Series, No. 27316, June 2020. (R&R at the Journal of Financial Economics.)