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  • 2022
  • Working Paper

High-Yield Debt Covenants and Their Real Effects

By: Falk Bräuning, Victoria Ivashina and Ali Ozdagli
  • Format:Print
  • | Language:English
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Abstract

High-yield debt including leveraged loans is characterized by incurrence financial covenants, or “cov-lite” provisions. A traditional loan agreement includes maintenance covenants, which require continuous compliance with the covenant threshold, and their violation shifts the control rights to creditors. Incurrence covenants preserve equity control rights but trigger pre-specified restrictions on the borrower’s actions once the covenant threshold is crossed. We show that the prevalence of incurrence covenants indirectly imposes significant constraints on investments as restricted actions become binding: Similar to the effects associated with the shift of control rights to creditors in traditional loans, the drop in investment under incurrence covenants is large and sudden. The deleveraging and drop in investment and market value associated with such latent violations point to a shock amplification mechanism through contractual restrictions that are at play for a highly levered corporate sector prior to firms filing for bankruptcy and independently of whether they ever do so.

Keywords

Debt Covenants; Incurrence Covenants; Borrowing and Debt; Banks and Banking

Citation

Bräuning, Falk, Victoria Ivashina, and Ali Ozdagli. "High-Yield Debt Covenants and Their Real Effects." NBER Working Paper Series, No. 29888, March 2022.
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About The Author

Victoria Ivashina

Finance
→More Publications

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More from the Authors
  • Weak Corporate Insolvency Rules: The Missing Driver of Zombie Lending By: Bo Becker and Victoria Ivashina
  • Loan Types and the Bank Lending Channel By: Victoria Ivashina, Luc Laeven and Enrique Moral-Benito
  • PE Secondaries: Blackstone Strategic Partners By: Victoria Ivashina, Luis M. Viceira, John D. Dionne and Alys Ferragamo
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