Hostname: page-component-78c5997874-lj6df Total loading time: 0 Render date: 2024-11-15T09:17:57.106Z Has data issue: false hasContentIssue false
  • English
  • Français

Bank Skin in the Game and Loan Contract Design: Evidence from Covenant-Lite Loans

Published online by Cambridge University Press:  18 July 2016

Matthew T. Billett ,
Redouane Elkamhi ,
Latchezar Popov  and
Raunaq S. Pungaliya
Matthew T. Billett
Affiliation:
mbillett@indiana.edu, Indiana University, Kelley School of Business, Bloomington, IN 47405
Redouane Elkamhi
Affiliation:
redouane.elkamhi@rotman.utoronto.ca, University of Toronto, Rotman School of Management, Toronto, ON M5S 3E6, Canada
Latchezar Popov*
Affiliation:
lpopov@virginia.edu, University of Virginia, Department of Economics, Charlottesville, VA 22903
Raunaq S. Pungaliya
Affiliation:
raunaq@skku.edu, Sungkyunkwan University (SKK), Graduate School of Business (GSB), Seoul110-745, Korea.
*
*Corresponding author: lpopov@virginia.edu
Get access Rights & Permissions [Opens in a new window]

Abstract

In a model of dual-agency problems where borrower–lender and bank–nonbank incentives may conflict, we predict a hockey stick relation between bank skin in the game and covenant tightness. As bank participation declines, covenant tightness increases until reaching a low threshold, at which point the relation sharply reverses and covenant protection is removed with a commensurate increase in spread. We find support for the hockey stick relation with bank’s stake in covenant-lite loans averaging 8% (0% median). We also find that covenant-lite loans are more likely when borrower moral hazard is less severe and when bank relationship rents are high.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 51 , Issue 3 , June 2016 , pp. 839 - 873
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2016 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Aghion, P., and Bolton, P.. “An Incomplete Contracts Approach to Financial Contracting.” Review of Economic Studies, 59 (1992), 473–494.Google Scholar
Ayotte, K., and Bolton, P.. “Covenant-Lite Lending, Liquidity, and Standardization of Financial Contracts.” In Research Handbook on the Economics of Property Law, Ayotte, K. and Smith, H. E., eds. Cheltenham, UK: Edward Elgar (2011).CrossRefGoogle Scholar
Barley, R. “The Return of Credit-Market Craziness?” Wall Street Journal, Heard on the Street, http://www.wsj.com/articles/SB10001424052748704353504575596500757294116 (Nov. 6, 2010).Google Scholar
Berger, A., and Udell, G.. “Did Risk-Based Capital Allocate Bank Credit and Cause a ‘Credit Crunch’ in the United States?” Journal of Money, Credit and Banking, 26 (1994), 585–628.Google Scholar
Berlin, M., and Loeys, J.. “Bond Covenants and Delegated Monitoring.” Journal of Finance, 43 (1988), 397–412.Google Scholar
Berlin, M., and Mester, L.. “Debt Covenants and Renegotiation.” Journal of Financial Intermediation, 2 (1992), 95–133.CrossRefGoogle Scholar
Chava, S., and Roberts, M.. “How Does Financing Impact Investment? The Role of Debt Covenants.” Journal of Finance, 63 (2008), 2085–2121.Google Scholar
Coffey, M. “Opportunity Knocks … and Borrowers Answer.” LSTA Loan Market Chronicle (2005), 39–44.Google Scholar
Demiroglu, C., and James, C.. “The Role of Private Equity Group Reputation in Buyout Financing.” Journal of Financial Economics, 96 (2010), 306–330.CrossRefGoogle Scholar
Drucker, S., and Puri, M.. “On Loan Sales, Loan Contracting, and Lending Relationships.” Review of Financial Studies, 22 (2009), 2635–2672.Google Scholar
Elkamhi, R.; Popov, L.; and Pungaliya, R. S.. “The Design of Financial Maintenance Covenants.” Working Paper, University of Toronto (2015).Google Scholar
Fama, E. “What’s Different about Banks?” Journal of Monetary Economics, 10 (1985), 10–19.Google Scholar
Gande, A., and Saunders, A.. “Are Banks Still Special When There Is a Secondary Market for Loans?” Journal of Finance, 67 (2012), 1649–1684.Google Scholar
Garleanu, N., and Zwiebel, J.. “Design and Renegotiation of Debt Covenants.” Review of Financial Studies, 22 (2009), 749–781.CrossRefGoogle Scholar
Gorton, G., and Pennacchi, G.. “Banks and Loan Sales Marketing Nonmarketable Assets.” Journal of Monetary Economics, 35 (1995), 389–411.CrossRefGoogle Scholar
Ivashina, V., and Sun, Z.. “Institutional Demand Pressure and the Cost of Corporate Loans.” Journal of Financial Economics, 99 (2011), 500–522.Google Scholar
James, C. “Some Evidence on the Uniqueness of Bank Loans.” Journal of Financial Economics, 19 (1987), 217–235.CrossRefGoogle Scholar
Kashyap, A.; Stein, J.; and Hanson, S.. “An Analysis of the Impact of ‘Substantially Heightened’ Capital Requirements on Large Financial Institutions.” Working Paper, University of Chicago (2010).Google Scholar
LeveragedLoan.com. “It’s Official: Covenant-Lite Deals Now Represent Majority of Leveraged Loan Market.” http://www.leveragedloan.com/going-lite-covenant-lite-deals-now-represent-majority-of-leveraged-loan-market/ (Feb. 3, 2014).Google Scholar
Manso, G.; Strulovici, B.; and Tchistyi, A.. “Performance-Sensitive Debt.” Review of Financial Studies, 23 (2010), 1819–1854.Google Scholar
Miller, S. “Share of Covenant-Lite Loans Jumps to Post-Crisis High in April.” Forbes blog, http://www.forbes.com/sites/spleverage/2012/05/29/share-of-covenant-lite-loans-jumps-to-post-crisis-high-in-april/ (2012a).Google Scholar
Miller, S. “A Guide to the U.S. Loan Market.” Standard & Poor’s Leveraged Commentary and Data, http://www.leveragedloan.com/wp-content/uploads/2013/05/2012-Guide-To-US-Loan-Market.pdf (2012b).Google Scholar
Natarajan, S., and Torres, C.. “Regulators Caution Banks to Boost Standards on Leveraged Loans,” Bloomberg, http://www.bloomberg.com/news/articles/2013-03-21/regulators-caution-banks-to-boost-standards-on-leveraged-loans (Mar. 21, 2013).Google Scholar
Pennacchi, G. “Loan Sales and the Cost of Bank Capital.” Journal of Finance, 43 (1988), 375–396.CrossRefGoogle Scholar
Peterson, M., and Rajan, R.. “The Effect of Credit Market Competition on Lending Relationships.” Quarterly Journal of Economics, 110 (1995), 407–443.Google Scholar
Rajan, R., and Winton, A.. “Covenants and Collateral as Incentives to Monitor.” Journal of Finance, 50 (1995), 1113–1146.Google Scholar
Rajan, U.; Seru, A.; and Vig, V.. “Statistical Default Models and Incentives.” American Economic Review Papers and Proceedings, 100 (2010), 1–5.Google Scholar
Roberts, M., and Sufi, A.. “Control Rights and Capital Structure: An Empirical Investigation.” Journal of Finance, 64 (2009), 1657–1695.Google Scholar
Ross, D. G. “The ‘Dominant Bank Effect’: How High Lender Reputation Affects the Information Content and Terms of Bank Loans.” Review of Financial Studies, 23 (2010), 2730–2756.Google Scholar
Stein, J. C. “Overheating in Credit Markets: Origins, Measurement, and Policy Responses.” Research Symposium Speech at Federal Reserve of Saint Louis, http://www.federalreserve.gov/newsevents/speech/stein20130207a.htm (Feb. 7, 2013).Google Scholar
Tan, G. “Debt Rises in Leveraged Buyouts Despite Warnings.” Wall Street Journal, http://online.wsj.com/news/articles/SB10001424052702304422704579574184101045614 (May 20, 2014).Google Scholar
Tchistyi, A. “Security Design with Correlated Hidden Cash Flows: The Optimality of Performance Pricing.” Working Paper, University of California at Berkeley (2013).Google Scholar
Supplementary material: PDF

Billett supplementary material

Internet Appendix

Download Billett supplementary material(PDF)
PDF 287.5 KB
Supplementary material: File

Billett supplementary material

Figure image

Download Billett supplementary material(File)
File 126.2 KB