Working Paper: CEPR ID: DP16300
Authors: Karin S. Thorburn; B. Espen Eckbo; Xunhua Su
Abstract: While institutional tranches in term loans typically include a cancellation fee, commercial banks allow penalty-free prepayment in 90% of their tranche-A loan facilities. We show that compensating banks for a penalty-free prepayment option by raising the initial loan rate increases the prepayment risk and may result in credit rationing. However, combining a lower loan rate with an upfront fee allows the bank to break even. Empirically, upfront fees increase in prepayment risk and are lower in credit lines and performance-sensitive debt, as predicted. Moreover, high industry merger intensity, which exogenously increases prepayment risk, further raises the upfront fee.
Keywords: Credit Rationing; Upfront Fee; Prepayment Risk; Performance-Pricing; Cancellation Fee
JEL Codes: D82; D86; G21; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| prepayment risk (G21) | upfront fees (G24) |
| upfront fee + lower loan rate (G21) | break even (M21) |
| high industry merger intensity (L19) | upfront fees (G24) |
| upfront fees (G24) | prepayment risk (G21) |
| upfront fees (credit lines) (G21) | upfront fees (term loans) (G21) |
| upfront fee (G24) | penalty-free prepayment option (G21) |
| initial loan rate (E43) | prepayment risk (G21) |