Working Paper: NBER ID: w27316
Authors: Victoria Ivashina; Boris Vallee
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: No keywords provided
JEL Codes: G23; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| presence of weakening clauses (Y20) | market's response in terms of loan and stock prices (E44) |
| weakening clauses (Y20) | value transfer from lenders to shareholders (G21) |
| carveouts and deductibles (G22) | weakening of contractual protections for creditors (G33) |
| weaker covenants (K12) | larger price drops following restructuring announcement (D49) |