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    Weak Credit Covenants
    26 Jun 2020Working Paper Summaries

    Weak Credit Covenants

    by Victoria Ivashina and Boris Vallée
    Prior to the 2020 pandemic, the leveraged loan market experienced an unprecedented boom, which came hand in hand with significant changes in contracting terms. This study presents large-sample evidence of what constitutes contractual weakness from the creditors’ perspective.
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    Author Abstract

    Using novel data from 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.

    Paper Information

    • Full Working Paper Text
    • Working Paper Publication Date: June 2020
    • HBS Working Paper Number: NBER Working Paper Series, No. 27316
    • Faculty Unit(s): Finance
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    Victoria Ivashina
    Victoria Ivashina
    Lovett-Learned Professor of Business Administration
    Unit Head, Finance
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    Boris Vallee
    Boris Vallee
    Torstein Hagen Associate Professor of Business Administration
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