Abstract

http://ssrn.com/abstract=1964843
 
 

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Penalty-Free Prepayments, Credit Rationing, and the Use of Upfront Fees in Bank Loans


B. Espen Eckbo


Dartmouth College - Tuck School of Business; European Corporate Governance Institute (ECGI)

Xunhua Su


Norwegian University of Science and Technology

Karin S. Thorburn


Norwegian School of Economics; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

March 28, 2013


Abstract:     
We show that the use of non-interest terms in bank loans is a way to maintain the borrowers' flexibility to prepay freely. If voluntary prepayments are penalty-free, as widely observed for bank loans in practice, over time good borrowers prepay their loans while bad borrowers stay. This reclassification effect leaves the lender with bad borrowers only. Increasing the interest rate is not sufficient to compensate the lender for the prepayment risk, so the bank resorts to non-interest credit rationing. In addition to non-price instruments such as collateral, a non-linear pricing approach, in which the loan price is split into the interest and the upfront fee, can be employed. The model predicts that: higher loan prices and lower refinancing costs are associated with higher upfront fees; secured loans use higher upfront fees, but performance-sensitive loans use lower. Empirical evidence supports these predictions. Using a sample of 29,510 term loans to U.S. firms between 1992 and 2011, we find that a 100 basis points increase in the loan spread leads to an average increase in the upfront fee by over 15 basis points. Loans with higher refinancing costs, unsecured loans and performance-sensitive loans are in general associated with lower upfront fees.

Number of Pages in PDF File: 45

Keywords: credit rationing, upfront fee, borrower risk, performance-pricing, security, collateral

JEL Classification: D82, D86, G21, G32

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Date posted: November 26, 2011 ; Last revised: March 29, 2013

Suggested Citation

Eckbo, B. Espen and Su, Xunhua and Thorburn, Karin S., Penalty-Free Prepayments, Credit Rationing, and the Use of Upfront Fees in Bank Loans (March 28, 2013). Available at SSRN: http://ssrn.com/abstract=1964843 or http://dx.doi.org/10.2139/ssrn.1964843

Contact Information

B. Espen Eckbo
Dartmouth College - Tuck School of Business ( email )
Hanover, NH 03755
United States
603-646-3953 (Phone)
603-646-3805 (Fax)
HOME PAGE: http://www.tuck.dartmouth.edu/eckbo
European Corporate Governance Institute (ECGI)
c/o ECARES ULB CP 114
B-1050 Brussels
Belgium
Xunhua Su (Contact Author)
Norwegian University of Science and Technology ( email )
University Campus at Dragvoll
Building 7, Level 5
N-7491 Trondheim
Norway
HOME PAGE: http://sites.google.com/site/xunhuasu/
Karin S. Thorburn
Norwegian School of Economics ( email )
Helleveien 30
N-5045 Bergen
Norway
+4755959283 (Phone)
HOME PAGE: http://www.nhh.no/cv/thorburn
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
European Corporate Governance Institute (ECGI)
c/o ECARES ULB CP 114
B-1050 Brussels
Belgium
HOME PAGE: http://www.ecgi.org
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