Perceptions of Bank Loan Officers Regarding Financial Covenants in Private Debt Contracts: Evidence from New Zealand

Abstract

This paper examines the perceptions of lending bankers of the use of financial covenants and the consequences of their breach in private lending agreements in New Zealand. Based on a survey of 26 bank loan officers, the results show that lenders perceived use of covenants is associated with the size of the loan and with capital structure, but not with the term of the loan, size of audit firm, and ownership structure (private/public). In the case of a material breach of debt covenants, the action most preferred by bank loan officers is to obtain more detailed and frequent information. High cost options such as recalling the loan and converting a term loan to an on-call loan are less preferred choices. In the event of a technical breach of covenants due to the promulgation of mandatory accounting standards, bankers are likely to require more information from the borrowers and are usually willing to renegotiate the terms of the covenant based on the old standards that were in place at the time of agreement. The results in this study suggest that violations of debt covenants do not necessarily incur high costs to borrowers, and the perceived severity of penalties imposed by creditors depends on the circumstances surrounding violation.

JEL Classification: G21, M41