Covenant-Light Contracts and Creditor Coordination

44 Pages Posted: 31 Mar 2016 Last revised: 4 Apr 2016

See all articles by Bo Becker

Bo Becker

Stockholm School of Economics; Centre for Economic Policy Research (CEPR); ECGI

Victoria Ivashina

Harvard University; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: March 31, 2016

Abstract

In 2015, 70% of newly-issued leveraged loans had weaker enforcement features, called covenant-light or “cov-lite;” this is nearly a three-time increase in cov-lite issuance compared to a previous peak in 2007. We evaluate whether this development can be attributed to market overheating, increased borrower demand for cov-lite loans, or a rise in creditor coordination costs. The last hypothesis stems from the increasing involvement of non-bank institutions and, in particular, the rise of mutual fund participation in the leveraged loan market after the financial crisis. Based on the wider syndication, (narrower) skills, and diverse incentives of non-bank institutional lenders, optimal contracts between them and corporate borrowers likely involve fewer monitoring tools and weaker control rights. We evaluate these explanations of cov-lite contract provisions in a large sample of U.S. loans for the 2001-2014 period. Consistent with creditor-driven explanations for cov-lite issuance, we show that cov-lite prices compress as the prevalence of cov-lite rises. Time patterns in cov-lite issuance closely match inflows to institutional lenders, and at a given time, cov-lite loans are, overwhelmingly, those with the highest ownership by structured products and/or mutual funds. The number and share of structured products and mutual funds also impact the propensity toward other contractual features that influence when and how creditors have control. However, these factors are less relevant in explaining the strength of restrictions on indebtedness, liens, payments, or assets sales.

Keywords: Credit cycles; Loan contracts; Debt Covenants

JEL Classification: G11, G22, G30

Suggested Citation

Becker, Bo and Ivashina, Victoria, Covenant-Light Contracts and Creditor Coordination (March 31, 2016). Swedish House of Finance Research Paper No. 16-09. Available at SSRN: https://ssrn.com/abstract=2756926 or http://dx.doi.org/10.2139/ssrn.2756926

Bo Becker (Contact Author)

Stockholm School of Economics ( email )

Drottninggatan 98
Dept. of Finance
111 60 Stockholm, 11160
Sweden

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

ECGI ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Victoria Ivashina

Harvard University ( email )

Harvard Business School
Baker Library 233
Boston, MA 02163
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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