Risk Hedging and Loan Covenants

Abstract

We study lending agreements and derivative positions of U.S. oil and gas producers, showing that loan covenants are important determinants of hedging policies. Hedging covenants appear in more than 85% of sample loan agreements, with explicit minimum hedging requirements in more than half. Covenants are more common when expected default costs are larger. The well-documented positive relation between borrowing and hedging is largely attributable in our sample to binding covenants, as the relation is much weaker in their absence. These results imply that understanding firms’ hedging policies requires the consideration of lender interests along with those of owners and managers.

Keywords: hedging, risk management, debt, covenants, credit boom, fracking

JEL Classification: G30, G32, G21