Non-Fundamental Loan Renegotiations

Abstract

In contrast to prior research that focuses on the role of borrower fundamentals in explaining loan renegotiations, we examine non-fundamental renegotiations of loans traded on the secondary loan market. We exploit the semi-annual rebalancing of the Morningstar LSTA US Leveraged Loan 100 Index as an exogenous shock to the trading conditions in this market, which are critical to non-bank institutional lenders that largely rely on the secondary market for their liquidity needs. In line with improved loan liquidity and greater institutional demand arising from the index inclusions, we find that index-included loans achieve lower bid-ask spreads, higher prices, and greater mutual fund holdings. We further find that index-included loans experience significantly higher likelihood of interest rate-reducing renegotiations than index-excluded loans, consistent with non-bank lenders sharing with borrowers non-fundamental surplus driven by the index inclusion. We rule out explanations related to borrower fundamental by showing that non-traded loans included in the same package as index-included loans do not experience interest rate reducing renegotiations and by conducting placebo analyses that employ an artificial index inclusion threshold and the time period preceding the index origination. Overall, our findings provide novel evidence that non-fundamental forces, such as a loan's inclusion in a major index, can trigger loan renegotiation. 

Keywords: private loans, liquidity, renegotiation, non-fundamental demand, institutional lender demand, nonbank lenders, institutional investors, debt financing

JEL Classification: G11, G12, G21, G23, G32