Weak Credit Covenants

Abstract

Using novel data on 1,240 credit agreements, we investigate sources of contractual complexity in the leveraged loan market. While negative covenants are widespread, clauses that weaken them are as frequent. We propose simple measures of contractual weakness, which explain the market-wide price reaction that followed a high-prole court case on such contractual elements. Leveraged buyouts have signicantly weaker loan agreements, and a larger non-bank funding of a loan is conducive to weaker contractual terms. Weak covenants translate into modestly higher issuance spreads. Our ndings are consistent with sophisticated borrowers catering to a reaching for yield phenomenon by exploiting contractual complexity.