Debt Renegotiation and the Design of Financial Contracts

Abstract

This study examines the design of financial contracts after renegotiations. It focuses on the degree of renegotiation as measured by the number of amendments to the contract. I find that the design of renegotiated financial contracts is not homogenous, although the most frequent amendments are to the loan’s amount and maturity. I show that the number of amendments increases with longer maturities. Collateral and bank reputation have the opposite effect. Creditors friendly environments with fewer renegotiation frictions increase the number of amendments. Overall, contractual, organizational, and legal features have a significant influence on the design of financial contracts after renegotiation.

Appendices

Appendix 1: Description of amended terms

• Amount

Borrow amount = change to borrowed amount.

Borrowing base amount = change to borrowing base amount which is the value assigned to a collection of a borrower’s assets (such as accounts receivable or inventory), used by lenders to determine the initial and/or ongoing loan amount, and/or compliance with one or more debt covenants.

Facility amount = change to facility amount.

LOC amount = change to line of credit amount which acts as a guarantee provided by lenders to pay off debt or obligations if the borrower cannot.

Outstanding amount = change to loan outstanding amount.

Prepay amount = change to prepay amount.

Tranche amount = change to tranche amount.

Covenants financial = change to financial covenants which enforce minimum financial performance against the borrower (such as coverage, leverage, current ratio, tangible net worth and maximum capital expenditures).

Covenants non-financial = change to non-financial covenants which can be affirmative (state what action the borrower must take to comply with the loan) and negative (limit the borrower’s activities).

• Maturity:

Maturity change = change to loan maturity.

• Pricing:

Loan fee = change to loan fees (such as upfront fee, commitment fee, facility fee, etc.)

Pricing grid = change to pricing grid such as altering the level of applicable margin contingent on borrower’s leverage.

• Definition:

Definition change = change to definition of key terms in loan agreement (for instance the definition of an accounting ratio used as a benchmark for a financial covenant, such as the equity to assets ratio)

Appendix 2: Variables definitions

Loan, syndicate & amendment variables (source: Bloomberg).

Amount = Loan facility amount at origination (in billions USD).

Covenants =1 if loan has covenants.

Spread = loan spread over the benchmark rate (in bps).

Secured = 1 if loan is secured.

Previous issues = Number of loans previously issued by a firm.

Lenders = Number of lenders in the syndicate.

Concentration = Herfindahl-Hirschman index computed on the retained shares of the loan by syndicate members.

Lead share = % of the loan retained by the lead lender.

League = 1 if the loan agent was listed among the top 3 of the Bloomberg European league table one year before the amendment year.

Relationship = 1 if the loan agent syndicated a loan for the same borrower during the last 3 years before the amendment year.

Same country = Percentage of lenders in the pool which are from the same country as the borrower.

Duration = Time between renegotiation rounds (in months).

Round = Counter of renegotiation rounds by borrower.

Firm variables (source: Factset).

Listed = 1 if a firm is listed on a stock exchange.

Sales = Net sales or revenue of the firm (in billions USD).

Debt / Assets = Total debt to total assets.

RoA = Net income / average total assets.

Country variables (sources: Djankov et al. (2007) and Favara et al. (2012))

English = 1 if the borrower’s country has English legal origin.

French =1 if the borrower’s country has French legal origin.

German = 1 if the borrower’s country has German legal origin.

Creditor rights = Average creditor rights index.

Renegotiation failure = Measures the probability that shareholders fail to force a renegotiation of debt with creditors. The index is the average of the following binary (0 if no, 1 if yes) indicators: 1) secured creditors may seize and sell their collateral without court approval; 2) secured creditors may enforce their security either in or out of court; 3) the entire firm’s assets can be pledged as collateral; 4) an insolvency or liquidation order cannot be appealed at all; 5) an insolvency case is suspended until the resolution of the appeal; 6) the firm may enter liquidation without attempting reorganization; 7) secured creditors may enforce their security upon commencement of the insolvency proceedings; 8) a defaulting firm must cease operations upon commencement of insolvency proceedings; 9) management does not remain in control of decisions during insolvency proceedings; 10) secured creditors have the right to approve the appointment of the insolvency administrator; 11) secured creditors may dismiss the insolvency administrator; 12) secured creditors vote directly on the reorganization plan.

Priority = Equals 0, 1, 2, 3, or 4 to reflect the order in which creditors’ claims are served. A value of 4 indicates that creditors’ claims are always served first.

Creditors’ recovery = Recovery rate for secured creditors, conditional on default.

Lender variables (source: Orbis).

Total Assets = Total assets (in trillions USD).

TC Equity Ratio = tangible common equity ratio: total equity – (intangible assets + goodwill + preferred stock equity) / tangible assets (total assets less goodwill and intangibles).

Net Interest Margin = (Interest received - interest paid) / average invested assets.

RoCE = Return on common equity: net income / average common shareholder’s equity.

Efficiency Ratio = Overhead / revenue.

Loans / Assets = Total loans / total assets.