Relationship Bank Behavior during Borrower Distress

Abstract

This article provides a comprehensive examination of the time-series behavior of relationship banks around and during borrower distress. Relationship and outside loans have similar interest rates during distress and even 2 years prior to distress. Relative to outside loans in distress, relationship loans in distress have lower maturity. The fraction of bank lending given by relationship banks reduces during borrower distress. Overall, borrowers in distress do not derive benefits from relationship banks. These findings are inconsistent with models that suggest banks have an implicit commitment to help their borrowers in distress due to reputation concerns.

How costly is corporate bankruptcy for the CEO?

“…To illustrate, in Recoton's 2003 bankruptcy filing, DIP lenders demanded replacement of the incumbent CEO with outsider Jerry Kalov and included a covenant making removal of Kalov a default on the DIP facility. More generally, DIP lenders exert substantial power over the bankrupt firm's day-to-day decisions through use of tight covenants (Dahiya et al, 2003;Skeel, 2003;Li et al, 2013).…”

The Value of Lending Relationships When Creditors are in Control

“…This still allows to exploit the variation from 40% of the estimation sample to calculate coefficients of interest. I show that results also hold for alternative solutions, such as a lender-borrower distance instrument (Bharath et al, 2011;Ross, 2010;López-Espinosa, Mayordomo & Moreno, 2017;Li et al, 2017). Two different endogeneity problems do not seem to be significant: I show that early loan terminations and accelerated repayments cannot be explained by changes in observable borrower quality, and that relationship lenders are not more inclined to avoid covenant violations before they occur.…”

“…11 As with the length measure, averages are used if there are multiple leaders. Results are hardly affected when one divides this frequency by the all number of loans issued by the borrower in total or in the recent past as in Bharath et al (2007Bharath et al ( , 2011; Li et al (2017). Fourth, a 1 is added if the relationship is "concentrated", for cases where the bank accounts for 50% or more of the aggregate loan volume recorded for all deals for that firm in DealScan during the 5 years preceding the issuance.…”

“…As possible remedies, literature has used lender-borrower distance metrics as instruments (Ross, 2010;Bharath et al, 2011;Dass & Massa, 2011;López-Espinosa et al, 2017;Li et al, 2017) or direct measures of relationship banking (Bolton et al, 2016;Beck et al, 2018); propensity score matching estimators (Drucker & Puri, 2005;Bharath et al, 2011;Li et al, 2017); borrower IPO events as negative shocks to the value of inside information from relationship lending (Schenone, 2010); the interstate branching deregulation following the 1994 Riegle-Neal Act (Dass & Massa, 2011;Jiang, Levine & Lin, 2017) This alleviates a potential concern that the observations used may reflect a highly selective special sample.…”

“…suggests benefits during periods of crisis or borrower distress with regards to a greater supply of loans (Hoshi, Kashyap & Scharfstein, 1990, 1991Elsas & Krahnen, 1998;Jiangli, Unal & Yom, 2008;Bolton, Freixas, Gambacorta & Mistrulli, 2016;Beck, Degryse, Haas & van Horen, 2018), better terms in new contracts (Bodenhorn, 2003;Jiangli et al, 2008;Bolton et al, 2016;Li, Lu & Srinivasan, 2017) and more favorable management of existing loans by the bank 1 (Bodenhorn, 2003;Bolton et al, 2016).…”