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, carve-out and deductible clauses that qualify them are as frequent. We propose simple and comprehensive measures of contractual weakness based on the usage of such clauses. The economic significance of the actions allowed by these clauses, and the market-wide price reaction that followed the 2017 J.Crew restructuring, a high-profile use of such contractual elements, support this interpretation. Leveraged buyouts, large transactions, and non-bank funding are conducive to weaker contractual terms for credit agreements.