Capital Market Access and Corporate Loan Structure Kenneth Khang Idaho State University Tao-Hsien Dolly King University of North Carolina - Charlotte Current version: September 2010 We thank Steven Byers for helpful comments. Khang is at Idaho State University, College of Business, 921 S. 8 th Avenue, Stop 8020, Pocatello, ID 83209. Ph. (208) 282-6398, Fax (208) 282-4367, Email: khankenn@isu.edu. King is at University of North Carolina Charlotte, Department of Finance, 9201 University City Boulevard, Charlotte, NC 28223. Ph. (704) 687-7652, Fax. (704) 687-6987, Email: tking3@uncc.edu.
Capital Market Access and Corporate Loan Structure Abstract In this paper, we use a sample of 20,155 loan packages issued from 1993 to 2007 to examine how borrower access to external capital markets influences loan structure and how this influence varies across lender type and economic environments. We classify firms into three borrower access categories: private, unrated public, and rated public firms. Private firms have the least access, whereas rated public firms who have public debt and equity have the most. We find that borrower access influences corporate loan structure in ways that are largely consistent with expectations. First, borrower access influences loan maturity, with the rated public firms using corporate loans mainly for liquidity and short-term financing purposes. Second, greater access is associated with fewer individual loan facilities per lending package. Third, greater access is also associated with a greater number of lenders per package after controlling for firm and loan size. Fourth, there is a non-monotonic relation between the number of covenants and borrower access. Unrated public firms have the most covenants, while private and rated public firms have less. Fifth, we find that loans to unrated public firms have a higher probability of being secured than those to the other borrower types. Sixth, we find that the influence of borrower access is similar across lender types. Finally, we find that economic conditions influence aggregate market loan structure in a manner consistent with borrower access.
1. Introduction Corporate loans are a major source of financing for firms. Fama (1985) and Bernanke (1983) refer to corporate loans as inside debt because the lender obtains information about the borrower that is not available to other security holders. Unlike public and non-bank private debt where the transaction is arms-length, corporate loans are characterized by close scrutiny and monitoring at and after issuance. Further, unlike public debt, the lenders in corporate loans are concentrated and easily identified. Thus, corporate loans have features that distinguish them from public and non-bank private debt, though many basic features are similar. In this paper, we use a sample of 20,155 loan packages issued between 1993 and 2007 to examine how access to external capital markets affects loan structure and how this influence varies across lender type and economic environments. Our analysis is motivated by recent studies showing how access to public financial markets affects capital structure. Brav (2009) and Faulkender and Petersen (2006) find that access to public financial markets affects leverage ratios. Brav (2009) finds higher leverage ratios for private firms than public firms in the U.K. Faulkender and Petersen (2006) find that rated public firms who have access to the public debt markets have more leverage than unrated public firms that do not have access. This paper contributes to the literature by examining how access to public financial markets influences security structure, or more specifically corporate loan structure. 1 Corporate 1 It is important to note that access is a function of both supply and demand. A lack of access does not necessarily imply an inability, but may imply a decision not to access a given market because the costs of doing so are too high. For example, a private firm may have the ability to issue equity, but has chosen not to because the costs of equity financing are too high relative to the benefits of doing so. Similarly, an unrated firm may have the ability to issue public debt, but supply and demand conditions in the public debt market make the cost too high for the given firm relative to the benefits. 1
loans provide a unique opportunity to examine whether financial market access affects security structure since business loans are the only form of external financing used by all types of firms from small privately-held companies to large publicly-held corporations. In the spirit of Brav (2009) and Faulkender and Petersen (2006), we classify borrowers into three categories: private, unrated public, and rated public. 2 We call these borrower access categories and use them as proxies for financial market access. Rated public firms have the most access because they have issued in the public debt and equity markets to obtain external financing. Private firms have the least access to external capital, having never issued in the public debt or equity markets. Unrated public firms have accessed the public equity market, but not the public debt market, putting them in-between the other two categories. 3 1.1. Private Firms and Loan Structure As stated above, we investigate the choice to obtain a corporate loan by firms with differing access to external capital markets and how this differing access affects loan structure and explains empirical regularities in the corporate loan market. The first issue is to examine why private firms obtain corporate loans rather than accessing the public markets. With respect to financing choices, Brav (2009) suggests that there are two primary differences between private and public firms. The first is ownership structure and its effect on the degree of control. Relative to public firms, owners of private firms place a greater value on control of 2 A private loan is one to a firm designated as private by Dealscan. An unrated public loan is one to a firm designated as public by Dealscan and lacking an S&P senior debt rating in Compustat. A rated public loan is one to a firm designated as public by Dealscan, matched to Compustat, and having an S&P senior debt rating in Compustat. 3 Faulkender and Petersen (2006) and Cantillo and Wright (2000) note that cases where firms have a debt rating, but no public debt, and cases where firms have no debt rating, but have public debt are fairly rare. In Cantillo and Wright s (2000) sample, these cases amounted to show only 2.4% and 0.3% of the sample, respectively. 2
the firm. Private firms have fewer shareholders, many of whom exercise a large degree of control. By issuing public equity, private shareholders risk losing control, which is a risk they may be unwilling to take (see Brav (2009), Amihud, Lev, and Travlos (1990), and Stulz (1988)). This tendency is further reinforced because private shareholders recognize that management in a public firm may seek to dilute the control of large shareholders by issuing more equity (see Morellec (2004)). In fact, maintaining control is one of the primary reasons why many private firms are privately held (see Pagnano et al (1998)). Hence, the control consequences of ownership structure lead to private firms preferring debt in the form of corporate loans over public equity as a source of external financing. Also, by extension, they may have a preference for bank debt that gives them more flexibility and control rather than bank debt that imposes a lot of restrictions. The second primary difference distinguishing private from public firms is information asymmetry between insiders and outsiders. Relative to public firms, private firms are more opaque, having never been scrutinized by public investors. Myers and Majluf s (1984) pecking order theory implies that firms with greater information asymmetry will issue the less information sensitive instrument, or debt in this case. Furthermore, given that financial intermediaries are more effective at monitoring borrowers than arms-length investors, the form of the debt for firms with a high degree of opaqueness is private loans (see Denis and Mihov (2003), Diamond (1984), and Fama (1984)). Thus, as with ownership structure, information asymmetry gives private firms a preference for private loans over public equity and debt financing. 3
In addition to those in Brav (2009), we add one additional reason for why private firms prefer corporate loans. To the extent private firms are smaller and have greater growth opportunities than public firms, agency costs of debt may be higher in terms of underinvestment since firms with risky debt may forego these opportunities (see Myers (1977), Smith and Warner (1979b), and Denis and Mihov (2003)). Myers (1977) suggests that one way to reduce this problem is through a continuous, intimate and flexible relationship with the lender. This implies that private firms prefer corporate loans to public debt. Also, we can extend this argument and suggest that other agency costs may be reduced by such a relationship with the lender, further reinforcing private firms preference for loans over public debt. For example, because of greater growth opportunities, asset substitution problems may be more severe in private firms. However, these problems may be less severe when monitored bank loans instead of public debt are used. 1.2. Rated Public Firms and Loan Structure The decision to obtain a corporate loan is more complex for public firms because they have greater access to other types of external financing, but choose to obtain a corporate loan. Rauh and Sufi (2009) provide an explanation for why rated public firms with access to the external capital markets choose to obtain bank loans. They examine debt heterogeneity in the capital structure of these firms and find it to be related to credit quality (see Bolton and Freixas (2000), Park (2000), and Diamond (1991) for the theoretical literature). Rauh and Sufi (2009) show that high credit quality firms rely primarily on public senior unsecured debt and equity, while lower credit quality firms use public equity with multiple tiers of debt. The multiple tiers 4
include senior unsecured, secured, and subordinated debt. Further, they find that for low credit quality firms, the greater amount of secured debt relative to high credit quality firms is in the form of secured bank loans. Low credit quality issuers lack the ability to issue commercial paper, shelf registration debt, and medium-term notes. Therefore, these firms rely on secured bank debt with tight liquidity covenants. Finally, they show that high credit quality firms whose credit quality deteriorates (or fallen angels) obtain more secured bank and subordinated debt, causing an increase in the heterogeneity of their capital structure. Thus, rated public firms with bank debt may include a significant number with low or deteriorating credit quality. Lastly, rated public firms are the most transparent and have the fewest growth opportunities. 1.3. Unrated Public Companies and Loan Structure The main difference between rated and unrated public firms is that the latter have never accessed the public debt markets, though they have accessed the public equity market. This makes them less transparent (more opaque) than rated public firms. Thus, unrated public firms are more likely to obtain loans from financial intermediaries, who specialize in evaluating and monitoring borrowers, than to issue public debt (see Denis and Mihov (2003), Boyd and Prescott (1986), Fama (1985), Diamond (1984), and Leland and Pyle (1977)). Further, Sufi (2007) shows that syndicate structure is more concentrated in syndicated loans if the borrower is less transparent. We extend Raul and Sufi s (2009) arguments regarding debt heterogeneity and credit quality of rated public firms to unrated public firms. Diamond (1991), Rajan (1992), and Denis and Mihov (2003) suggest that the highest quality firms issue public debt (eg. commercial 5
paper), while the medium quality firms choose bank loans. Since firms that issue public debt are typically rated and firms that resort to bank loans are typically unrated, this implies that rated public firms will generally be of higher credit quality than unrated public firms. Following the arguments in Raul and Sufi (2009), we consider unrated public firms as lower quality public firms (relative to rated public firms) whose only option in terms of debt financing is a corporate loan. Also, because unrated public firms are smaller and likely have more growth opportunities than rated public firms, they are subject to greater agency costs related to underinvestment and possibly others. 1.4. Summary of Contributions We make the following important contributions to the literature. First, we provide evidence that borrower access to financial markets influences loan structure in ways that are largely consistent with expectations from previous literature. The structure of loans to private firms is consistent with these firms significant reliance on lenders and high levels of information asymmetry. For example, private firms have more multiple facility loan packages and fewer lenders. The structure of loans to rated public firms is consistent with these companies using loans for mainly short-term liquidity purposes and having lower levels of information asymmetry. For example, rated public firms have a higher prevalence of short maturity loans and a greater number of lenders per package. The loan structure of unrated public firms meets the expectations that these firms reliance on lenders is greater than rated public firms, but less than private firms. The severity of information asymmetry issues on loan structure for unrated public firms is between that of the public rated and private firms. Finally, 6
we show that covenant structure and security are influenced by borrower access in ways that lead to a nonmonotonic relation between borrower access and covenant restrictiveness. In particular, though unrated public firms have the intermediate amount of access to capital markets, their loans contain the most restrictive covenants relative to the other two types of borrowers. Second, we provide evidence that loans made by banks, finance companies, and investment banks have more similarities than differences in terms of the influence of borrower access on loan structure is similar across lender types. Thus, the differences in loan structure across borrowers with varying access to the capital markets are not due to institutional differences in lender types (or lender characteristics). Rather, as stated above, borrower considerations such as ownership structure, information asymmetry, and agency costs are major drivers of corporate loan structure. Third, we provide evidence that the state of the economy influences loan structure at the aggregate level. For example, average loan maturity shortens in poor economic conditions. Finally, we provide a comprehensive examination of loan characteristics across borrower access and lender types. The rest of the paper proceeds as follows. Section 2 discusses the hypotheses of the relation between borrower access and loan structure. Section 3 describes the data and presents preliminary analyses. Section 4 presents the multivariate analyses of loan characteristics. Section 5 concludes. 7
2. Hypotheses We develop the following hypotheses on how borrower access to external financing influences corporate loan structure. 2.1. Loan Maturity Raul and Sufi (2009) find rated public firms with lower credit quality that never had or lost access to the commercial paper market use corporate loans mainly for short-term finance purposes. Also, public debt and equity are usually associated with financing of longer term projects. Thus, we hypothesize that loans to rated public firms tend to be of shorter maturity. Unrated public firms have fewer financing options than rated public firms for their longer term projects because they do not have public debt issues. However, they have more external financing options than private firms. For example, unrated public firms may use a combination of short-term loans, long-term loans, and public equity. Note that this may imply an increasing heterogeneity in the loan structure as one shifts from rated public to unrated public firms, which would be an extension of Raul and Sufi (2009). We hypothesize that the average maturity on the loans to unrated public firms should be longer than those to rated public firms, but shorter than those to private firms. The latter is because unrated public firm can use additional public equity for some of their long-term financing, making them less dependent on long-term loans. 8
2.2. Number of Facilities per Loan Package Corporate loans are structured as loan packages negotiated between borrowers and lenders. Each loan package can contain a single loan facility or multiple facilities. A loan facility refers to an individual loan within a package. For example, a loan package may consist of a term loan and a short-term revolver, counting as two facilities. Since rated public firms have the most financing options available, especially for long-term financing, these firms likely have the lowest proportion of multiple facility packages and the smallest number of loan facilities per loan package. Private firms are on the opposite end of the spectrum with the most limited sources of external financing. Thus, they are likely to finance their activities exclusively with corporate loans, avoiding the public markets. This implies that they finance a wider range of activities when obtaining a loan. For example, a private firm may obtain both their short-term liquidity and long-term financing from banks. 4 Given that each instance of obtaining a loan is costly, it is cheaper to obtain two loans in one package rather than two loans in two separate packages. This suggests that private borrowers likely have a greater proportion of multiple facility packages and a larger number of loan facilities per loan package. Unrated public firms have the option of public equity financing, but not public debt financing. Consequently, we expect that the number of facilities in a loan package for unrated public firms is likely inbetween that of the other two borrower types. 4 Public borrowers will have more options since they can issue equity or debt for some forms of financing rather than take loans out for all their financing needs. 9
2.3. Number of Lenders per Loan Package We stress that information asymmetry is an integral part of determining borrower access. Given that rated public firms are the most transparent, they should have the lowest amount of concentration in their lender structure (see Sufi (2007). Therefore, we expect rated public firms to have the greatest number of lenders per loan package after controlling for loan size. Private firms, who have the greatest degree of information asymmetry, should have the fewest lenders per loan package. Unrated public firms are more opaque than rated public firms, but less opaque than private firms. Thus, their lender count should fall in-between the other two borrower types. 2.4. Covenant Structure Smith and Warner (1979b) and Stohs and Mauer (1996) argue that smaller firms are subject to greater agency costs. Noting that in general private firms are the smallest; rated public firms are the largest; and unrated public firms are in-between, we expect a monotonic relation between borrower type and covenant restrictiveness. Based on severity of agency issues, we expect private firms to have the greatest covenant count, rated public firms to have the lowest, and unrated public firms to be in-between. Debt covenants are structured to protect bondholders from possible actions by managers/shareholders to expropriate wealth from the bondholders. For example, overinvestments (investing in negative NPV projects), asset substitutions, mergers and acquisitions, sale of crown jewels, dividends/share repurchases, and other transactions (see Berkovitch and Kim (1990), Jensen and Meckling (1976), Smith and Warner (1979b)) can result in wealth transfers from bondholders to 10
shareholders. Most covenants are designed to alleviate these agency conflicts between shareholders and bondholders. However, there is another factor that may affect this ordering. Since private firms are more likely to be smaller and higher-growth firms, they may have a stronger preference for less restrictive covenants on the loans to maintain maximum flexibility in setting various corporate policies (e.g., investments, future financing, dividend). In fact, as Brav (2009) argues, private firms place more value on control of the firm. At the same time, lenders are motivated to require more covenants to protect against the greater agency conflicts between shareholders and debtholders in private firms. The interaction of the above influences makes the relation between borrower access and covenant structure indeterminate, and it is an empirical issue as to what that relation is. 5 2.5. Security Structure Besanko and Thakor (1987), Chan and Thakor (1987), and Chan and Kanatas (1985) provide a theoretical reason why collateral is associated with safer borrowers and loans. Intuitively, high-quality borrowers faces a lower probability of default and transfer of collateral to the lender, so these borrowers are more willing put up collateral. In other words, collateral is less costly for them. However, Boot, Thakor, and Udell (1991) and Berger and Udell (1995) suggest the opposite relation that collateral is imposed on the riskiest borrowers to protect the lender in case of default. Thus, whether collateral is included in a loan may be the result of 5 Bradley and Roberts (2003) find that smaller firms, firms with higher growth opportunities, and firms with higher leverage are more likely to have loan covenants. Note that they examine only public firms. We find a similar result for public firms, but also find that private firms appear to have fewer covenants than their public counterparts. 11
opposing influences. In addition, we can view security as a covenant that reduces the agency problems of asset substitution and overinvestment, as discussed above. Empirically, Raul and Sufi (2009) find that the population of rated public firms who pursue loans from financial intermediaries might contain a disproportionate number of firms with low credit quality (fallen angels). However, the average credit quality of the sample of rated public firms who obtain bank loans is still high with two-thirds having a BBB- S&P rating or better. Regardless, the relation between borrower access and security for corporate loans is an empirical issue. We predict that borrower access has an effect on the security structure of loans and examine how the proportion of secured loans varies with borrower access. 6 2.6. Economic Environment The influence of the level of access on loan structure may vary with the economic environment. Diamond (1991b) argues that in poor economic states, higher quality borrowers who seldom obtain loans in a good economy will do so as the supply of credit in the public debt market diminishes. Thus, rated public firms become more dependent on financial institutions in poor economic states than in good economic states. This suggests that loan issuance to rated public borrowers rises in poor economic states, while issuance to private firms who have fewer options may remain constant. It follows that economic conditions also affect loan structure. For example, maturity may shorten in poor economic states. 6 As mentioned with covenants, one potential empirical factor is that rated public firms that are in distress and have lost access to the short-term public debt market may represent a significant portion of the population of rated public firms that obtain corporate loans. 12
2.7. Lender Types Lastly, in the examination of loan structure and capital market access, we separate the sample by lender type: banks, finance companies, and investment banks. Fama (1985) and James (1987) argue that banks have an advantage in monitoring due to their ongoing relationship with borrowers. Thus, market segmentation may exist in the market for corporate loans, which will be reflected in the structure of loans across lender categories. Carey, Post, and Sharpe (1998) compare US bank loans and finance company loans on data from 1987 to early 1993 and find evidence of specialization by lenders. They find that compared to US banks, finance companies lend to smaller, riskier borrowers using loans with longer maturities and larger spreads. Given these differences, we consider lender type when conducting the analysis of corporate loans. 3. Dealscan Loan Data Table I shows summary statistics for the sample of US loans from Dealscan over the sample period from January 1993 to June 2007, excluding those made to financials, agricultural companies, and public sector entities. We categorize the loans by lender type: US banks, finance companies, and investment banks. We determine lender type by examining the lead lender(s). For a loan with multiple lead lenders, we use the lender type exhibited by the majority of lead lenders in the syndicate. Those loans that could not be classified by lead lender are excluded. Note that the statistics are calculated at the package level for most items. The facility level items are loan type, facility amount, security, and maturity. 13
3.1. Descriptive Statistics for the Corporate Loan Sample For each lender type, we present the descriptive statistics of corporate loans by borrower access: private, unrated public, and rated public firms. Table I indicates that US bank loans are clearly the largest category with investment bank loans being the smallest. A comparison across the columns in the table illustrates a number of differences in corporate loans across the three borrower access categories. We use the US bank sample to present our findings. We later discuss the results for the finance company and investment bank loans. First, the number of loan packages made to unrated public firms is the largest, such that they account for about half of all loan packages. However, this may not be surprising since they also represent about half of all the individual borrowers. 7 Second, based on sales in 2007 US dollars, private firms and their loans tend to be the smallest, while unrated public firms and their loans are much larger. Rated public firms and their loan packages are by far the largest. For example, for US bank loans, the average sales (package size) is $872.98 million ($266.57 million) for private firms, $1,350.39 million ($326.55 million) for unrated public firms, and $5,003.40 million ($945.15 million) for rated public firms. Thus, firm and loan package size increase monotonically from private, unrated public, to rated public firms. 8 Interestingly, the 7 Although Dealscan does not contain the loan universe, it does consist of a large majority of all commercial loans in the U.S. according to Carey and Hrycray (1999), especially from 1995 onward. 8 The banking industry often defines firm size based on sales when classifying borrowers into corporate, middle market, and small business lending segments. Although it varies depending on the source, corporate borrowers are often defined as having more than $0.5 billion in sales, middle market borrowers are defined as having between $100 million and $0.5 billion in sales, and small business borrowers are defined as having sales less than $100 million. 14
ratio of package to sales is largest for private firms, suggesting that private firms tend to take on much larger loans relative to firm size than the other two types of borrowers. 9 Third, unrated public firms have the highest percentage of secured bank loans with 57.1%, while rated public firms exhibit the lowest percentage with 27.4%. It is interesting to note that private firms exhibit the lowest percentage for finance company and investment bank loans. Fourth, the distribution of loan type varies across the borrower access categories. For US bank loans, the proportion of loans that are term loans is highest for private firms at 35%, while the proportion of loans that are 364-day revolvers is highest for rated public firms at 28.8%. Unrated public firms have the highest proportion of bank loans that are multi-year revolvers at 61.4%. Consistent with this, the average maturity for private loans is the longest at 49.46 months, while it is the shortest for rated public firms at 42.51 months. Also, private firms have the largest percentage of loans over four years in maturity, while rated public firms have the largest percentage of loans less than one year. In addition, the yield spreads for rated public firms are the smallest among all three borrower types. Fifth, there is a monotonic relation between the number of facilities in a loan package and borrower access. Private firms have the largest number of facilities in a package with an average of 1.60, while rated public firms have the fewest with an average of 1.34. This is largely driven by private firms having the fewest single facility bank loans with 58.8%, while rated public firms have the most at 73.2%. Unrated public firms are in-between the other two borrower types. Sixth, there is a monotonic relation between the number of lenders and borrower access. On average for US bank loans, private firms have the fewest with 5.47 9 This is consistent with Brav (2009) who finds that private firms in the U.K. have higher leverage than public firms and access the loan market less frequently. 15
lenders, while the rated public firms have the most with 11.90 lenders. This result is consistent with information asymmetry as in Sufi (2007). It is also consistent with firm and loan size effects. Seventh, the distribution of loan purpose is generally similar across private, unrated public, and rated public firms. Corporate purposes (working capital) is the most common category for all three borrower types. Debt repayment and acquisition/lbo are the next most common types. There are two notable differences: 1) rated public firms make greater use of bank loans for commercial paper backup/credit enhancement than the other two borrower types and 2) unrated public firms make greater use of bank and finance company loans for debt repayment than the other two borrower categories. Finally, the findings for US bank loans mentioned above are generally similar to those for finance company and investment bank loans. However, there are certain differences worth noting. 10 First, finance companies and investment banks issue a much larger proportion of term loans relative to banks, making the average maturity relatively higher. Finance company loans are much smaller, and their borrowers are smaller in firm size (measured by sales). Also, finance company loans contain higher yield spreads than banks and investment banks. Interestingly, investment bank loans are used for acquisition/lbo purposes more often than loans from banks and finance companies. This suggests that investment bank loans are commonly tied to investment banking business that the borrower is engaged in with the lender. Table I also provides the results of t-tests for differences in the means and proportions of the characteristics in Table I. The comparisons are between loans to private versus unrated 10 Carey, Post, and Sharpe (1998) show that loans from banks and finance companies differ and that these differences can be explained by credit quality, regulatory, and reputation-based differences. 16
public firms and unrated public versus rated public firms. The significant differences are indicated by an asterisk between the comparison borrower types and serve as the basis for later analysis. The first set of comparisons are related to the control variables of firm size and package/facility size. Firm and package/facility size are significantly different across borrower types. Private firms are smaller and have smaller loans than unrated public firms. Unrated public firms are smaller and have smaller loans than rated public firms. Also, the distributions of loan type and loan purpose differ across borrower types. Given our discussions above, we are interested in examining the determinants of the following loan characteristics: loan maturity, the number of facilities per loan package, the number of lenders in a loan package, and loan security. In a later section, we examine these characteristics in a multivariate analyses by controlling for loan type at the facility level and loan purpose at both the package and facility levels. A final loan structure characteristic that we are interested in is loan covenants, which we discuss in the next section. 3.2. Loan Covenants Table II presents a summary of the incidence of covenants on loans to private firms, unrated public firms, and rated public firms across US bank loans, finance company loans, and investment bank loans. For this table we follow Demiroglu and James (2008) and group the financial covenants into seven categories: maximum capital expenditure, maximum debt-tocash flow, maximum debt-to-balance sheet, minimum cash flow, minimum coverage, minimum liquidity, and minimum net worth. We also include a dividend restriction category and a sweep 17
category that includes five different sweep covenants. The proportions in this table are defined as the percentage of the loan packages reporting a covenant. In other words, only packages that report covenant information for at least one covenant are included in these proportions. Note that all the covenants are assigned at the package level. Of the 20,155 total packages, 11,907, or 59%, report covenant information for at least one type of covenant. We assume that those packages that report information on at least one type of covenant, but have a missing value for the other types of covenants, do not contain the other covenants. For example, packages that report having a maximum capital expenditure covenant, but have a missing value for the minimum cash flow covenant, are assumed not to have a minimum cash flow covenant. Our procedure is supported by the fact that Dealscan consistently reports the inclusion of a covenant, but does not always report the exclusion of a covenant. As a result, the figures in Table II for covenant inclusion are lower than those reported in Bradley and Roberts (2003) because of the method of recording covenants. For example, in later years the asset sweep covenant field in Dealscan indicates either the inclusion of an asset sweep covenant or a missing value. Thus, if one relies on Dealscan to report the exclusion of an asset sweep covenant from a package before classifying it as not having an asset sweep covenant, then it appears as if 100% of the loan packages have an asset sweep covenant as reported in Bradley and Roberts (2003). This number is misleadingly high because a large proportion of those loans with missing values clearly had no asset sweep covenant. Thus, our procedure assumes that if a package reported at least one covenant, but had missing values for the other covenants, then the package did not contain the other covenants. However, if a package had missing values for all the covenant fields, we omitted the observation rather than 18
assume the package had no covenants. This sample of packages reporting at least one covenant is what we call the covenant sample. Comparison of the incidence of covenants among private, unrated public, and rated public loans shows that the incidence of covenants is similar among borrower access categories. Minimum net worth, minimum coverage, and maximum debt-to-cash flow are the most frequently included financial ratio covenants across all borrower access types and lenders. Dividend restrictions and sweeps are next in frequency. With respect to borrower access type, three comparisons stand out. First, loans to unrated public firms have the highest covenant count across the three lender types. Covenant count is the sum of the covenants within a package. Second, loans to rated public firms have a lower frequency of the maximum capital expenditure covenant than those to private and unrated public firms. This is consistent with rated public firms using financial intermediary loans primarily for liquidity purposes as opposed to longer term investment. Finally, loans to private firms have a lower frequency of the maximum debt-to-balance sheet covenant relative to the other two borrower access categories. Perhaps private firms have less access to alternative sources of debt (both private and public), making this covenant less applicable to them. Finally, there are differences in covenants among lender categories. First, maximum capital expenditure covenants are less common for bank loan packages than those from finance companies and investment banks. This is consistent with bank loans being used more often for liquidity and not investment purpose than loans from finance companies and investment banks. Second, maximum debt-to-balance sheet covenants are more common among bank loan 19
packages than the other lender types. This may be due to the fact that bank loan borrowers are larger and able to obtain debt financing from alternative sources more easily. Lastly, investment banks make the greatest use of sweep covenants, using them in 64 percent of their loans. It may be that investment bank lending is related to transactions commonly based on a shorter-term relationship with borrowers. Sweep covenants, which are a mechanical way to force payment, may be a convenient monitoring tool in these cases. 3.3. Economic Activity and Loan Characteristics In Table III we present the relation between loan characteristics and the state of the economy. To examine how economic conditions affect loan characteristics, we make two comparisons. The first comparison is between high growth and low growth quarters. To do this, we rank the calendar quarters by GDP growth and divide the quarters into thirds: the low growth group, the middle growth group, and the high growth group. We then compare the loan characteristics from Table I between the low and high GDP growth quarters. In the second comparison, we examine two time periods in which GDP growth was notably low or high. The period with the lowest GDP growth occurred over the 2001 through 2002 period, which included the March 2001 peak in economic activity as defined by the NBER. The period with the highest GDP growth was the 2004 through 2005 period. Table III includes the analysis of US bank loans only. The results for finance company loans and investment banking loans are similar to those for US bank loans and are omitted for brevity. 11 Overall, the results in Table III suggest that many of the variables of interest vary with 11 These are available upon request. 20
economic conditions. First, loan type exhibits variation consistent with expectations suggested in Diamond (1991) and Julio, Kim, and Weisbach (2007). The primary variation in loan type is that when economic growth is poor, 364-day revolvers become more prevalent. The opposite is true for multi-year revolvers and term loans, whose prevalence declines with poor economic conditions. We observe similar effects for loan maturity, where maturity rises when economic conditions are good and shortens when they are poor. These effects are consistent for all borrower types; however, the maturity effects are especially pronounced for rated public firms. Average firm size and deal purpose are the other variables affected by economic states across all borrower types. Firm size and the proportion of loans for CP backup / credit enhancement rise in poor economic states and fall in good economic states. The effect of economic conditions on CP backup / credit enhancement is especially evident for rated public firms. The proportion of loans for corporate purposes has the opposite pattern: the proportion falls in poor economic states and rises in good economic states. This shift in purpose may not be surprising since working capital requirements are higher in good economic states, while the need for immediate short-term liquidity is higher in poor economic states. These results are consistent with Diamond s (1991) prediction that higher quality firms will turn to more bank financing relative to commercial paper in poor economic states. Overall, the results indicate that variations in economic conditions affect loan structure. In the following section, we include variables related to economic states in the multivariate analysis of loan characteristics. 21
4. Multivariate Analyses In this section, we construct multivariate regressions to explain differences in loan structure among loans to private, unrated public, and rated public borrowers. The general specification is (1) The dependent variables (Char) are loan characteristics that we expect to vary with access, such as number of facilities in a loan package. These variables are either continuous or categorical in nature. The main independent variable of interest is Access, which is incorporated as indicator variables reflecting whether the loan is to a private, unrated public, or rated public firm. In all specifications, private firms are the omitted group for Access. Unrated public measures the difference between unrated public and private firms, and rated public measures the difference between rated public and unrated public firms. X represents a set of control variables. We first include the natural log of firm size, industry indicator variables, and the natural log of the package or facility size. 12 In addition, we include indicator variables for loan type and loan purpose since these are exogenous to loan structure but may influence the dependent variables. Given the results in Table III, we include five economic variables (Econ), including annual GDP growth, credit spread, slope of the yield curve, volatility of interest rates, and a variable indicating whether quarterly GDP growth was low, medium, or high. Finally, standard errors are heteroscedasticity-consistent and clustered at the borrowing firm. 12 As in Sufi (2007), the controls for firm size and loan size may cause a downward bias in the coefficients on access for two reasons. First, firm size could also be used to measure access, though it is used as a control here. Second, firms with less access may obtain smaller loans partially because of their level of access. Faulkender and Petersen (2006) argue that when monitoring cannot eliminate information asymmetry, then credit my be rationed. Firms with less access also tend to have greater degrees of information asymmetry than average. 22
4.1. Regression Analysis of Loan Structure Table IV presents the results for cases where the dependent variable is continuous in nature. We examine five loan characteristics. These include the natural log of maturity, facility count, lender count, covenant count, and spread over the default base. For each loan characteristic, we show the results for the US bank, finance company, and investment bank loans, respectively. The first three columns in Table IV show that loans to unrated public firms and rated public firms tend to be of shorter maturity than private firms. 13 These results are consistent with Raul and Sufi (2009) who find that the rated public firms that acquire loans from financial intermediaries do so primarily for liquidity purposes. The implication is that they have lost or are unable to access the public short-term debt (commercial paper) market. It is also consistent with Diamond (1991) whose model implies that higher quality firms will acquire loans from financial intermediaries primarily for liquidity purposes. Finally, macroeconomic variables related to the state of the economy come into play. Consistent with Diamond (1991), lower annual GDP growth leads to shorter maturities, as higher quality firms look to financial intermediaries for liquidity. Higher credit spreads are associated with longer maturities. Steeper yield curves are correlated with shorter maturities. Thus, the results are consistent with borrower access having an influence on the maturity of loan structure. The next three columns present the results for facility count. As mentioned above, since corporate loans are the only external financing option for private firms, it is reasonable that they would use loans to finance a wider range of activities than unrated public or rated public 13 In unreported results, when the indicator variables are set up to examine private versus rated public firms directly, the results are statistically significant that maturity is longer for rated public firms. 23
firms. By the same token, unrated public firms will rely on corporate loans more than rated public firms because while they have access to the public equity market, they do not have access to the public debt market. The results in Table IV support this assertion. Packages to unrated public firms have a lower facility count than packages to private firms. Further, loan packages to rated public firms have a lower facility count than packages to unrated public firms. This evidence is consistent with the notion that borrower access influences loan structure in terms of the facility structure in a package. Sufi (2007) shows that for syndicated loans with multiple lenders, lender concentration is related to information asymmetry. Since information asymmetry is an integral part of borrower access, we include single lender loans and examine the relation between lender count and borrower access. We note that Sufi (2007) groups private and unrated public firms together as opaque in most of his analysis and does not include single lender loans. Since we focus on capital market access, the distinction between private and unrated public firms is important. The results for lender count indicate unrated public firms have more lenders per package than private firms and rated public firms have more lenders per package than unrated public firms and private firms. Finally, the macroeconomic variables of yield curve slope and interest rate volatility are significant. A flatter yield curve and greater interest rate volatility is associated with fewer lenders, which may indicate that information asymmetry problems are more severe when there is economic uncertainty. These results are consistent with borrower access having an influence on loan structure by influencing the number of lenders in a bank loan. 24
The next three columns examine covenant count. The results show that the number of covenants is higher for unrated public firms relative to private firms. However, there is no difference between private and rated public firms. At first glance, this pattern may seem counterintuitive. Based on severity of agency issues, we expect private firms to have the greatest covenant count, while rated public firms have the lowest. Unrated public firms would be in-between. Debt covenants are structured to protect bondholders from possible actions by managers/shareholders to benefit themselves at the expense of the bondholders. For example, overinvestments, asset substitutions, mergers and acquisitions, sale of crown jewels, dividends/share repurchases, and similar transactions (see Berkovitch and Kim (1990), Jensen and Meckling (1976), and Smith and Warner (1979b)) have the potential to benefit the shareholders at the expense of bondholders. Most covenants are aimed to alleviate these shareholder vs bondholder agency conflicts. We recognize one other factor that may affect the result on covenant count. Private firms are more likely to be smaller and higher-growth firms. Thus, private firms may have a stronger preference for less restrictive covenants on their loans to maintain maximum flexibility in setting various corporate policies (e.g., investments, future financing, dividend). Further, Brav (2009) argues that owners of private firms value control more than managers in public firms. Conversely, at the same time, lenders are motivated to require more covenants to protect against the greater agency conflicts between shareholders and debtholders in private firms. The empirical finding on the covenant ordering reflects how these preferences interact to determine the restrictiveness of loan covenants. Finally, there is some evidence that covenants are more prevalent when credit spreads are high. 25
The final three columns in Table IV look at spread over the default base, which is a proxy for credit risk. The results indicate that other factors are more important than borrower access in influencing spread, such as firm size and size of the loan package. 4.2. Probit Analysis of Loan Structure Table V presents the results for cases where the dependent variable is categorical. Thus, we use a probit model with a form analogous to equation (1), where standard errors are heteroscedasticity-consistent and clustered at the borrowing firm. We examine four characteristics, including the proportion of loans with one year or less to maturity, the proportion of loans that are 364-day revolvers, the proportion of loan packages with a single facility, and the proportion of loan facilities that are secured. The first three columns show that the proportion of bank loans with one year or less to maturity is greatest for rated public firms and lowest for private firms. The proportion of bank loans with one year or less for unrated public firms is in-between the other two borrower types. These results are consistent with the maturity results in Table IV, also confirming that rated public firms have the highest tendency to borrow from banks for short-term liquidity purposes only. This is due to the fact that rated public firms have access to the public debt and equity markets for their long-term financing. Unrated public firms have the next highest tendency, because they have the public equity market as an option for their long-term financing. These findings are consistent with Raul and Sufi (2009) and Diamond (1991), and provide additional evidence that borrower access influences the maturity aspect of loan structure. 26