Using the Shared National Credit supervisory data, we find Private Equity (PE) sponsored firms violate loan covenants more often than comparable non-PE firms. However, upon covenant violation, PE-sponsored borrowers experience relatively smaller reductions in credit commitments, suggesting lenders are more lenient with these borrowers. Consistent with this limited-punishment effect, sponsor-backed borrowers experience a smaller increase in loan spread and reduction in loan maturity upon covenant violations. Limited punishment is driven by repeated deals and sponsor reputation, as well as the higher bargaining power of sponsors in loan renegotiation. Our results indicate sponsors generate financial flexibility by dampening debt contract enforcement for distressed borrowers.
Sharjil Haque, Federal Reserve Board
Anya Kleymenova, Federal Reserve Board