Losing Control: The 20-Year Decline in Loan Covenant Restrictions


Over the last twenty years, financial covenants in syndicated loan agreements have steadily become looser. The result is that the fraction of U.S. public companies reporting a violation of a loan covenant during a given year decreased from over 12% in 1997 to less than 5% in 2016. Although the decline accelerates in recent years, the trend is present prior to the recent financial crisis. The trend cannot be explained by changes in the composition of public firms, a decrease in the usage of debt, or a long series of positive ex-post outcomes for firms. Nor does the rise in institutional lenders or an increased supply of credit explain the decline. The loosening of covenants is widespread among all types of borrowers and loans and accompanies an increase in loan spreads over the period, suggesting that the trend reflects fundamental changes in the costs and benefits of tight covenants. 

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