Mehdi Beyhaghi

The Cross-Section of Expected Returns in the Secondary Corporate Loan Market

Corporate loans increasingly have become an important part of portfolio management with the advent of a liquid and transparent secondary market. This paper examines the pricing of characteristics and betas in the cross-section of expected loan returns. Expected loan returns decrease with default beta. Default beta contains information not captured by rating or spread-to-maturity. Among loan characteristics, a 3-month formation momentum strategy earns a monthly premium of 122 bps. Momentum is prominent in loans issued by the lowest-rated borrowers.

Do Tighter Loan Covenants Signal Improved Future Corporate Results? The Case of Performance Pricing Covenants

We explore the relation between corporate loan spreads and performance pricing covenants (PPCs) which automatically adjustment interest-rate spread when a change occurs in the borrower’s subsequent performance. We pioneer separate measurement of the impact of performance pricing depending on whether it is based on accounting ratios such debt-toEBITDA (common practice for smaller, riskier borrowers) or on the borrower’s debt rating. Applying a matched-pairs technique holding borrower and lending syndicate constant, we find that over 90% of PPCs are accounting-based and for this sub-sample the average spread reduction is 45.8 basis points. In contrast, debt-rating-based PPCs result in spreads that are only 3-4 basis points lower a difference that is only weakly statistically significant. We distinguish between interest-increasing and decreasing PPCs. Identifying the latter as a tight covenant in the covenant signaling framework of Demiroglu and James (2010), we show that such covenants are associated with significantly greater spread reduction.