Bad Loan Externalities: Evidence from the Syndicated Loan Market

Abstract

This study examines external impacts of distressed bank loans on the lending banks and other borrowing firms. The banks, on average, lose almost 1% of their total market value, and the effect spills over to other loan syndicate members. The distress news also impacts the banks’ other borrowers, who experience seven-day mean cumulative abnormal returns of -0.31% for each distress announcement. Distress externalities are worse when the bank is more exposed to the bad loan, and for borrowers that are more relationship dependent. Future lending business is also negatively affected, as loan rates rise by 67 BP following large distress damage, and lenders are less likely to retain existing relationship borrowers.