Banks and Bonds: The Impact of Bank Loan Announcements on Bond and Equity Prices

Abstract

We study the effect of bank loan announcements on the borrowing firms' bond and equity prices. Our sample consists of 896 loan deals signed between 1997 to 2003 involving 364 different U.S. firms. We report the first comprehensive evidence that also firm bond prices react to bank loan announcements. The cumulative abnormal reaction of bond credit spreads equals minus 11 bps on average in the two-day period comprising the day prior to and the event day itself. The cumulative abnormal return on the firm stocks equals plus 26 bps on average in the same period. While stock returns are unaffected by firm risk, credit spreads react less negatively for risky or small firms. The bondholders of the riskier firms are more sensitive to the loss given default which increases with bank borrowing. The overall positive effect on the value of equity is due to two forces. First, bank certification reduces information asymmetry. Second, there is a transfer of bondholder's welfare to the shareholders as a results of claim dilution. Finally, our analysis provides an estimate of the net impact on firm value of bank loan announcements, between minus 5 bps for riskier and smaller firms and plus 18 bps for safer and larger companies.