Debt Renegotiation Research Articles

The Impact of Crisis-Period Interest Rate Declines on Distressed Borrowers

Abstract We measure the causal impact of reductions in benchmark interest rates on the renegotiation and performance of distressed loans, using 2000s subprime mortgages as a laboratory. Subprime borrowers treated with larger benchmark rate reductions benefited from increased debt-renegotiation probabilities and lower debt-service payments. Modification rates were similar among current and delinquent borrowers but higher for real estate investors, highlighting the role of financial acumen in renegotiation. Renegotiations also reduced longer-run foreclosures, but treated borrowers who lingered in delinquency offset these benefits. Findings suggest monetary easing can spur debt renegotiation but alone may not lead to longer-run curative outcomes.

Capital flow freezes

AbstractThe period following the 2008 financial crisis focused attention on “twin-crises,” where banking crises precipitate sovereign crises due to increased bank support. We show that when private sector debt is renegotiated centrally, and bargaining power is low, it results in suboptimally low levels of debt and default rates (haircuts). If, instead, the bargaining power is sufficiently high, the supply of debt exceeds its demand and capital inflows “freeze”. These inefficiencies arise because the decentralized borrowers fail to consider how their bond supply impacts debt renegotiation outcomes, affecting both bond prices and the asset span. These issues can be addressed through macroprudential policies in the form of taxing capital inflows.

Bank loan renegotiation and financial institutions' network

We investigate how lender's capacity of sourcing information about a borrower, proxied by its centrality in the networks of syndicated lending, influences the process of bank loan renegotiation. Using a large sample of more than 6000 loans issued in 25 European countries we find that the presence of network-central and better-informed lenders in a syndicate has a significant impact on the renegotiation process, increasing the likelihood of renegotiation, the number of renegotiation rounds, and the number of amendments to the loan agreement. Our findings survive numerous robustness checks and confirm that access to superior information encourages private debt renegotiation.

The determinants of debt renegotiation: Evidence from Brazil

We investigate factors that affect debt renegotiation in an emerging economy, focusing on Brazil's publicly-listed non-financial firms. We manually collect novel data from more than three thousand notes to financial statements. The results show that the deterioration in the financial condition of companies - marked by declining profitability and increasing leverage - increases the probability of debt renegotiations. Furthermore, our findings reveal that the impairment in a firm's payment capacity, such as reduced profitability, cash flow, and interest coverage heighten the chances of renegotiations incorporating debtholder compensation mechanisms. Our results expand the knowledge about renegotiation to a context that has been scarcely addressed in previous studies: emerging markets. Additionally, it provides novel insights into the use of compensation mechanisms during renegotiations — an aspect little explored in the literature, although very present in renegotiations. We also innovate by addressing renegotiations with bondholders, an aspect largely overlooked in extant literature.

How does soft information on the causes of default affect debt renegotiation? The Italian evidence

How does soft information on the causes of default affect debt renegotiation? The Italian evidence

Forbearance versus Foreclosure in a General Equilibrium Model

AbstractIn a business cycle model with endogenous firms' dynamics and debt renegotiation, we show that during financial crises loan forbearance does not harm the economy unless banks imperfectly monitor loans, and loan opacity worsens banks' moral hazard problem. Aggressive interest rate reductions and quantitative easing limit defaults and financial crisis‐induced output contractions without hampering the entry of new firm entries. The decline in the natural interest rate, due to slower productivity growth and persistent liquidity shocks, potentially explains the observed long‐term trend in nonperforming loan shares.

Language and private debt renegotiation

AbstractWe study how language affects private debt renegotiation. We predict that stronger future time reference (FTR) languages alter the importance of renegotiation risk by lowering the perceived value of loan renegotiation. We test this hypothesis on a sample of 6500 loans issued to European firms between 1999 and 2017. We find that the use of a stronger FTR language decreases the likelihood of renegotiation and the number of renegotiation rounds. These findings are robust to several FTR proxies, various specifications including loan, borrower, and country‐level variables, and potential mitigation effects from specific loan, country, or time effects. They suggest that linguistic structure influences the renegotiation process of private debt contracts.

How does credit risk affect cost management strategies? Evidence on the initiation of credit default swap and sticky cost behavior

In this paper, we examine the effect of credit defaults swaps (CDS) initiation on reference firms' cost management strategies. CDS contracts provide insurance protection for creditors, inducing a shift in bargaining power from borrowers to creditors and an excessive incidence of bankruptcy. Anticipating more intransigent creditors in debt renegotiations and higher bankruptcy risk, CDS firms are incentivized to mitigate risk through decreasing cost stickiness after CDS initiation, as cost stickiness lowers liquidity and triggers early covenant violations. We find that, on average, CDS initiation is associated with a decline in reference firms' cost stickiness. This association is more pronounced for less liquid, financially distressed, and lower credit quality firms. We also find that CDS firms with a reduction in cost stickiness will exhibit lower future bankruptcy risk than CDS firms without such as reduction in stickiness. Collectively, our findings suggest that the CDS-induced “empty creditor problem” causes reference firms to undertake more conservative cost management practices to alleviate downside risk.

African agency, COVID-19 and debt renegotiations with China

ABSTRACT Africa is facing a new debt crisis, exacerbated by the COVID-19 pandemic. China, a major creditor nation, has demonstrated a willingness to negotiate debt relief measures with African states on both a bilateral and multilateral basis. An assessment of African agency in bilateral debt renegotiations remains a conundrum for China–Africa observers, however, due to the secretive nature of these talks. Given the power deficits that African states hold relative to China, this article, on the basis of the application of an analytical framework and a study of the Zambian case, argues that it would be more strategic for African officials to engage with the Chinese via multilateral channels when it comes to debt renegotiations. Additionally, in view of decreased Chinese lending and the concerns of Chinese creditors about their debt exposure in Africa, the article provides a brief look ahead at the future of Chinese lending to the continent.

Creditor Rights and Household Debt Renegotiation: Evidence from Unsecured Debt

Creditor Rights and Household Debt Renegotiation: Evidence from Unsecured Debt

The New Timing of Debt Renegotiations

The New Timing of Debt Renegotiations

The new timing of debt renegotiations

The new timing of debt renegotiations

Private debt renegotiation, corporate policies, and performance: empirical evidence from Europe

ABSTRACT We investigate the effects of private debt renegotiation on a firm’s performance and financial and investment policies. We employ endogenous switching regressions using a large cross-country sample of loans issued and amended over a long-term in Europe. We find that bank loan renegotiation has an economically significant and causal impact on financial policy and performance. Renegotiation offers firm added degrees of freedom and unlocks its economic potential, implying significant effects of the firm’s tangibility, growth, opportunities, and cash on financial policy and performance. Bank loan renegotiation also shows a certification and signalling effect, which can increase the effect of amendments to the credit agreement on a firm’s financial policy.

How China lends: a rare look into 100 debt contracts with foreign governments

Abstract China is the world’s largest official creditor, but we lack basic facts about the terms and conditions of its lending. Very few contracts between Chinese lenders and their government borrowers have ever been published or studied. This paper is the first systematic analysis of the legal terms of China’s foreign lending. We collect and analyse 100 contracts between Chinese state-owned entities and government borrowers in 24 developing countries in Africa, Asia, Eastern Europe, Latin America and Oceania, and compare them with those of other bilateral, multilateral and commercial creditors. Three main insights emerge. First, the Chinese contracts contain unusual confidentiality clauses that bar borrowers from revealing the terms or even the existence of the debt. Second, Chinese lenders seek advantage over other creditors, using collateral arrangements such as lender-controlled revenue accounts and promises to keep the debt out of collective restructuring (‘no Paris Club’ clauses). Third, cancellation, acceleration and stabilization clauses in Chinese contracts potentially allow the lenders to influence debtors’ domestic and foreign policies. Even if these terms were unenforceable in court, the mix of confidentiality, seniority and policy influence could limit the sovereign debtor’s crisis management options and complicate debt renegotiation. Overall, the contracts use creative design to manage credit risks and overcome enforcement hurdles, presenting China as a muscular and commercially savvy lender to the developing world.

Debt Renegotiations Outside Distress

Abstract This article develops a model to explore the implications of nondistressed debt renegotiation on debt prices and corporate policies. The model incorporates the empirical observation that creditors can influence firms also outside corporate distress through debt covenant renegotiation and not only in distress. We find that considering both distressed and nondistressed creditor interventions is key to investigating how creditor governance affects firms. The model explains cross-sectional patterns of control premiums and credit spreads that traditional debt renegotiation models do not capture. We also derive novel implications for the impact of firm characteristics associated with renegotiation on debt prices and corporate policies.

Credit Default Swaps and Lender Incentives in Bank Debt Renegotiations

AbstractUsing a regression-discontinuity design and within lender–borrower variation, we analyze how credit default swaps (CDSs) affect bank incentives and borrower outcomes in renegotiations after covenant violations. While existing studies document an investment decline after covenant violations, we find that covenant-violating firms maintain their investment subsequent to the introduction of CDS trading. Moreover, after CDS introduction, covenant-violating firms are less likely to default. Our results suggest that in the private debt markets, CDSs discipline borrowers, while the empty creditor problem due to CDS is mitigated because of lenders’ reputation concerns and lower coordination frictions.

Improving sovereign debt restructurings

The wave of sovereign defaults in the early 1980s and the string of debt crises in subsequent decades have fostered proposals involving policy interventions in sovereign debt restructurings. The global financial crisis and the recent global pandemic have further reignited this discussion among academics and policymakers. A key question about these policy proposals for debt restructurings that has proved hard to handle is how they influence the behavior of creditors and debtors. We address this challenge by evaluating policy proposals in a quantitative sovereign default model that incorporates two essential features of debt: maturity choice and debt renegotiation in default. We find, first, that a rule that tilts the distribution of creditor losses during restructurings toward holders of long-maturity bonds reduces short-term yield spreads, lowering the probability of a sovereign default by 25 percent. Second, issuing GDP-indexed bonds exclusively during restructurings also reduces the probability of default, especially of defaults in the five years following a debt restructuring. The policies lead to welfare improvements and reductions in haircuts of similar magnitude when implemented separately. When jointly implemented, they reinforce each other’s welfare gains, suggesting good complementarity.

The UN MDGs in Indonesia: Analyzing Its Failure in Eradicating Poverty in Indonesia

The United Nations (UN) Millennium Development Goals (MDGs), an international development movement oriented towards human welfare and global poverty eradication with measurable goals and targets, had hit the deadline by 2015. Its implementation reaped various contestations and claims regarding its success and failures in eradicating poverty in Indonesia. The Indonesian government claimed to have succeeded (on the track) in meeting the MDGs targets in eradicating poverty by reducing half of the number of Indonesians who earn one dollar per day (purchasing power parity/PPP) for the period 1990-2015. Meanwhile, the reality on the ground showed the contrast. Many Indonesian people lived in poverty and had minimal access to public health and education facilities. UNESCAP reported that Indonesia was one of the countries in the Asia Pacific region, which was alarming to achieve the MDGs. Based on such contradictions regarding the MDGs' poverty eradication mission in Indonesia, this article aims to examine why the MDGs program had not been able to overcome the problem of poverty in Indonesia? This article employs norm life cycle (dynamics) theory to investigate the problem behind UN MDGs' inability to overcome poverty in Indonesia. UN MDGs were considered a global norm in this article, substantiating the poverty eradication mission. Using the norm life cycle theory theorizing the three stages of norm development, starting from norm emergence, cascade, and internalization, this article reviews and investigates how Indonesia had dealt and performed in each of those norm life cycle stages within the framework of global poverty eradication norm. Based on the theoretical approach used, this article argues that the inability of UN MDGs to resolve poverty in Indonesia was due to the excessive use of statistical and quantitative basis of poverty eradication efforts rather than a more qualitative and welfare building approaches. Moreover, a systemic problem existed upon MDGs' coordination and implementation on the Indonesian government and donor countries/institutions. It included the lack of commitment to official development aid (ODA) realization, renegotiation and elimination of Indonesia's foreign debt, and rampant corruption in the national development and poverty eradication funds.

Optimal public debt composition during debt crises: A review of theoretical literature

AbstractThis study surveys the theoretical literature on the optimal public debt composition during sovereign debt crises. This survey is particularly relevant because sovereign debt crises have been recurrent manifestations over the past few decades, and there is growing evidence on the critical role of the composition of public debt portfolios during such events. Public debt composition refers to the characteristics of public debt portfolios, such as debt maturity, currency composition, and types of creditors. This survey adopts a broad definition of sovereign debt crisis, encompassing a post‐default phase when the crisis‐ridden country enters debt renegotiations and restructuring, and a pre‐default phase in which debtor countries either take a large non‐concessional loan from the International Monetary Fund (IMF) to avoid debt default and restructuring or experience critically high bond spreads and default risk. This survey collects the dispersed literature on the theoretically optimal public debt composition choices from a sovereign borrower's perspective during both phases of the sovereign debt crisis. The surveyed theoretical literature reveals several trade‐offs underlying the sovereign's public debt composition choices during debt crises.

Language and private debt renegotiation

Language and private debt renegotiation