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

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 US firms. Wereport the first comprehensive evidence that also firm bond prices react to bank loan announcements. Using a two-day event window, we find significant abnormal bond credit spreads reduction of 11 basispoint spread (BPS) on average. The corresponding average stock price reaction is 26 BPS. While stock returns are unaffected by firm risk, bondholders of riskier firms are more sensitive to the loss given default which increases with bank borrowing. Such firms experience bond credit spread increases. Our analysis also provides an estimate of the net impact on firm value of bank loan announcements, between -5 BPS for riskier and smaller firms and 18 BPS for safer and larger companies. Collectively, the results indicate that the overall positive effect on equity value comes from two sources. First, bank certification reduces information asymmetry. Second, there is a transfer of bondholder's wealth to the shareholders as a resultof claim dilution.