How Do Banks Respond to the Operational Weather Risk of Borrowers? Evidence from Loan Contracts

This study examines how banks respond to the operational weather risk of borrowers. We quantify borrower-specific operating exposure to cumulative unexpected weather conditions and study how it affects the pricing and non-pricing features of loan contracts. We find that banks increase loan spread, demand more collateral requirements, and impose greater covenant intensity for borrowers with higher operating exposure to abnormal weather conditions. The results further show that banks grant more covenant slack for operation-related loan covenants (e.g., maximum debt-to-EBITDA covenants and minimum EBITDA-to-interest covenants), while tightening the strictness of maximum leverage covenants. Ultimately, firms with more operating weather exposure reduce their financial leverage and are less likely to violate loan covenants. These findings suggest that banks informatively design loan contracts to address the operational risk of borrowers exposed to increasingly volatile weather fluctuations