A note on: Capital adequacy and the
information content of term loans and lines of
credit
P. Andr
e
a,1, R. Mathieu
b,*, P. Zhang
c,2 aEcole des HautesEtudes Commerciales, 3000 Chemin de la Co^te-Sainte-Catherine, Montreal, Que.,
Canada H3T 2A7
bSchool of Business and Economics, Wilfrid Laurier University, Waterloo, Ont., Canada N2L 3C5 cSchool of Accountancy, University of Waterloo, Waterloo, Ont., Canada N2L 3G1
Received 2 October 1998; accepted 25 October 1999
Abstract
This study examines the information content conveyed by the disclosure of credit agreements in a Canadian setting. We argue that the introduction of the 1988-capital adequacy requirements lead banks to reduce their level of commitment at the issuance of lines of credit to avoid their inclusion in the calculation of the capital ratio. As a result, after 1988, the disclosure of lines of credit is expected to be less informative than the disclosure of term loans since banks may exert less eort to screen and monitor ®rms. Our results are consistent with the argument that the dierence between the market reactions at the disclosure of term loans and lines of credit is signi®cant after 1988. We also provide evidence that ®rm size and concentration of borrowing aect the market reaction at the disclosure of bank credit agreements.Ó2001 Elsevier Science B.V. All rights reserved.
JEL classi®cation:G21
Keywords:Information of bank credit agreements; Capital adequacy
www.elsevier.com/locate/econbase
*
Corresponding author. Tel.: +1-519-884-1970, ext. 3142; fax: +1-519-884-0201.
E-mail addresses: paul.andre@hec.ca (P. AndreÂ), rmathieu@wlu.ca (R. Mathieu), pzhang@uwaterloo.ca (P. Zhang).
1Tel.: +514-340-6528; fax: +514-340-5633.
2Tel.: +519-888-4567, ext. 6548; fax: +519-888-7562.
0378-4266/01/$ - see front matterÓ2001 Elsevier Science B.V. All rights reserved.
1. Introduction
Bank credit agreements (term loans and lines of credit) provide ®rms with important access to capital. These agreements, when disclosed, can provide a signal to the market of ®rmsÕability to raise capital and banksÕassessment of ®rmsÕ value (Fama, 1985; James, 1987; James and Wier, 1990; Slovin and Young, 1990; Lummer and McConnell, 1989). The empirical evidence indicates that the characteristics of both banks and ®rms can aect the degree of in-formativeness of bank credit agreements (Johnson, 1996; Preece and Mul-lineaux, 1996; Petersen and Rajan, 1994). The empirical ®ndings also suggest that the informativeness of bank credit agreements depends on how well ®rms are monitored (Slovin et al., 1992; Best and Zhang, 1993).
In this paper, using a sample of Canadian ®rms, we examine the relationship between the informativeness of credit agreements and banksÕ level of com-mitment. BanksÕ level of commitment at the issuance of a credit agreement is aected by several factors such as time to maturity, the collateral oered on the loan, and their ability to unconditionally cancel the credit agreement. If banks reduce their level of commitment when providing ®nancing, their risk exposure would be reduced which may lead them to exert lower eort in screening and monitoring ®rms. In such a case, we expect to observe a lower market reaction at the disclosure of bank credit agreements.
In 1988, Canadian authorities changed the capital adequacy requirements to adopt the recommendations of the Bank of International Settlements. We ar-gue that the introduction of the 1988-capital ratio results in a reduction of banksÕlevel of commitment at the issuance of lines of credit so that they can avoid some costs associated with the issuance of o-balance sheet instruments. Therefore, by comparing the information content conveyed by the disclosure of term loans and lines of credit before and after 1988, we can test the impact of banksÕlevel of commitment on the market reaction at the disclosure of bank credit agreements.3
Our sample consists of 122 announcements of new and revised bank credit agreements in the Canadian market during the period 1982±1995. Our results indicate that the information content conveyed by the disclosure of lines of credit diers before and after 1988 for small ®rms. The information content conveyed by lines of credit and term loans for small ®rms diers after 1988, but not before. Furthermore, the information content conveyed by term loans
3
The conditions on the credit agreements can be used as proxies for bankÕs level of commitment. Those conditions include, among others, time to maturity, the collateral oered on the loan, and their ability to unconditionally cancel the credit agreement. However, in our sample of announcements, information with respect to the time to maturity and the collateral oered on the loan are not always disclosed, and information on banksÕability to unconditionally cancel is not available.
before and after 1988 is the same. We view these results as evidence that the introduction of the 1988-capital adequacy requirements has reduced the in-formativeness of lines of credit.
We also document in this paper signi®cant average announcement excess returns when bank credit agreements are new, when they are provided to small ®rms, when they are issued by single banks or when renewals are favorable. The remainder of the paper is structured as follows. Section 2 describes the 1988-capital adequacy requirements and presents our predictions. Data col-lection and methodology are discussed in Section 3. Section 4 presents the empirical results and Section 5 summarizes the paper.
2. Capital adequacy requirements and the information of bank credit agreements
To maintain public con®dence in the banking system, the Canadian gov-ernment insures deposits up to $60,000. To limit the level of risk chosen by banks, the government imposes capital adequacy measures that link the capital issued by banks to their investing activities. Prior to 1988, the capital adequacy guidelines suggested that banks maintain 1 dollar of capital for every 30 dollars of assets. However, this basic ratio did not take into account banksÕexposure to risk and included only on-balance sheet activities.
In 1988, Canadian authorities changed the capital adequacy requirements to comply with the recommendations of the Bank of International Settlement, referred to as the Basle Accord. The Basle Accord introduces a common def-inition of capital, uses a weighting system to calculate the minimum capital requirement, and takes into consideration o-balance sheet activities.
Before the introduction of the Basle Accord, the used portion of a line of credit had no impact on the required minimum level of capital. However, after 1988, lines of credit may be included in the calculation of the capital ratio. Like all o-balance sheet instruments, the inclusion of lines of credit follows a two-step procedure. First, a credit conversion factor (i.e., a weight) is applied to obtain the asset equivalents. Second, the weight applied to similar assets is used to convert these asset equivalents into risk-adjusted o-balance sheet activities. The guidelines published by the Superintendent of ®nancial institutions de®ne the weights used for the conversion of o-balance sheet instruments. With respect to lines of credit, the following weights are used to obtain the asset equivalents:
· 50%: commitments with an original maturity exceeding 1 year, including
un-derwriting commitments and commercial credit lines.
· 0%: commitments with an original maturity of 1 year or less or that are
un-conditionally cancelable at any time without prior notice.
or introducing a clause that allows them to unconditionally cancel the lines of credit at any time without prior notice. Discussions with bankers revealed that most Canadian banks have changed the basic conditions associated with lines of credit to avoid their inclusion in the calculation of the capital ratio. The consequence of these changes in the basic conditions of lines of credit is to lower the commitment of banks to their clients. As a result, we expect to ob-serve a weaker market reaction at their disclosure after 1988 and the following predictions are developed accordingly:
Prediction 1: The information content conveyed by the disclosure of lines
of credit and term loans prior to 1988 does not dier.
Prediction 2: The information content conveyed by the disclosure of lines of
credit and term loans after 1988 diers.
Prediction 3: The information content conveyed by the disclosure of lines
of credit before and after 1988 diers.
Prediction 4: The information content conveyed by the disclosure of term
loans before and after 1988 does not dier.
3. Data and methodology
TheGlobe&Mailon CD-ROM and the database of Canadian Business and
Current Aairs (CBCA) are used to obtain the announcements of Canadian bank credit agreements in the Globe &Mail over the period 1982±1995.4;5 Only ®rms with stock prices on theTSE Westerndaily ®le are included in the sample, and we obtain a total of 150 announcements. From this total, 28 observations are discarded since there is other information in the announce-ments about the ®rms. The ®nal sample consists of 122 announceannounce-ments. De-scriptive statistics of the sample are provided in Table 1.
To analyze the information content of bank credit agreements, we examine the relationship between changes in ®rmsÕmarket value at the announcement of bank credit agreements using an event study methodology. As in Brown and Warner (1980), James (1987), and Lummer and McConnell (1989), the excess returns are calculated using the market model, and the two-day event window
4
TheGlobe&Mailis a daily newspaper that specializes in economic issues and is the Canadian equivalent of theWall Street Journal. During our sample period, it was the only nation-wide newspaper.
5Given that some parent companies are not Canadian corporations, there is a possibility that the
announcements in Canada lag the announcements in foreign countries. We conduct a search of the
Table 1 New and revised credit agreements 4
Lines of credit 46
Term loans 64
Lines of credit and term loans 12
(B) Loan amount (in millions of dollars)
Number of observa-tionsa
Mean Median Minimum Maximum
Full sample 111 317 140 0.5 2520 New agreements 85 337 123 0.5 2520 Revised agreements 23 259 211 5 1400 New and revised
agree-ments
3 1978 246 22 326
Lines of credit 44 352 161 5 2250 Term loans 56 279 106 0.5 2520 Lines of credit and term Lines of credit 13 30 3 Term loans 24 32 8
aRepresents the number of observations for which the information is provided. b
is de®ned as the day of the announcement in theGlobe&Mail t0and the
previous day t ÿ1. The parameters of the market model on daily returns
are estimated over the period ranging fromt ÿ170 to t ÿ21 prior to the
announcement.6 Tests of statistical signi®cance (z-statistics) of the average abnormal returns are based on standardized prediction errors using the pa-rameters of the market model (see James, 1987).
4. Empirical results
4.1. The information content of bank credit agreements
Before examining the impact of the introduction of the 1988-capital adequacy requirements on the market reaction, we present the average ex-cess returns for the two-day announcement period around the disclosure of bank credit agreements controlling for various dimensions of the credit agreements, ®rms, and banks. These results are presented in Panel A of Table 2. Consistent with prior studies, we observe signi®cant positive market reactions at the announcements of bank credit agreements. We also obtain evidence that the market reaction is stronger when ®rms obtain loans from single banks than from multiple banks. The market reaction is sig-ni®cant when the credit agreements are provided to small ®rms but not to large ®rms. The empirical evidence suggests that the market reaction is signi®cant at the disclosure of new credit agreements and favorably revised agreements.
The average announcement excess return is statistically dierent from zero when the credit agreement involves a term loan (announcement excess return of 2.20% with a z-statistic of 2.45) and both a term loan and a line of credit (announcement excess returns of 5.24% with az-statistic of 3.27), but it is not statistically dierent from zero when it involves a line of credit (announcement excess returns of 1.59% with az-statistic of)0.02). While the signi®cant pos-itive market reaction at the disclosure of term loans is consistent with the re-sults obtained by James (1987), the lack of signi®cance at the disclosure of lines of credit is not. Our results suggest that the market may perceive the infor-mation content of a commitment to lend dierently from the actual lending. However, the null hypothesis that the two market reactions are the same cannot be rejected.
6To correct for thin trading problems, missing returns are calculated using the bid and ask
prices. More precisely, the price used to calculate the return for a day is assumed to be the mean of the bid and ask prices when no transaction is recorded for that day.
4.2. Investigation of causes for the dierence between the information content of term loans and lines of credit
The predictions developed in Section 2 can potentially explain the dierence between the market reactions at the disclosure of lines of credit and term loans. Panel B of Table 2 presents the average announcement excess returns at the disclosures of both lines of credit and term loans before and after 1988. The market reactions at the disclosure of both types of agreement before 1988 are not signi®cant. The null hypothesis that the market reactions are the same cannot be rejected, which is consistent with prediction 1.
The market reaction at the disclosures of term loans after 1988 is signi®cant while the reaction at the disclosure of lines of credit is not. The null hypothesis that the market reactions are the same is rejected at 5% level (ttest of 2.27). This result is consistent with prediction 2. The null hypothesis that the market reactions at the disclosure of lines of credit before and after 1988 are the same cannot be rejected, which is contrary to prediction 3. The null hypothesis that the market reactions at the disclosure of term loans after and before 1988 are the same cannot be rejected, which is consistent with prediction 4.
Results in Panel A of Table 2 and previous studies (for example, Slovin et al., 1992) provide evidence that ®rm size aects the information content of bank credit agreements. We reexamine the predictions developed in Section 2 by dividing the sample according to ®rm size. Results are presented in Panels C and D of Table 2.
For small ®rms before 1988, the average announcement excess returns are 6.63% for lines of credit (z-statistic of 0.53) and )0.04% for term loans (z -statistic of 1.37).7 After 1988, the average announcement excess returns are 0.06% for lines of credit (z-statistic of 1.18) and 4.69% for term loans (z-statistic of 2.97). Furthermore, all four predictions are supported.8 Therefore, for small ®rms, the introduction of the 1988-capital adequacy requirements has signi®cantly reduced the information content of lines of credit, while the in-formativeness of term loans is not aected.
7
Note that the negative (but not signi®cant) market reaction at the disclosure of term loans is surprising since we expected to have a positive and signi®cant market reaction. Further investigation reveals that a positive and signi®cant market reaction is obtained when one speci®c negative observation is excluded from the test (the impact of one observation can be important in this test given the small sample size). Even with the exclusion of this variable, we still cannot reject the null that the two market reactions are the same.
8
Table 2
Full sample 122 2.27 2.68 57
New agreements 91 2.27 2.22 58
Revised agreements 27 1.97 1.03 50
New and revised agreements 4 4.24 1.51 75
Favorable revisions 23 2.86 1.89 48
Small ®rmsa 61 2.97 2.19 59
Large ®rms 61 1.57 1.59 54
Single bank 38 4.67 2.59 66
Multiple banks 72 0.68 0.73 48
Canadian banksb 49 3.25 1.38 55
Foreign banks 22 1.06 0.97 59
Lines of credit 46 1.59 )0.02 48
Term loans 64 2.20 2.45 61
Lines of credit and term loans 12 5.24 3.27 67
(B) Average announcement excess returns and capital adequacy: Full samplec Before 1988
Lines of credit 13 4.82 0.37 62
Term loans 22 1.14 1.42 64
After 1988
Lines of credit 33 0.32 0.47 42
Term loans 54 3.30 3.35 61
(C) Average announcement excess returns and capital adequacy: Small ®rmsd Before 1988
Lines of credit 7 6.63 0.53 86
Term loans 11 )0.04 1.37 64
After 1988
Lines of credit 15 0.06 1.18 40
Number of
observa-(D) Average announcement excess returns and capital adequacy: Large ®rmse Before 1988
Lines of credit 6 2.70 0.54 33
Term loans 11 2.32 0.02 64
After 1988
Lines of credit 18 0.54 0.45 44
Term loans 26 1.70 1.73 62
aWe use the median of the total value of ®rms
Õassets to distinguish between small and large ®rms.
bCanadian banks include credit agreements provided by a group of Canadian banks (or a single Canadian bank) and a group of banks that include
Canadian banks.
cThe null hypothesis that the market reactions are the same at the disclosure of lines of credit and term loans before 1988 cannot be rejected. The null
hypothesis that the market reactions are the same at the disclosure of lines of credit and term loans after 1988 can be rejected at 5% level (t-test of 2.27). The null hypothesis that the market reactions are the same at the disclosure of lines of credit before and after 1988 cannot be rejected. The null hypothesis that the market reactions are the same at the disclosure of term loans before and after 1988 cannot be rejected.
dThe null hypothesis that the market reactions are the same at the disclosure of lines of credit and term loans before 1988 cannot be rejected. The null
hypothesis that the market reactions are the same at the disclosure of lines of credit and term loans after 1988 can be rejected at 5% level (t-test of 2.16). The null hypothesis that the market reactions are the same at the disclosure of lines of credit before and after 1988 can be rejected at 10% level using the Mann±WhitneyU-test (see footnote 10). The null hypothesis that the market reactions are the same at the disclosure of term loans before and after 1988 cannot be rejected.
e
We cannot reject any null hypothesis that any two market reactions are the same.
For large ®rms (Table 2, Panel D), the market reaction is not signi®cant at the disclosure of lines of credit before 1988 (the average announcement excess returns is 2.70 and thez-statistic is 0.54) and at the disclosure of term loans (the average announcement excess returns is 2.32 and thez-statistic is 0.02). After 1988, the market reaction is not signi®cant at the disclosure of lines of credit (the average announcement excess returns is 0.54 and thez-statistic is 0.45), while it is signi®cant at the disclosure of term loans (the average announcement excess returns is 1.70 and thez-statistic is 1.73). However, predictions 2 and 3 are not supported.
We perform additional tests to explore other causes that could explain the dierence between the market reactions at the disclosure of term loans and lines of credit. First, we examine the possibility that there was initial borrowing when ®rms received lines of credit. Second, we examine if there is a dierence between the market reaction at the disclosure of revolving credit agreements versus other types of lines of credit. Third, we then examine the possibility that the relevant event-window for lines of credit diers from the one for term loans.9The results of these tests failed to explain the dierence between the two market reactions. Therefore, the 1988-capital adequacy requirements best explains the dierence between the information content conveyed by the dis-closure of lines of credit and term loans.
4.3. Multivariate analysis
In this section, we use multivariate regressions to test the relationship be-tween announcement excess returns and the variables used in the univariate analysis to examine the market reaction to the disclosure of bank credit agreements. As in Lummer and McConnell (1989) and Johnson (1996), we control for heteroscedasticity in cross-sectional stock returns by using a weighted least squares regression using the inverse of the relevant standard prediction errors as weight. We start with a simple model that consists of four variables as follows:
PEiab1SMALL82±87ib2SMALL88±95ib3LARGE82±87i
b4LARGE88±95iei;
where PE is the two-day excess return, SMALL82±87 a dummy variable that takes the value of 1 when a small ®rm receives a term loan before 1988 and takes the value of 0 when it receives a line of credit, SMALL88±95 a dummy
9
We examine the average announcement excess returns for windows ranging from 2 to 11 days prior to the announcement. We ®nd that 62% of our sample ®rms report non-trivial corporate news items duringÿ4 toÿ11 days window. As a result of this noise, it is not appropriate to extend the window beyondÿ3 days.
variable that takes the value of 1 when a small ®rm receives a term loan after 1988 and takes the value of 0 when it receives a line of credit, LARGE82±87 a dummy variable that takes the value of 1 when a large ®rm receives a term loan before 1988 and takes the value of 0 when it receives a line of credit, LARGE88±95 a dummy variable that takes the value of 1 when a large ®rm receives a term loan after 1988 and takes the value of 0 when it receives a line of credit;eiis a noise term.
Given the results obtained in the univariate analysis, we expect to have a positive sign for the variable SMALL88±95 since banksÕlevel of commitment at the issuance of lines of credit after 1988 is expected to be lower. The coef-®cients of the variables SMALL82±87, LARGE82±87, and LARGE88±95 are expected to be non-signi®cant.10
Results of this regression are presented in Columns B and C of Table 3. The adjustedR2of the model is 4.3%. The only signi®cant variable is SMALL88±95 (t-statistic of 2.92) and it has the expected sign. Therefore, the results indicate that the introduction of the 1988-capital adequacy rules have changed the market perception regarding the level of information conveyed by lines of credit and term loans.
Based on the results of the univariate analysis, we add the following vari-ables to the model:
The predicted signs of the above variables, presented in Column A of Table 3, are based on the results of the univariate analysis and the evidence provided in the literature.
LOGASSET the logarithm of the total value of assets;
NUMBK a dummy variable that takes the value of 1 when the loan is
provided by a single bank and takes the value of 0 when the loan is provided by multiple banks or when the information is not provided;
NATBK a dummy variable that takes the value of 1 when the loan is
provided by a Canadian bank and takes the value of 0 when the loan is provided by a non-Canadian bank or when the information is not provided;
NR a dummy variable that takes the value of 0 when it is a new
loan and takes the value of 1 when it is a revised loan.
10
Table 3
Multivariate analysisa
Independent variables
(A) (B) (C) (D) (E) (F) (G) Sign Results t-Statistic Results t-Statistic Results t-Statistic Intercept ? )0.005 )1.14 0.058 1.52 0.079 1.94
SMALL82±87 ? 0.019 1.16 0.009 0.47 0.017 0.85 SMALL88±95 + 0.028 2.92 0.024 2.02 0.035 2.47
LARGE82±87 ? 0.006 0.52 )0.005 )0.36 0.002 0.13
LARGE88±95 ? 0.003 0.53 0.004 0.56 0.007 0.88 LOGASSET ) )0.003 )1.58 )0.003 )1.89
AdjustedR2 0.043 0.069 0.079 a
where PE is the two-day excess return, SMALL82±87 a dummy variable that takes the value of 1 when a small ®rm receives a term loan before 1988 and takes the value of 0 when it receives a line of credit, SMALL88±95 a dummy variable that takes the value of 1 when a small ®rm receives a term loan after 1988 and takes the value of 0 when it receives a line of credit, LARGE82±87 a dummy variable that takes the value of 1 when a large ®rm receives a term loan before 1988 and takes the value of 0 when it receives a line of credit, LARGE88±95 a dummy variable that takes the value of 1 when a large ®rm receives a term loan after 1988 and takes the value of 0 when it receives a line of credit, LOGASSET the logarithm of the total value of assets, NUMBK a dummy variable that takes the value of 1 when the loan is provided by a single bank and takes the value of 0 when the loan is provided by multiple banks or when the information is not provided, NATBK a dummy variable that takes the value of 1 when the loan is provided by a Canadian bank and takes the value of 0 when the loan is provided by a non-Canadian bank or when the information is not provided, NR a dummy variable that takes the value of 0 when it is a new loan and takes the value of 1 when it is a revised loan, NUMBKInt an interactive dummy variable that takes the value of 1 if the ®rm
receives a term loan from a single bank and takes the value of 0 otherwise, and NATBKIntis an
interactive dummy variable that takes the value of 1 if the ®rm receives a term loan from a Canadian bank and takes the value of 0 otherwise.
bThere are a total of 115 observations in the regression since some information is missing for few
®rms and we exclude ®rms that receive both a new and a revised credit agreement.
*Signi®cant at 0.10 level. **Signi®cant at 0.05 level. ***Signi®cant at 0.01 level.
Columns D and E of Table 3 present the results. The adjusted R2 of the model is 6.9%. The variable SMALL88±95 is still signi®cant (t-statistic of 2.02) with the predicted sign. This con®rms the results of the previous model as well as the univariate analysis. However, it is surprising that none of the other variables is signi®cant.
Given the interaction that seems to exist between some of the variables and the type of credit agreements (term loan and line of credit), we further expand our model by including the following two variables:11
Columns F and G of Table 3 present the results of the regression with the interaction variables. The inclusion of these additional variables increases the adjusted R2 from 6.9% to 7.9%. Once again, the coecient of the variable SMALL88±95 is signi®cant (t-statistic of 2.47) with the expected sign. With the inclusion of the two interaction variables, the coecient of the variable LOGASSET becomes signi®cant (t-statistic of )1.89) with the expected sign. Finally, the variable NUMBKInt is signi®cant (t-statistic of 1.78) with the ex-pected sign. The remaining variables are not signi®cant.
5. Conclusion
Our paper contributes to the banking literature by examining the impact of the 1988-capital adequacy requirements on the informativeness of bank credit agreements. We provide evidence that, for small ®rms, the information content conveyed by the disclosure of lines of credit before and after 1988 signi®cantly diers. We also provide evidence that the information content conveyed by the disclosure of term loans and lines of credit signi®cantly diers after but not before 1988. Finally, the null hypothesis that the market reactions at the dis-closure of term loans before and after 1988 are the same cannot be rejected. We view these results as evidence that the market perceives that banks reduced their level of commitment when issuing lines of credit after the implementation of the 1988-capital adequacy requirements.
NUMBKInt an interactive dummy variable that takes the value of 1 if
the ®rm receives a term loan from a single bank and takes the value of 0 otherwise;
NATBKInt an interactive dummy variable that takes the value of 1 if
the ®rm receives a term loan from a Canadian bank and takes the value of 0 otherwise.
11We also included other variables such as the relative loan amount (loan amount over total
We also examine the eect of concentration of borrowing, ®rm size, na-tionality of the lending bank, and new versus renewed loans on the information content conveyed by bank credit agreements. We obtain evidence that the market reaction is stronger when credit agreements are issued by single banks than by multiple banks. The market reaction is signi®cant when credit agree-ments are provided to small ®rms. Our empirical evidence also suggests that the market reaction is signi®cant at the disclosure of new credit agreements.
Acknowledgements
The authors would like to thank Jean-Francßois Gosselin Labbe and John John D'Argensio for their research assistance. Financial support from Cana-dian Academic Accounting Association is gratefully acknowledged. The au-thors would like to thank Glenn Feltham, Terry Levesques, Theresa Libby, Sean Robb and seminar participants at the 1998 Northern Finance Association Meetings, the 1999 Canadian Academic Accounting Association, European Accounting Association Meetings and the Ecole des HEC for their useful comments.
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