Bank's Industry Diversification and Debt Contracting

I examine how industrial diversification of commercial loans influences banks’ lending terms and borrower clientele. Using individual loan data from Dealscan, I derive an industry di- versification measure in the spirit of the Herfindahl index. For loan terms, results suggest that industry diversification is associated with lower spreads, less collateral, longer matu- rities, and larger loans. Further, industry diversification is related to tighter covenants, with a higher likelihood of performance-based covenants violations, a lower likelihood of capital-based covenants violations, a higher likelihood of performance pricing provisions, and a higher number of negative covenants. Analyzing banks’ loan portfolios reveal that the average borrower risk of diversified banks portfolio is not statistically different from non-diversified banks, there is greater diversity in the borrowers’ risk profiles. Additionally, diversified banks’ portfolios have higher dispersion in the spreads, which is consistent with diverse borrowers.