Loan evergreening: does it “save” firms?

I have written about my paper on loan evergreening in Uruguay in a couple of previous posts (here and here). A paper that is coming soon, by the way. The strategy we study—providing a bullet loan to repay an existing amortising loan—could improve the prospects of the borrower. Therefore, a relevant empirical question is: when firms receive loan evergreening, are they less likely to be delinquent—i.e., less likely to be delayed in their loan repayment?

We analyse this question by looking at whether the firm is delinquent with the bank providing loan evergreening 12 months after receiving it. Here, delinquent means 60 days or more of repayment delay. We find in fact the opposite: firms receiving loan evergreening are actually more likely to be delinquent a year later.

Yet the interesting results do not stop there. When we use Firm x Month fixed effects, the results reverse: firms receiving loan evergreening are less likely to be delinquent later on. What explains this difference? Two factors: first, when we use Firm x Month FE, we restrict the sample to firms obtaining loans from two or more banks. This is because firms with just one banking relationship in a given month only have one observation for that particular month, and these FE perfectly capture its variation. This alone only gets rid of the positive result; to get the negative one, we need the actual FE.

How can we interpret this? In general, and this result is driven by single-banking-relationship firms, loan evergreening is associated to a higher probability of loan delinquency. When analysing firms borrowing from two—or more—banks, however, loan evergreening leads to fewer loan delinquencies or, in other words, when a firm obtains loan evergreening from one bank but not the other, it tends to become delinquent more frequently with the latter.

We also find that the positive association for single-relationship firms between loan evergreening and loan delinquency disappears for banks with higher solvency. In fact, for banks with high enough capital, the relationship reverses. This suggests that better-capitalised banks might use loan evergreening more to help borrowers withstand temporary financial stress and less exclusively to save in loan-loss provisioning.

What does this mean for policy makers? First, loan evergreening is used to temporarily reduce loan delinquency, but not only do firms end up delinquent anyway, they are more likely to end up delinquent than other firms under similar circumstances. Furthermore, this is more important for less-solvent banks, precisely those that we should worry about the most—hence, this is a practice that should be looked into by supervisors. More-solvent banks, however, might be actually helping borrowers with this strategy. In other words, supervisors should pay less attention to better-capitalised banks using this strategy. Finally, the dynamics are different for firms with multiple banking relationships: the strategy can be used to signal to the borrower that one bank is willing to help it more than the other, and hence the borrower should prioritise the repayment to the first.

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