Lenders have a comparative advantage over bondholders in recovering their claims. There are factors that tend to result in higher expected recoveries of loans over bonds, including:
- Bank loans are typically more highly collateralized than bonds at origination;
- Banks can intervene in the affairs of a borrower at an early stage of developing credit risk;
- Banks have the option to seek more or better collateral on existing loans or reduce the exposure when a borrower’s breached the contract; and
- Banks tend to be more involved in the restructuring process by becoming major shareholders or appointing new directors than bondholders, which should result in lower agency costs; and
- Defaulted bank loans are more likely to be restructured out-of-court than through formal bankruptcy proceedings.
| 3 Key Factors in Bond Value Recovery |
| 1. Price at initial credit event – predictive of LGD. |
| 2. Market value of instrument at the resolution of distress. |
| 3. Actual cash flows occurring during the resolution process. |
Banks, unlike bondholders, have the option to revise the terms of an existing loan contract outside of bankruptcy when the borrower breached the contract. Collective action requirements also generally allow restructuring to be more easily accomplished with a small group of bank lenders than with a large group of public bondholders.
Bondholders cannot readily modify the terms of a bond outside of bankruptcy since the majority of the creditors need to agree to any bond contractual modifications.