Third-Party Credit Guarantees and the Cost of Debt: Evidence from Corporate Loans

TL;DR

This paper investigates how third-party credit guarantees influence the cost and risk of corporate loans, revealing that guarantees reduce loan risk and rates, especially for smaller firms facing asset shocks.

Contribution

It provides empirical evidence on the role of third-party guarantees in lowering loan risk and rates, highlighting their importance in credit market dynamics.

Findings

Third-party guarantees are used in over one-third of US corporate loans.

Guarantees are associated with lower loan risk, rates, and delinquency.

Smaller firms rely more on guarantees when facing asset shocks.

Abstract

Using a comprehensive dataset collected by the Federal Reserve, I find that over one-third of corporate loans issued by US banks are fully guaranteed by legal entities separate from borrowing firms. Using an empirical strategy that accounts for time-varying firm and lender effects, I find that the existence of a third-party credit guarantee is negatively related to loan risk, loan rate, and loan delinquency. Third party credit guarantees alleviate the effect of collateral constraints in credit market. Firms (particularly smaller firms) that experience a negative shock to their asset values are less likely to use collateral and more likely to use credit guarantees in new borrowings.