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The Value of Lending Relationships

Authors: Thomas Ruchti, Andrew Bird, Stephen A. Karolyi, and Michael Hertzel

Lending relationships constitute a potentially important driver of bank value, but the quantitative significance of this intangible capital is unknown. To estimate the value of relationships, we model the lender’s decision to enforce a contractual breach of predetermined covenant thresholds based on a tradeoff between the cost of potential relationship termination and the benefits of increased fees and reduced risk. The implied value of a relationship to the lender is 11.6% of loan principal, on average, and is higher for opaque borrowers with fewer outside options. Relationship value averages 6.6% of bank assets and is positively associated with bank value.