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This paper examines whether and how lenders use debt contract terms and specialization to manage the uncertainty that borrowers¡¯ regulatory exposure introduces to their loan portfolios. We find that borrower regulatory exposure is positively associated with interest spreads, but neither increased covenant use nor covenant strictness. Consistent with specialization, we find banks are more likely to lend to the regulatory peers of borrowers to which they have previously issued loans, and do so at lower interest spreads. Further analysis suggests that bank specialization offsets the effect of regulatory exposure on interest rates. The results hold across several specifications and methods. Overall, our results suggest that regulatory exposure is an important source of uncertainty for lenders, and banks specialize within regulatory peer groups to manage this uncertainty.

zcarol2@ceibs.edu