Covenant

A covenant is a contractual promise in a loan agreement. Affirmative covenants require actions (such as providing financials); negative covenants restrict actions (such as further borrowing); financial covenants require metrics (such as a minimum DSCR or maximum leverage) to stay within agreed limits.

Standard in private credit, bank facilities and structured debt.

Loan agreements typically contain three types. Affirmative covenants require the borrower to do things, such as providing financial information; negative covenants restrict actions, such as raising further debt; and financial covenants require metrics — for example a minimum debt service coverage ratio or maximum leverage — to stay within agreed limits.

A covenant breach can trigger an event of default even when payments are fully up to date. In practice lenders often respond first by discussing the position, granting a waiver or resetting terms, but the breach gives them early warning, leverage in negotiation and, ultimately, the right to enforce their security.