Loan Covenant

What is a Loan Covenant?

Author: Matthew Retzloff
Matthew Retzloff
Matthew Retzloff
Investment Banking | Corporate Development

Matthew started his finance career working as an investment banking analyst for Falcon Capital Partners, a healthcare IT boutique, before moving on to work for Raymond James Financial, Inc in their specialty finance coverage group in Atlanta. Matthew then started in a role in corporate development at Babcock & Wilcox before moving to a corporate development associate role with Caesars Entertainment Corporation where he currently is. Matthew provides support to Caesars' M&A processes including evaluating inbound teasers/CIMs to identify possible acquisition targets, due diligence, constructing financial models, corporate valuation, and interacting with potential acquisition targets.

Matthew has a Bachelor of Science in Accounting and Business Administration and a Bachelor of Arts in German from University of North Carolina.

Reviewed By: Patrick Curtis
Patrick Curtis
Patrick Curtis
Private Equity | Investment Banking

Prior to becoming our CEO & Founder at Wall Street Oasis, Patrick spent three years as a Private Equity Associate for Tailwind Capital in New York and two years as an Investment Banking Analyst at Rothschild.

Patrick has an MBA in Entrepreneurial Management from The Wharton School and a BA in Economics from Williams College.

Last Updated:May 12, 2022

A covenant is a term used in loan documents (for example in an LBO) and any other kind of bond issuance and it dictates any terms of a corporate takeover or acquisition or bond repayment. The covenant is simply any specified agreement, the most common one being the Debt / EBITDA ratio and the Loan to Value ratio in real estate. This is important because when calculating the amount available for debt repayments or the total amount able to be borrowed to finance a transaction, covenants will determine the amount of money that can be borrowed, the value of bonds that can be issued, the total free cash flow which can be used to pay debt, etc. The purpose of a covenant is to give the lender and the target company security that certain activities will not be carried out and that the company will not be run unsustainably. If the terms of a covenant are violated, there will be a penalty incurred. This penalty could vary from simply repairing a technical default to losing control of the company under a payment default or acceleration of the funds due. Breaking a covenant is often referred to as a default, and this can be a technical default (the company is still paying its debts) or an actual default (the company misses a payment). If a covenant is breached, the borrower typically has to put up equity or pay extra money and if it is unable to do this, then the entire amount of the loan is due and there could even be a firesale at massively reduced asset prices. Some of the most commonly used covenants are:

Covenants can be often be waived at the discretion of the lender. For example, in a situation of exceptional circumstances whilst the company in question is still sound and stable. Enforcing or abiding by covenants can actually have negative consequences for both parties as the restrictions may lead to reduced efficiences and lower profits than would otherwise be experienced.

 

 

 

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