Loan Covenant
From Open Risk Manual
Definition
A Loan Covenant is any explicit provision in the documentation / term sheet of a loan (or related credit product that stipulates specific restrictions for the borrower.
The breach of a covenant typically gives the lender the right to call (accelerate) the loan, require higher interest or more collateral.
Types of Covenants
Covenants can take a wide variate of forms and may concern financial ratios, information provided, ownership etc.
- limits to the allowed Loan to Value Ratio (LTV)
- limits to the allowed Debt Service Coverage Ratio (DSCR)
- limits to the allowed Interest Service Coverage Ratio (ISCR).
- requirement to deliver annual accounts
- restrictions on other third party debt
- restrictions on negative pledges
- requirements for bank approval to change the form of the debtor business
Examples
Covenant Lite (Cov-Lite)
Covenants may be waived at the discretion of lenders, a practice that prevails during periods of credit expansion. In such period lenders may remove required covenants, thereby expanding the potential borrower base at the expense of potentially increasing credit risk
Issues and Challenges
- Credit risk analysis, e.g. Credit Scoring or other systems and frameworks are typically not able to capture the impact of the presence or absence of Loan Covenants