covenant investment & finance definition
The
rules on a loan agreement that require certain financial conditions be met or
prohibit other financial actions by the borrower. A covenant may limit how much
additional debt can be issued, require financial targets such as sales and
earnings to be met, limit the payment of dividends, and require that certain
cash levels be maintained. If a covenant is violated, then the bank or loan
issuer can require that the loan or note be immediately repaid.
See covenant in Wall Street Words
A clause in a loan agreement written to protect the lender's claim by keeping the borrower's financial position approximately the same as it was at the time the loan agreement was made. Essentially, covenants spell out what the borrower may do and must do in order to satisfy the terms of the loan. For example, the borrower may be prohibited from issuing more debt by using certain assets as collateral. Likewise, the borrower may be required to issue reports to bondholders on certain dates. Also called
protective covenant,
restrictive covenant. See also
negative covenant,
positive covenant.
In February 2002 Qwest Communications issued a warning that the company was in danger of violating a bank loan covenant by the end of June. A major slump in the telecom business combined with heavy indebtedness caused concern that the firm's debt would exceed the specified maximum of 3.75 earnings before interest, taxes, depreciation, and amortization. A month later the company announced that in return for agreeing to use $608 million from a $1.5 billion bond issue to reduce bank debt, the bankers agreed to a concession that raised the covenant maximum to 4.25 until the end of September, and 4.00 during the following six months. The covenant had been included as part of the original bank loan agreement in order to help insure that Qwest could continue to meet its existing obligations before taking on additional debt.
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