Covenant Analysis

covenant-analysis

Covenant analysis — financial covenants, incurrence vs maintenance tests.

When to Activate

• Reviewing loan agreements or bond indentures for covenant terms
• Analyzing covenant headroom and breach risk
• Negotiating covenant packages in new financing
• Assessing EBITDA adjustments and their impact on covenant compliance
• Evaluating covenant-lite structures versus traditional covenant packages
• Monitoring portfolio companies for covenant compliance
• Advising on waiver or amendment processes following a potential breach

Core Concepts

Covenant Types

Financial covenants — quantitative tests on financial metrics:

• Leverage ratio: Net Debt / EBITDA — most common. Typically tested quarterly on a trailing twelve-month (TTM) basis
• Interest coverage ratio (ICR): EBITDA / Interest Expense. Ensures the borrower can service debt from operating cash flow
• Fixed charge coverage ratio (FCCR): (EBITDA - Capex - Taxes) / (Interest + Scheduled Principal). More conservative than ICR — captures total fixed obligations
• Debt service coverage ratio (DSCR): Net Operating Income / Total Debt Service. Common in project finance and real estate
• Minimum EBITDA or revenue: Absolute floor rather than a ratio — prevents the denominator problem when EBITDA approaches zero
• Maximum capex: Limits annual capital expenditure. Unused amounts may carry forward (basket mechanics)

Affirmative covenants — actions the borrower must take:

• Deliver financial statements (monthly, quarterly, annual audited)
• Maintain insurance, pay taxes, comply with laws
• Provide compliance certificates with each reporting period
• Notify lenders of material adverse changes or events of default

Negative covenants — restrictions on borrower actions:

• Limitations on additional indebtedness (debt incurrence tests, permitted debt baskets)
• Restrictions on liens, asset sales, dividends/distributions, investments, affiliate transactions
• Change of control provisions (often trigger mandatory prepayment or put right)
• Limitations on mergers, consolidations, and fundamental changes

Maintenance vs. Incurrence Covenants

Maintenance covenants (tested periodically):

• Must be satisfied at each testing date (typically quarterly)
• Breach triggers a default (or event of default after cure period)
• Common in leveraged loans and bank facilities
• Provide early warning and lender intervention rights

Incurrence covenants (tested only upon a specific action):

• Must be satisfied only when the borrower takes a specified action (e.g., incurring new debt, making a distribution, completing an acquisition)
• If the borrower takes no action, the covenant is never tested — even if financial performance deteriorates
• Standard in high-yield bonds
• Less protective for creditors but more flexible for borrowers

Leverage Ratio

The centerpiece of most covenant packages:

• Definition matters: Net Debt typically includes funded debt minus unrestricted cash. EBITDA definition is negotiated and often includes extensive add-backs
• Typical levels by risk profile:
• Investment grade: 2.00x | 3.25x | 62.5% | Pass

Fixed Charge Coverage | (EBITDA-Capex) / DS | > 1.10x | 1.35x | 22.7% | Pass Max Capex | Annual capex | < $25M | $21.2M | 15.2% | Pass

Binding covenant: Net Leverage (tightest headroom at 11.8%) Trend: Headroom narrowing — was 18.5% two quarters ago

### EBITDA Bridge (Accounting to Covenant)

EUR M Reported EBITDA (Accounting) 42.0

• Stock-based compensation 3.5
• Restructuring charges 2.8
• Transaction / advisory fees 1.2
• Non-recurring litigation costs 0.9
• Run-rate synergies (capped at 20%) 4.0
• Pro forma acquisition EBITDA 6.5
• Pro forma disposal EBITDA (2.1)

Adjusted EBITDA (Covenant Definition) 58.8

Adjusted EBITDA is 40% higher than reported EBITDA. Run-rate synergies represent 6.8% of Adjusted EBITDA (within 20% cap).

### Covenant Sensitivity Matrix

Revenue Decline from Base Case: 0% -5% -10% -15% -20% Net Leverage 4.85x 5.12x 5.45x 5.88x 6.42x Covenant Max 5.50x 5.50x 5.50x 5.50x 5.50x Headroom 11.8% 6.9% 0.9% BREACH BREACH

Margin Compression from Base Case: 0bp -100bp -200bp -300bp -400bp Net Leverage 4.85x 5.05x 5.28x 5.55x 5.86x Headroom 11.8% 8.2% 4.0% BREACH BREACH

Breakeven: Revenue can decline ~9.5% or margins compress ~220bp before leverage covenant breach (assuming no management action).

### Waiver / Amendment Checklist

1. Identify the covenant(s) at risk and projected breach date
2. Quantify the severity: How far below/above threshold?
3. Assess cure rights: Equity cure available? How many remain?
4. Prepare amendment request:

• Revised covenant levels sought (temporary or permanent)
• Business plan demonstrating path to compliance
• Consideration offered (fee, margin increase, additional reporting)

1. Lender group dynamics: Required majority (typically 50-66.7%)
2. Timeline: Allow 4-8 weeks for syndicated facilities
3. Legal review: Confirm no cross-default triggers in other facilities

## Quality Gate

- [ ] Credit agreement definitions extracted verbatim — EBITDA, Net Debt, and each covenant metric
- [ ] All permitted add-backs identified and mapped to financial line items
- [ ] Covenant compliance calculated using the agreement definition, not management's adjusted figures
- [ ] Headroom analyzed for each covenant; binding constraint identified
- [ ] Forward projection models covenant metrics under at least three scenarios (base, upside, downside)
- [ ] Breakeven analysis completed — identifies the performance decline that triggers a breach
- [ ] Cure rights documented: number remaining, amount, consecutive quarter restrictions
- [ ] Cross-default provisions checked across all facilities
- [ ] Step-down schedule tracked — upcoming tightening of covenant levels flagged
- [ ] EBITDA add-back caps verified; run-rate synergies tested for reasonableness
- [ ] Compliance certificate template matches the credit agreement requirements

## Source & license

This open-source skill is cataloged on AgentStack and links to its original source — we do not rehost the code.

- **Author:** [brainbytes-dev](https://github.com/brainbytes-dev)
- **Source:** [brainbytes-dev/everything-claude-finance](https://github.com/brainbytes-dev/everything-claude-finance)
- **License:** MIT

Install and usage instructions live in the source repository linked above.