Debt covenant
A debt covenant is a lender-imposed restriction in a loan requiring the borrower to maintain financial ratios above set levels, such as minimum interest cover.
See it move
Maintenance covenants are tested at every reporting date, for example requiring net debt below 3.0 times EBITDA or interest cover above 2.5 times. Incurrence covenants are tested only when a specific action is proposed, such as raising new debt or paying a dividend, and that action is permitted only if the borrower passes the test at that moment.
Check yourself
A term loan requires the borrower to keep its net debt to EBITDA ratio below 3.0×, tested at each quarter-end. EBITDA falls unexpectedly in Q3 and the ratio rises to 3.2×. Which statement correctly describes the legal and financial significance of this situation?