Covenant
Definition
Covenants are contractual promises in credit agreements and bond indentures that protect lenders. Affirmative covenants require actions (deliver financials, pay taxes, maintain insurance); negative covenants restrict actions (limits on additional debt, liens, dividends and other restricted payments, asset sales, investments, and affiliate transactions); financial covenants tie the borrower to metric tests.
Financial covenants come in two flavors: maintenance covenants, tested regularly regardless of the borrower's actions, and incurrence covenants, tested only when the borrower takes a specified action. Breaching a covenant is an event of default (often after cure periods), giving lenders leverage to demand fees, tighter terms, or acceleration.
The modern leveraged market is heavily "covenant-lite": most institutional term loans lack maintenance covenants, and negative covenants contain heavily negotiated baskets and carve-outs — the fine print behind liability-management maneuvers like collateral drop-downs and uptiering.
Why interviewers ask
Credit-oriented interviews ask you to categorize covenants and explain who benefits. "What is covenant-lite and why does it matter?" is a common current-market question, and covenant baskets underpin most restructuring war stories interviewers like to discuss.
Related terms
Interviews don't test definitions — they test recall under pressure.
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