Covenant
1. Law.
A formal legal agreement to take, or not to take, certain actions.
2. Debt documentation - loan documentation - bond documentation.
In debt documentation, covenants are generally about protecting the lender-investor against an increase in their credit risk relating to the borrower.
In this context, covenants are generally promises given by the borrower to take - or not to take - specified actions relevant to the borrower's creditworthiness.
For example, a borrower's financial covenant to maintain a minimum ratio of net worth to debt.
Breach - or potential breach - of such a covenant is designed to act as an early warning indicator of potential problems.
- Amendments to IAS 1: Non-current liabilities with covenants
- "Borrowers [need] to bear in mind how covenant packages in lending arrangements will be reflected in or impact their financial statements for accounting periods starting on or after 1 January 2024.
- [The amendments change] the criteria for the classification of a loan as a current or non-current liability, which depends on the entity's compliance with covenant tests on or before the accounting date...
- ... it is not clear whether the [changes] would have the effect of bringing forward future covenant tests, requiring them to be notionally tested at the end of the accounting period by reference to then-existing facts and circumstances, even if not contractually due to be tested until a later date...
- Of broader relevance is a new requirement... to disclose information about covenants to which non-current liabilities are subject and are tested after the balance sheet date...
- This means that all borrowers with loans that are subject to covenants that are applicable within 12 months of the accounting date will need to outline those in disclosures to their accounts..."
- Slaughter and May - Seeds of change: Loan financing in 2024, p10.
3. Pensions.
In relation to pension funds, the credit strength of the sponsoring employer and its commitment to the pension fund.
See also
- Acceleration
- Accounting exposure
- Asset cover
- Bond
- Breach of covenant
- Clause
- Compliance
- Condition
- Contingent covenant
- Contract
- Covenant-lite
- Covenant trigger
- Credit risk
- Current liabilities
- Default
- Documentation
- Event of default
- Financial covenant
- Generally accepted accounting principles
- Grace period
- Headroom
- Incurrence covenant
- Interest cover
- Loan
- Loan agreement
- Maintenance covenant
- Net worth
- Non-current liabilities
- Non-current Liabilities with Covenants
- Non-financial covenant
- Representations
- Restrictive covenant
- Sponsor
- Term
- Trigger event
- Waiver
- Warranty
