Covenant-Lite Loan
AdvancedA covenant-lite loan is a loan, usually to a leveraged company, with few or no maintenance covenants, meaning the borrower does not have to meet regular financial tests, such as leverage or interest coverage limits, to avoid default.
Traditional loans include maintenance covenants, tested regularly, often quarterly. If a borrower breaches them, lenders can step in early, renegotiate or demand repayment. Covenant-lite loans remove most of these tests, keeping only incurrence covenants, which apply when the borrower takes specific actions, such as borrowing more or paying dividends.
Covenant-lite loans became common in the leveraged loan market from the 2010s onwards, and now make up a large share of new leveraged loans in the United States and Europe, driven by strong demand from investors.
For example, a company with a covenant-lite loan whose earnings fall sharply would not breach its loan terms simply because its leverage rose, as long as it continued to pay interest.
Borrowers benefit from more flexibility and less risk of technical default. Lenders lose early warning signals and bargaining power. Some research suggests recovery rates on covenant-lite loans may be lower when defaults eventually occur, because problems are addressed later.
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