Leveraged finance—financial covenants
Leveraged finance—financial covenants

The following Banking & Finance guidance note provides comprehensive and up to date legal information covering:

  • Leveraged finance—financial covenants
  • Traditional financial covenants v covenant lite
  • Leveraged financial covenants—getting started
  • Leverage covenant
  • Cashflow cover covenant
  • Interest cover covenant
  • Capital expenditure covenant
  • Testing financial covenants
  • Other uses of financial ratios
  • Accounting principles and IFRS 16
  • more

Financial covenants are used on a wide range of different kinds of banking transactions to monitor and test the financial performance of the borrowing company or group.

This Practice Note explains the use of financial covenants in a leveraged finance context. It explains:

  1. the covenant package traditionally used on a traditional leveraged finance transaction

  2. what is meant by covenant lite and covenant loose

  3. how financial covenants are tested

  4. other uses of financial ratios, and

  5. equity cure, mulligan and deemed cure provisions

For information on financial covenants more generally, see Practice Notes: Financial covenants—principles and Common financial covenants. For information on use of financial covenants in specific types of finance transactions (including leveraged), see Leveraged finance—financial covenants—Financial covenants in finance transactions—further information.

Traditional financial covenants v covenant lite

Due to the higher risk profile, leveraged finance facilities agreements traditionally included a full financial covenant package comprising:

  1. a debt or senior debt to earnings ratio (leverage/senior leverage covenant)

  2. a cashflow to debt service ratio (cashflow cover covenant)

  3. an earnings to interest/senior interest ratio (interest cover covenant), and

  4. a limit on capital expenditure

Leveraged financings are generally based on the cashflow of the group, rather than its assets, and this is reflected in the financial covenants listed above. A loan to value ratio, for example, commonly used in real estate finance transactions