Covenant Package
A covenant package is the set of contractual protections and restrictions in a debt agreement that govern borrower behavior and lender remedies.
Allocator relevance: A key determinant of downside protection, default outcomes, and recovery value in private credit and leveraged finance.
Expanded Definition
Covenants can be maintenance-based (ongoing tests like leverage ratios) or incurrence-based (limits triggered by actions such as additional debt). Covenant strength influences how quickly lenders can intervene when performance deteriorates and how much control they have in restructuring.
In loose covenant environments, lenders may have fewer levers until distress is severe, increasing loss severity.
How It Works in Practice
Underwriters assess covenants alongside collateral, leverage, borrower quality, and capital stack seniority. During downturns, covenant breaches can trigger negotiations, amendments, pricing changes, or control actions.
Decision Authority and Governance
Underwriting standards and IC processes should specify minimum covenant quality by deal type and cycle conditions. Governance is especially important when market competition pressures teams to accept weaker protections.
Common Misconceptions
- Seniority alone guarantees protection.
- All covenants are equally enforceable.
- Higher yield compensates for weak covenants by default.
Key Takeaways
- Covenant quality often drives recovery outcomes.
- Cycle conditions influence covenant looseness.
- Covenants work together with collateral and leverage.