In this lesson
- Terms: Covenant, EBITDA, Default and recovery
- To work through: a worked example, a 36-second film, 3 check questions
Underlined terms show their definition when you rest on them or tap them.
A covenant is a promise in the loan agreement. Some say what the borrower must do (send accounts, keep insurance); others what it must not do (take on more debt, pay out dividends) or what financial levels it must keep.
The difference that matters is when they are tested. A maintenance covenant is checked regularly, often every quarter: for example, debt must stay below a set multiple of earnings. If the company breaks it, the lenders gain rights, which can extend to taking control. An incurrence covenant is tested only when the borrower takes an action, such as borrowing more or paying a dividend; it restricts that action but does not, by itself, put the company in breach. Boston Fed researchers describe incurrence covenants as preserving the owners’ control.
Loans with only incurrence covenants are called covenant-lite. In the syndicated leveraged loan market the cov-lite share grew from just over 10% in 2007 to more than 80% in 2020, by the Boston Fed researchers’ count. Direct lending has traditionally kept maintenance covenants, but the Fed note cites industry commentary that some recent private credit deals, competing with banks for larger borrowers, have none.
A loan has a maintenance covenant: debt may not exceed 5.0 times EBITDA. The company owes $100 million.
| EBITDA $25 million: $100m ÷ $25m | 4.0x, within the covenant |
|---|---|
| EBITDA falls to $18 million: $100m ÷ $18m | about 5.6x, a breach |
| Same fall under a cov-lite loan | no breach until the company tries to borrow more or pay out |
The maintenance covenant brings the lender to the table early, while there is still value to protect. Simple example. Terms vary.
Key takeaway: why it matters to investors
Covenants decide how early lenders can act when a borrower weakens, which drives how much they recover. A fund that lends with maintenance covenants and one that lends cov-lite may report the same yield but offer very different protection.
Watch · 36 seconds
Every payment on time, and still in defaultA loan covenant is a condition written into a loan. Break one and the lender may waive it, charge more or call the loan, even if every payment was made on time.
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Sources
The facts in this lesson were checked against these public pages on November 11, 2026. Examples use round invented numbers. Simple examples; terms vary by fund.
- High-Yield Debt Covenants and Their Real Effects (Working Paper 22-5, 2022; Bräuning, Ivashina and Ozdagli), Federal Reserve Bank of Boston. Maintenance covenants are tested continually and a breach can shift control to creditors; incurrence covenants restrict actions once a threshold is crossed and preserve equity control; the cov-lite share of leveraged loans grew from just over 10% in 2007 to more than 80% in 2020.
- Private Credit: Characteristics and Risks (FEDS Notes, February 23, 2024; Fang Cai and Sharjil Haque), Board of Governors of the Federal Reserve System. Definition (debt-like, non-public instruments from non-bank lenders, mostly through funds and BDCs); nearly $1.7 trillion as of June 2023, direct lending about $800 billion or half; borrowers typically middle-market firms with $10 million to $1 billion of revenue; direct loans typically senior secured; about 15% hybrid loans, more junior; almost all floating rate; average maturity around five years, about 16% due in 2024; spreads above syndicated term loans; mean interest coverage about 2.0x vs 2.7x for leveraged loans (2023); default rates low vs syndicated loans through October 2023, not yet tested by a prolonged recession; post-default value around 33% vs 52% syndicated loans and 39% high-yield bonds (KBRA DLD); recent deals often without financial maintenance covenants (industry commentary); Form PF Q4 2021: pensions about 31% of private credit fund assets, other private funds 14%, insurers and individuals about 9% each; BDCs created by the Small Business Investment Incentive Act of 1980.
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