What is a loan covenant?

Maintenance covenants are tested regularly, often each quarter, while incurrence covenants apply only when a borrower takes an action such as adding debt. Loans with no maintenance tests, or tests only for revolving lenders, are called covenant-lite. A breach usually leads to a waiver, new terms or a fee rather than an immediate demand for repayment.

Say a loan requires debt of no more than 5 times EBITDA. If EBITDA falls and debt reaches 6 times, the borrower is in breach despite paying on time.

It gives lenders an early warning and a seat at the table, and a borrower can be in default even with every payment made on time.