Covenant-lite (cov-lite)

A covenant-lite financing, often shortened to cov-lite, is a loan with no maintenance covenant, that is no financial undertaking tested periodically over the life of the credit. It carries only so-called incurrence covenants, checked only when the borrower undertakes a specific action, such as raising new debt, paying a dividend or making an acquisition.

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The difference is major compared with a classic financing carrying maintenance Covenants, where a ratio such as the Leverage ratio (net debt / EBITDA) or the DSCR – Debt Service Coverage Ratio is measured at each closing. Under a cov-lite regime, a gradual deterioration in performance does not automatically trigger default: lenders lose that early warning signal and the ability to renegotiate early.

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By way of illustration, a classic financing tests a maximum leverage of 4 times each quarter, a breach at 4.3 times triggering default. Under a cov-lite financing without that maintenance test, the same drift to 4.3 times would go unnoticed until an action triggering an incurrence covenant.

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Popularised on large Leveraged Buy-Out (LBO) deals and the institutional Term Loan A vs Term Loan B (TLA vs TLB) market, cov-lite gives the borrower more flexibility at the cost of weaker creditor protection. On SME and mid-cap financings, lenders generally remain attached to maintenance covenants, the guarantors of close risk monitoring.