CH14 - Structural Mitigation

Question 1

What are covenants?

Answer 1

• Conditions imposed on the borrower as part of a loan or financing facility.
• Objective is to maintain the risk profile of the borrower by keeping the borrower from deviating too much from its current path
• For credit analysts, tight covenants guarantee that the borrower will endeavour to maintain its creditworthiness regardless of the evolution of its economic/operating environments
• Failure to maintain the conditions of the covenants is a default event and the loan becomes immediately due

Question 2

List the three types of covenants

Answer 2

1. Affirmative covenants
2. Negative covenants
3. Financial covenants

Question 3

Affirmative covenants

Answer 3

List what a company must do to maintain its business in good shape, for example, keep a legal existence, maintain its building, preserve trademarks

Question 4

Negative covenants

Answer 4

Limit what a company cannot do as long as the loan is outstanding. Elements include:

1. limitation on taking on other secured debt
2. limitation on sale and leaseback transaction
3. an interdiction to merge, sell itself or significant assets

Question 5

Financial covenants

Answer 5

Most common examples include: minimum coverage ratio (e.g. EBITDA over interest expenses), leverage, current ratio, tangible net worth, maximum capital expenditure.
-Also maintenance and insurance covenants