Loan covenant
On the English term covenants are in German usage of certain provisions or (side) agreements in credit agreements and indentures. There are contractually binding undertakings by the borrower or loan debtor during the term of the loan.
The word derives from the French term covenant ( Old-French for " contract ", Latin for " meet, come together " from convenire ) and is used for all kinds of contractual secondary obligations of the borrower. This credit contract practice (see syndication, syndicated ) - as far as it is in accordance with German law - adopted in German contracts and terms and conditions. These are ancillary provisions relating to specific conduct obligations and they define a contract.
Systematization
The large number of assertions can be systematized in financial indicators ( these are the financial covenants in the narrower sense), non- financial covenants and corporate (financial ) covenants. Covenants can also be defined as a credit event.
Financial ratios
The financial ratios include all key business indicators, which can be developed from the annual accounts of the borrowing company, such as the balance sheet Relations clauses. Financial ratios can but also build on the profit and loss account of the borrower or have any other financial ratios to content. Since it is variable sizes, minimum numbers ( for example in the equity ratio ) or fluctuation with the concrete specification of lower and upper limits ( "headroom " ) can be specified. Typical financial figures of this kind are:
- Equity ratio
- Gearing
- Return on assets
- Minimum cash flow
- Asset coverage
- Interest burden ratio
- Debt service coverage ratio
The financial ratios include interest rate clauses that make the change in the lending rate of the change in the creditworthiness of a borrower dependent ( so-called margin- grids or margin- ratchets ). The creditworthiness of the borrower deteriorates about rating due, then automatically increases the margin and vice versa.
Non- financial covenants
Among non- financial covenants positive, negative or equal rank clauses are understood ( pari passu clause ) prohibit the subsequent safety position to other creditors, unless the lender is not equal. This also includes the material adverse change clauses that define basis of examples listed individually a significant deterioration in the economic and / or legal circumstances of the borrower and trigger their arrival at Nachbesicherungspflichten or even a credit notice. The latter also applies to cross-default clauses, if the debtor violated agreements with third creditors. Here also undertaken the borrower contractually well-defined information about specific dates the lender to make available (such as quarterly reports, confirmations of compliance with at least the financial covenants ). For loans granted to subsidiary companies, banks often operate in Germany of the affiliation statement in order to oblige the parent company the entire fiscal year to offset losses in the borrowing subsidiary.
Corporate financial covenants
These include, for example, the ban on the disposal of significant assets ( " Disposals " ), restrictions on internal restructuring and restrictions on dividend policy of the company. In this context also frequently appeared on the notion of " Affirmative covenants " which is used inconsistently and often non- financial covenants and corporate financial covenants summarized. Affirmative covenants agreed in any case certain acts or failure to act by the borrower. Examples are:
- Constancy in the shareholder ratios ( "ownership clause" );
- Restriction of dividend payments or withdrawals ( "dividend / withdrawal restrictions" );
- Negative clauses prohibiting the safety position to other creditors without the lender is equivalent to such creditors;
- Restrictions on major capital items such as equity investments ( " Disposals ");
- Ordinary course of business ( "ordinary conduct of business ");
- Compliance with all laws and regulations ( " representations and warranties ").
Legal consequences
A deviation from the agreed financial covenants usually triggers a pre-scheduled healing period ( " remedy / grace period" ). This healing period is to allow the borrower the subsequent fulfillment of the prescribed measures or assurances. But failure to do so, a higher credit margins or even an extraordinary termination right by the so-called Covenant breach ( breach of contract ) is triggered. Alternatively, deviations from the agreed rules can make a claim to the position of collateral reasons (so-called Nachbesicherungsrecht ). The borrower is then required to provide for the first time or other loan collateral. If he does not comply with this, termination rights are automatically point. 13 paragraph 3 in conjunction with para. 19 Section 3 Conditions banks or point. 26 paragraph 2b Terms savings banks triggered.
With the agreement of (financial ) covenants in German law there is a danger that the clause and thus possibly the entire loan contract is ineffective. Very narrow and broad agreements borrowers can get into adverse situations, because of the risk of interference from lenders like gagging in the management of the borrower. When banks intervene in the management of their borrowers by the financial sector completely into the management of the debtor company itself and largely disempower the enterprises through credit gagging, they are liable to other creditors for their losses. To credit institutions move on the thin line between undue influence of corporate management and the required strict monitoring of their increased credit risk in particular, rehabilitation loans.
Monitoring needs
Based on the agreement of covenants resulting in the credit process prudential obligations of the credit institution, the financial circumstances of the borrower regularly - usually at least quarterly - check. The results are to be considered in the rating of the loan commitment. In particular, financial covenants are not ends in themselves. They lead to an instrumentalization of the risk assessment and thus for outside bodies ( supervisory or accountants) objectively comprehensible. They thus form a part of risk management at financial institutions, as required by the minimum requirements for the credit business.
With the agreement of the covenants, the cost of the monitoring effort from the interim disclosure economic conditions in relationship are put to risk relief. Covenants are basically at all, even supposedly first risk-free to use loans. It is not clear whether the credit quality ratios will deteriorate during the repayment period ( so-called rating migration ); a repair is then usually difficult to enforce if detailed covenants have been agreed. Then only the less concrete and therefore unverbindlicheren Conditions can help.
Purpose
Covenants are to cement in total existing at the beginning of the loan agreement status quo in the economic / legal situation of the borrower during the repayment period. This status forms the basis for business, based on which the credit has ever been acceptable to the Bank. Changes thereto somewhat detrimental to the Bank, the covenants form a kind of early warning system on it with the help of contractual options ( margin increase, additional collateral, credit termination) are adequately addressed.
Importance and impact
The rating agency, according to Moody's had 45 % of European companies in 2008 with a low credit risk ("Investment Grade " ) and 75 % of firms with a high risk of default ( the "Non- Investment Grade " ) credit agreements containing covenants. Thus, the proportion of borrowers with covenants with higher degree of risk increases, although it seems sensible to agree already covenants in times of favorable ratings. Obviously tend covenants in credit agreements to sharper regulations than in bonds. In a covenant breach threatens a credit termination, which in turn can be triggered by a wave of layoffs in other creditors (through the cross-default clause). In order to meet financial covenants at any time, debtors have to take entrepreneurial actions that ultimately contribute to the self- renovation.