Are covenant-lite loans riskier for lenders?

They change the risk more than they create it. A covenant-lite borrower is not necessarily more likely to fail, but its lenders find out later and have less say before it does, so by the time they can act there may be less value left to recover. Whether that costs money depends on the borrower, the security, the documents' limits on leakage and the price. In late 2023 the Bank of England cited the covenant-lite share of new leveraged loans, then near its historical high, as a sign that non-price lending terms had not yet tightened.

Do covenant-lite loans have any covenants?

Yes. They drop financial maintenance covenants, the quarterly ratio tests, but keep negative covenants that restrict borrowing, security, dividends, investments and asset sales, usually with baskets and incurrence tests that allow those steps within limits. They keep reporting and information undertakings. The revolving facility alongside the term loan commonly carries a springing covenant, a maintenance test that applies only when the revolver is drawn above a set level.

Why do lenders accept covenant-lite terms?

Mostly competition. Sponsors running a financing compare terms across banks, institutional investors and private credit funds, and a lender that insists on maintenance tests can lose the deal. Institutional investors that hold diversified portfolios and can sell a loan in the secondary market value the quarterly negotiation less than a relationship bank does. Lenders accepting the terms look for protection elsewhere: in pricing, in the starting leverage, and in the documents' limits on what can leave the business.

Are covenant-lite loans common in New Zealand and Australia?

In bank lending to mid-sized businesses, no: those facilities usually carry maintenance covenants tested each quarter or half-year. Covenant-lite terms appear in larger sponsor-backed financings, particularly term loan B deals and some unitranche loans in Australia written on US and European terms, often with a springing covenant on the revolving facility. A mid-market borrower is more likely to meet the idea in a competing offer than in its own facility letter.

// WORKED EXAMPLEWHERE THE RISK SITS

Covenant-Lite Loans: Where the Lender's Protection Goes

No quarterly test, so the warning comes when the cash is gone.

BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED 2026-11-07

// THE SHORT ANSWER

A covenant-lite loan is best understood not by what it lacks but by when its lender gets a say. A covenant-lite term loan has no ratio the borrower must meet each quarter, so a falling business breaches nothing while it trades down. The lender keeps restrictions on new debt, dividends and security, tested when the borrower acts. What it loses is the early conversation a missed test forces. Its protection moves later in the story: to the documents that limit leakage, to its security and ranking, and to the price it was paid for the risk.

BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.

// MAKE THE CALL

Issue 04 — Highview Industries. Same request as Issue 01 on the surface. A completely different file underneath. Your call first, then the senior banker's.

Read the file →

// 01 — WHAT A LENDER GIVES UP

A maintenance covenant is a promise about the business's condition, tested whether or not anything has happened: leverage below a level, interest cover above one. Its value to a lender is rarely the right to call the loan. It is the meeting. A breach turns a lender with no say into one whose consent the borrower needs, months before the cash runs out, while there is still something to negotiate over. Remove the maintenance tests and the lender's next point of leverage is a missed payment, a breach of some other undertaking, or a default under another facility.

Covenant-lite terms grew in loans to sponsor-backed companies that are syndicated to institutional investors, who hold many loans, trade them, and are less placed than a relationship bank to negotiate a waiver every quarter. The Bank of England put the covenant-lite share of new leveraged loan issuance at around two-thirds in late 2023. In Australia the structure is standard in term loan B deals and has spread into unitranche lending to larger sponsor-backed borrowers. In bank lending to mid-sized businesses in New Zealand and Australia, and in the UK mid-market, maintenance covenants remain the usual form.

// 02 — WHAT A COVENANT-LITE LOAN STILL HAS

Covenant-lite is not covenant-free. The term loan keeps negative covenants restricting debt, security, dividends, investments and asset sales, each with exceptions written as permitted baskets and many unlocked by an incurrence covenant, a ratio tested only when the borrower wants to take the step. It keeps reporting obligations, so the lender still sees the numbers. And the revolving facility beside it usually carries a springing covenant: one maintenance test that applies when the revolver is drawn beyond a set share.

The practical effect is that the documents control what the borrower can do, not how well it must perform. A business that stays within its baskets can lose money for a long time without breaching anything. The width of those baskets, and the EBITDA definition behind the ratio tests, then decide how much value can leave before any lender has a say.

// 03 — THE EXAMPLE

A sponsor-backed childcare operator, constructed for this page, has a US$150m term loan and a US$25m revolving facility. Enrolments fall over a year. Read the same numbers through three documents: a bank term loan with a 5.50 times maintenance leverage covenant; the revolver, with a 7.50 times test that springs above 40% drawn, US$10m; and a covenant-lite term loan. Every level is the example's.

EBITDA Cash RCF drawn Net debt Leverage Cash + undrawn

Dec 30 10 0 140 4.67× 35

Mar 27 6 0 144 5.33× 31

Jun 24 3 5 152 6.33× 23

Sep 21 1 12 161 7.67× 14

Dec 18 0 20 170 9.44× 5

Net debt = 150 term loan + RCF drawn − cash

The maintenance lender has a breach in June, with US$23m of liquidity left and a business still worth restructuring. The revolver lenders' test does not apply in June, because only 20% is drawn; it applies in September, at 48% drawn, and fails, with US$14m left. The covenant-lite term lenders have no test at all. Their first say comes if the revolver lenders act on that breach, since in these deals the term lenders' cross-default usually waits for them; otherwise when a payment is missed or the cash runs out, which on these numbers is early in the following year. The business is the same in every reading. Covenant-lite put the term lenders' first say at least a quarter behind the maintenance lender's, and more than six months behind it if the revolver lenders waive.

DEFINED IN ONE PARAGRAPH → · BANK LOAN VS PRIVATE CREDIT → · TERM LOAN B →

// 04 — HOW IT DIFFERS FROM COVENANT-LOOSE

The term readers confuse it with is covenant-loose, used mainly in the European mid-market: a loan that keeps a maintenance test, usually one leverage covenant, but sets it with so much room against the lender's base case that it bites only in a severe decline. A covenant-loose loan still gives its lender a test date, and a breach still forces the conversation; it simply comes later than under a tight covenant. Covenant-lite removes the date. A lender comparing two offers reads the headroom of the first and the baskets of the second, because a loose covenant and a missing one can leave a lender similarly late.

// 05 — WHERE IT DECIDES A FILE

For a mid-market bank, covenant-lite arrives most often as a competitor's term sheet. Issue 11 is that file: a long-standing client forwards a sharper offer with lighter terms and a Friday deadline, and the banker has to decide what protection is worth matching. The credit question is what replaces the warning. A lender that accepts lighter covenants can ask for more frequent reporting, tighter baskets, a liquidity covenant, lower leverage at the start or a higher price. A lender that cannot get any of those is lending on its view of the business today and its security tomorrow, and its credit paper says so.

LOAN COVENANTS, EXPLAINED → · LIQUIDITY HEADROOM →

// SOURCES

The documents the statements on this page rest on. Each was opened and checked when cited.

Bank of England, Financial Stability Report, December 2023 — Box B: Highly leveraged corporates — Reports the covenant-lite share of new leveraged loan issuance, loans that do not require the borrower to keep to set financial ratios, at around 66% and near historical highs, as evidence that non-price terms had not tightened — section 01 and the FAQ.

// QUESTIONS PEOPLE ASK

Are covenant-lite loans riskier for lenders?: They change the risk more than they create it. A covenant-lite borrower is not necessarily more likely to fail, but its lenders find out later and have less say before it does, so by the time they can act there may be less value left to recover. Whether that costs money depends on the borrower, the security, the documents' limits on leakage and the price. In late 2023 the Bank of England cited the covenant-lite share of new leveraged loans, then near its historical high, as a sign that non-price lending terms had not yet tightened.
Do covenant-lite loans have any covenants?: Yes. They drop financial maintenance covenants, the quarterly ratio tests, but keep negative covenants that restrict borrowing, security, dividends, investments and asset sales, usually with baskets and incurrence tests that allow those steps within limits. They keep reporting and information undertakings. The revolving facility alongside the term loan commonly carries a springing covenant, a maintenance test that applies only when the revolver is drawn above a set level.
Why do lenders accept covenant-lite terms?: Mostly competition. Sponsors running a financing compare terms across banks, institutional investors and private credit funds, and a lender that insists on maintenance tests can lose the deal. Institutional investors that hold diversified portfolios and can sell a loan in the secondary market value the quarterly negotiation less than a relationship bank does. Lenders accepting the terms look for protection elsewhere: in pricing, in the starting leverage, and in the documents' limits on what can leave the business.
Are covenant-lite loans common in New Zealand and Australia?: In bank lending to mid-sized businesses, no: those facilities usually carry maintenance covenants tested each quarter or half-year. Covenant-lite terms appear in larger sponsor-backed financings, particularly term loan B deals and some unitranche loans in Australia written on US and European terms, often with a springing covenant on the revolving facility. A mid-market borrower is more likely to meet the idea in a competing offer than in its own facility letter.

THE IN-TRAY · ONE MINUTE

Make the call on one file.

A short file on the ground this page covers. Every option opens with how far it sits from a senior banker’s read.

THE FIRST QUESTION · THE LOAN · PROTECTION

A term sheet offers three protections: a negative pledge, a quarterly leverage covenant, and monthly management accounts.

Which is likely to show deterioration first?

7 MORE ON THE LOAN · PROTECTION →WHERE DO YOU READ FROM? THE PLACEMENT →

THE GLOSSARYIN ONE PARAGRAPHCovenant-lite (cov-lite) What is a covenant-lite loan, and where does the lender's protection go?