Covenant Waiver: What It Costs and When It Counts

A failed financial covenant is usually an event of default, and from that moment the lender holds rights it did not hold the day before. A waiver is the lender agreeing, in writing, to give up those rights for that failure. Everything else stays in place: the covenant level, the next test date, all other terms.

Who has to agree depends on the facility. A bilateral lender decides alone. In a club or syndicate, the amendments clause says whose consent is needed, often the majority lenders for a financial covenant. Inside a bank, a waiver is a credit decision: the relationship manager proposes it and someone with delegated authority signs it off, often with the borrower's risk grade reconsidered in the same paper.

A well-drawn waiver names the covenant, the test date and the period, and it says that nothing else is waived. It usually comes with conditions, and failing one can bring the default back. Common terms include a fee, a margin increase until the covenant is next met, monthly rather than quarterly reporting, a block on dividends, and a forecast or an independent business review if the lender wants evidence.

There is no scale of charges. The price reflects how large the miss is, whether the cause is temporary, whether the lender now holds more risk, and how much choice the borrower has. A request made before the test date, with the cause named and a forecast attached, shows the lender a business that knows its numbers. A breach it discovers from a late certificate tells it something else, and the terms usually show it.

A maker of steel warehouse shelving, constructed for this page like every figure in it, has a June balance date and a term loan of US$22m, with US$2m repayable in the next twelve months. Cash is US$1m. Its leverage covenant is 3.50 times, tested each 30 June and 31 December. In May, after a slow quarter for warehouse fit-outs, its forecast shows June EBITDA of US$5.6m on a twelve-month basis. The level, fee and margin below belong to the example and are not offered as market norms.

The finance director calls the bank on 5 June with the forecast and the cause. By 24 June the bank has signed a waiver of the 30 June test alone. Its price:

It also agrees to monthly management accounts and no dividend until the test is next passed. Those conditions may cost it more than the money. Now consider the date. Current assets are US$14m and current liabilities US$10m, including the US$2m instalment. Suppose the letter had been signed on 12 July instead, with the failed test falling on 30 June.

The business is the same in both columns, and the bank's position is the same. The accounts differ because the loan was repayable on demand at balance date in one version and not in the other.

That result follows the IFRS-based rule in IAS 1, carried into Australia as AASB 101 and New Zealand as NZ IAS 1: a breach on or before the reporting date that makes the loan repayable on demand makes the liability current, even if the lender agrees afterwards not to demand payment, unless a qualifying arrangement was already in place. FRS 102 in the UK reaches the same place by its own words: paragraph 4.7 puts a creditor within one year when the company has no unconditional right at the reporting date to defer settlement for twelve months, and a lender free to demand repayment leaves it none. Smaller reporters on simpler frameworks should ask their accountant.

Four documents get confused. A waiver forgives a stated failure. A covenant reset changes the level going forward, and a borrower that expects to miss again needs that rather than a second waiver. A reservation of rights gives up nothing: the bank records that it knows and keeps its options. A standstill leaves the default in place and holds off enforcement for a period.

An equity cure differs in kind. It is a right in the agreement that the owners can use to repair a failed test by putting in money, usually without needing the lender's agreement. A waiver is the lender's to give or withhold.

DEFINED IN ONE PARAGRAPH → · THE BANK IN YOUR AUDIT FILE → · COVENANT RESET →

A lender reads the first waiver for the cause and the second for the pattern. If the same test needs relief twice, either the level was set in the wrong place or the business is no longer the one that was lent to, and the file should say which. The answer decides whether the next step is a reset with proper headroom or a move to closer monitoring.

A waiver given because a borrower is in financial difficulty may also be recorded inside the bank as a concession, with consequences of its own for how the loan is graded. For the borrower, the practical habit is to work out the headroom on the agreement's own definitions well before each test, and to raise a likely miss while there is still time to get a letter dated before balance date.

LOAN COVENANTS, EXPLAINED → · THE MONTHLY PACK →