Covenant step-down
What is a covenant step-down in a facility agreement?
ONE OF 416 TERMS · FREE · NO SIGNUP
BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED
// THE SHORT ANSWER
A covenant step-down is a schedule in a facility agreement that tightens a financial covenant over time: a leverage limit that falls, or a cover minimum that rises, at set test dates. It writes the borrower's plan to repay debt or grow earnings into the test, so headroom that is ample at signing narrows unless the business delivers. In one composite acquisition, leverage may not exceed 4.0 times in the first year, 3.5 times in the second and 3.0 times from the third; a borrower flat at 3.6 times passes the first test and fails the second without getting any worse.
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.
// THE FULL PAGE
Covenant Step-Down: a Worked Example →
The business stands still; the line moves towards it.
// WHAT IT IS NOT
A covenant reset changes the levels after signing, usually loosening them; a step-down is a tightening agreed at signing and written into the schedule from the start.
// WORKED IN
// NEXT TO IT
- Covenant headroom
- Negative pledge
- Condition precedent (CP)
- Event of default
- Covenant waiver
- Reservation of rights
- Term sheet
- Condition subsequent
- Review event
- Repayable on demand
- Material adverse change (MAC) clause
- Cross-default
- Change of control clause
- Cure period
- Compliance certificate
- Information undertakings
- Liquidity covenant
- Equity cure
- Springing covenant
- Covenant reset
- Covenant mulligan
- Covenant-lite (cov-lite)
- Incurrence covenant
- Test date (covenant)
- Permitted baskets
- Distribution lock-up
- Mandatory prepayment
- Clean-up period
- Certain funds
- Yank-the-bank clause (replacement of lender)
- Capex covenant
- Guarantor coverage test
- Frozen GAAP
- Restricted group
- Unrestricted subsidiary
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