Covenants: need or greed?

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Covenants have long formed a part of the funding documentation for any leveraged buyout. The heady days saw them loosen up a bit, with a handful of Europe's largest deals even being structured with none at all (in the US this number was much higher)

Intended as an early warning system of trouble, there have been whispers that the lack of any tight control may mean problems that require attention go undetected until it is too late. As a result, many in the market have been championing their comeback.

Others, however, suggest that while covenants are ostensibly a good thing, they are being misused in the current market. For example, in companies able to withstand the current market conditions and meeting repayments, it may be tempting for a bank to allow a borrower to breach a technical covenant rather than ameliorate the situation as the breach nears: they have a new revenue stream, and often get better margins for the same businesses on their books.

Amendment fees are often up to 100bps, and sometimes double that. Add to this the waiver fees (often significant vis-a-vis a company's earnings) and monitoring fee (around 1% of the debt) - as well as the legal costs of all involved parties borne by the target - and the banks may have more to gain by allowing such breaches rather than stepping in early.

Yours sincerely,

Kimberly Romaine

Editor-in-chief, unquote"

Tel: +44 20 7004 7526

kimberly.romaine@incisivemedia.com.