Financial Covenant
A financial covenant is a contractual condition in a loan agreement that requires the borrower to maintain specified financial metrics, such as a minimum debt service coverage ratio or a maximum leverage ratio, tested on a regular schedule. It gives the lender an early, measurable signal of deteriorating credit before a payment is ever missed.
Maintenance versus incurrence
A maintenance covenant is tested every period regardless of what the borrower does. An incurrence covenant is tested only when the borrower takes a specific action such as raising debt or paying a dividend. A loan with no maintenance financial covenants is called covenant-lite.
Common financial covenants
Recurring examples include the debt service coverage ratio, a leverage ratio (debt to EBITDA), an interest coverage ratio, minimum liquidity, and minimum tangible net worth. You can model the first with the DSCR calculator.
Why it matters
Financial covenants are the lender's earliest quantitative warning system, but only if a covenant breach is caught in time. Zolvo automates covenant compliance monitoring against reconciled data and alerts before a threshold is crossed. See the covenant compliance monitoring guide for private credit.