Bank covenants: the contract clauses few people read

In a loan agreement, the interest rate takes up one paragraph. The covenants take up three pages and they are the part that produces surprises. They are the financial conditions the company must meet throughout the life of the loan, usually checked quarterly, on the basis of the trial balance.

The ones that show up almost every time

Gearing (Total liabilities / Equity)

Usual ceiling: 2.0 - 3.0. Above it, the bank considers that the shareholders have too little skin in the game. It is computed straight from the trial balance and it is the easiest one to follow monthly.

Interest cover (EBIT / Interest expense)

Usual threshold: at least 3.0. It says how many times operating profit covers the interest. Below 1.5 it becomes tense; below 1.0 the company is not paying its interest out of its own activity.

DSCR - debt service coverage

Usual threshold: at least 1.2. The numerator is available cash flow, the denominator is the year's principal plus interest. It is the covenant closest to reality, because it works with money and not with an accounting result.

Minimum current ratio

Usual threshold: 1.1 - 1.2. See the dedicated article; it is computed identically.

Minimum equity

Sometimes as an absolute amount, sometimes as a percentage of total liabilities and equity. It protects the bank against dividend withdrawals that empty the company.

What happens if one is missed

As a rule, what people expect does not happen - the loan does not automatically fall due the next day. The usual sequence is:

1. Notification. The bank flags the breach and asks for an explanation.
2. Waiver. A written derogation for that period, usually against a fee and with conditions attached.
3. Repricing. The margin goes up. A missed covenant frequently costs an extra 0.5 - 1.5 percentage points.
4. Additional collateral or restrictions - no dividends, no new investment, no borrowing from other banks.
5. Acceleration. Rare, and normally only after repeated or serious breaches.

The important point: the bank finds out anyway, because it receives the trial balance. What makes the difference is whether it found out from you, with an explanation and a plan, or on its own, at the quarterly review.

How to monitor them effortlessly

All the covenants above are computed from the same trial balance the accounting department produces every month. Nothing extra is needed - what is needed is only for someone to compute them every time, not once a year, when it is too late.

In the report, the covenants appear as a list with the threshold, the achieved value and the remaining headroom, plus a clear mark for the ones that fail. If your contract sets thresholds other than the usual ones, compare them with those displayed: the contractual threshold always prevails.