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It was reported recently by Reuters News Service that according to a new report by ratings agency Moody’s Ratings, a growing number of U.S. companies were seeking more flexible covenants in their credit agreements to increase their debt loads while avoiding approvals from all their existing lenders. Moody’s had noted that U.S. corporate borrowers with weaker credit profiles were leaning harder on their lenders to get more flexibility in agreements to take out more debt without full consent from existing lenders, as they struggled to issue new debt in public markets.
This trend towards loans with more flexible terms and conditions is something that is cyclical, in that it normally appears at the peak of the lending cycle when banks are keenest to lend and borrowers thus have the greatest negotiating power.
In financial jargon, we call these loans “covenant lite” (often shortened to “cov-lite”). The term describes loan agreements that contain fewer restrictions and requirements for borrowers, and thus fewer protections for lenders, compared to traditional lending arrangements.
Breaking Down the Terminology
To understand “covenant lite,” let’s start with loan covenants. Covenants are promises or clauses in loan agreements that obligate the borrower to fulfill certain conditions (affirmative covenants), or refrain from certain actions (negative covenants).
Affirmative or positive covenants might require the borrower to provide financial reports, maintain insurance, or keep specified financial ratios. Negative covenants typically restrict the borrower from things like taking on extra debt, selling assets, or making risky investments.
The goal of both types of covenants is to protect the lender by setting “early warning signs,” ensuring the financial health of the business, and allowing lenders to intervene if problems arise.
A traditional loan (sometimes called “covenant heavy”) will include a variety of these covenants, especially financial maintenance covenants. These require the borrower to regularly prove (often monthly or quarterly) that their finances remain sound — for example, maintaining a certain ratio of debt to earnings, or not exceeding a specific level of borrowing.
A covenant lite loan, by contrast, removes many of these demands. Most notably, it does not require periodic financial maintenance tests. The borrower has more flexibility, and the lender loses some of their ability to step in if business performance deteriorates.
What Does This Look Like in Practice?
Let’s compare the two in a simple markdown table:
| Traditional Loans | Covenant Lite Loans | |
| Financial Maintenance Tests | Yes (regularly) | No (or rarely) |
| Borrower Restrictions | Many | Few |
| Lender Protection | Strong | Weaker |
| Intervention Triggers | Early and frequent | Fewer, delayed |
An example of a maintenance covenant in a traditional loan might be “Borrower must maintain a debt-to-earnings ratio below 4.0 on a quarterly basis.” Whereas in a cov-lite loan it might say “Borrower may take on additional debt provided total debt does not exceed 5x earnings at the time of incurrence (just once, not ongoing).”
Why Would Anyone Agree to Covenant Lite?
Borrower perspective: Companies, especially those engaging in leveraged buyouts (where lots of debt is used to buy a business), prefer covenant lite agreements because they reduce the risk of immediate default if business performance temporarily worsens; allow more freedom to operate without constant lender oversight and make it easier to manage financial hiccups, repurpose assets, or undertake business changes.
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Lender perspective: At first glance, covenant lite loans present more risk — they lose “early warning” signals and levers to intervene before losses mount. However, lenders in competitive markets might offer cov-lite terms to win business from desirable borrowers because these loans often carry higher interest rates, potentially compensating lenders for increased risk and the market for selling loans on to other investors (syndication) can share and disperse the risk.
The Rise of Covenant Lite Loans
Originally, cov-lite loans were rare and only offered to top-tier, low-risk borrowers. But trends over the last two decades have dramatically increased their use, especially in the leveraged loan market and among private equity–backed deals. (A leveraged loan is a type of commercial loan extended to companies that already have a substantial amount of debt or a relatively poor credit rating — that is, they are viewed as “high-risk” borrowers. These loans typically carry higher interest rates than traditional loans because lenders demand extra compensation for taking on greater risk.)
Pre-2008: Cov-lite loans were a minority in the market. Banks, eager to preserve protections, insisted on strict covenants.
Post-2008: Following the crisis, as markets recovered and competition among lenders intensified, borrowers gained more negotiating power. Cov-lite loans proliferated — by some estimates, they now account for over 75% of the value of new leveraged loans.
Leveraged Buyouts: Cov-lite loans are particularly common in deals where private equity firms acquire companies, as these buyers value flexibility to restructure and repurpose their investments.
Heavily indebted borrowers are uncommon in the coworking sector, so probably the greatest effect will be in financing takeovers of coworking operators and the acquisition of real estate for flex space use. In both cases, the ability to borrow on more flexible terms would be a big advantage for the borrower, possibly making deals possible where they were not otherwise financeable. Investors wanting to take advantage of cov-lite should not delay, because, as already noted, this is a peak cycle phenomenon and will be followed by a return to less availability and more onerous terms when the cycle turns.
Demand for Covenant Lite and the Lending Cycle
The lending cycle refers to periods of expansion and contraction in credit markets. When the economy is strong, investor appetite for risk rises. Banks and lenders compete aggressively to make loans, often relaxing their standards to attract borrowers, including offering covenant lite agreements.
Cov-lite issuance is most common at the peak of the lending cycle as borrowers can choose among many lenders, all eager to lend with fewer strings attached. When the economy turns down and economic uncertainty grows, defaults increase, lenders become cautious. New loans revert to stricter covenants, and cov-lite deals become rarer as lenders prioritize protection.
During periods of abundant capital and optimism, lenders loosen standards to win business — resulting in more covenant lite loans. When the cycle reverses, and risk aversion sets in, lenders reinstate traditional covenants, tightening their control over borrowers.
The risks and consequences for lenders are clear. Fewer covenants mean less ability to take action if a borrower’s finances deteriorate, increasing the potential for losses or lower recoveries when defaults happen. For borrowers, cov-lite loans reduce the risk of technical default (default caused by breaching a covenant, rather than missing a payment), making companies more resilient in downturns. However, this can also mean deeper financial problems go unaddressed until it is too late.
Debate persists over whether cov-lite loans truly increase risk in the system.
Some argue they simply reflect shifting power as lenders compete and investors spread risk through syndication and credit derivatives. Others say this can lead to greater systemic risk if too many lenders ignore warning signs.
Conclusion
Covenant lite loans mean a relaxation of lender protections — fewer regular financial checks, more freedom for borrowers, and increased risk for lenders. Their popularity rises and falls with the lending cycle, most common during credit booms when competition leads lenders to weaken their terms.
While they have benefits for borrowers, lenders must be mindful of the risks inherent in providing finance with fewer strings attached.
