Covenant-Lite Loan

A covenant-lite (covenant-light) loan is a type of loan that lacks the usual protective covenants, or conditions, typically imposed on borrowers. Traditional loan agreements include financial performance metrics that the borrower must meet (such as maintaining certain debt ratios). In covenant-lite loans, these requirements are relaxed, providing more flexibility to the borrower but increasing risk for the lender.

Example

A private equity firm might secure a covenant-lite loan for a leveraged buyout, allowing it to avoid strict financial performance benchmarks, which traditional loans would typically require.

Key points

• Covenant-lite loans have fewer restrictions and conditions for borrowers compared to traditional loans.

• They provide greater flexibility for borrowers but increase risk for lenders.

• Common in leveraged buyouts and corporate finance, particularly in periods of low interest rates.

Quick Answers to Curious Questions

What makes a covenant-lite loan different from a traditional loan?

Covenant-lite loans lack the stringent financial covenants or performance metrics that traditional loans impose on borrowers, providing more flexibility.

Why are covenant-lite loans considered riskier for lenders?

They provide fewer safeguards for lenders because borrowers are not required to meet strict financial performance criteria, increasing the risk of default.