Incurrence covenant says that some of the restrictions on a borrower are not binding if the restriction is exceeded because of external factors. The increased use of these covenants has increased the amount of distressed debt. Can any of you paraphrase this and explain please? Thanks in advance.
Hiya - I understood it that there has been a growth in the use of ‘covenant light’ loans which are debtor friendly and means the loans are lent with fewer covenant protections for the lender. The growth of these types of loans is one of the reasons that there has been an increase in distressed debt. Incurrence covenants are a type of ‘covenant light’. Incurrence covenants allow a covenant to be breached without the loan being in default provided it has been caused by an external factor only. An example of this is if the debt/earnings ratio was higher than the covenant allows, but has not been caused by the firm issuing more debt then although the covenant is technically in breach, the firm would still not be in default of the covenant. This means they wouldnt have to do anything to rectify it and there is therefore more chance of the loan going into distress in the future. Did anyone understand this differently?
Wow - I think this makes total sense. Thank you so much, yet again! Truly appreciate.
You’re welcome, glad it makes sense to you too