Covenant Analysis Mastery: Key Takeaways from Our Latest FLT Office Hours

The following blog was written by our Founder, Sabrina Fox, following Friday’s FLT Office Hours session.

In our recent FLT Office Hours session, we discussed the practical, covenant-by-covenant assessment that can completely change how you approach these deals. If you missed it, here's what you need to know.

Don't Start with the Covenants (Seriously)

Look, I get it. You want to dive straight into the covenant analysis. But here's the thing - that's exactly how you end up completely lost. I've seen analysts do this countless times, and it never ends well.

You've got to zoom out first. These covenant terms aren't just random legal language - they're part of a contract, sitting inside a transaction, between real people, happening in this absolutely wild market we're all dealing with right now.

I call this your "Point A" - where are you actually starting from? What's your position in the capital structure? What collateral do you have? What guarantees? Once you nail that down, everything else will make much more sense.

The Three Buckets Framework (Yes, I Talk About This All the Time)

Okay, for those who've heard me bang on about this before -sorry, but it's just that important. Take everything the borrower owns and sort it like this:

Bucket One: What's pledged to you

Bucket Two: What's pledged to other lenders

Bucket Three: What's not pledged to anyone

That third bucket? It's basically your early warning system. The value sitting there today tells you everything about what could happen down the road.

Debt Covenants: It's Not Just About the Ratio

Here's where people get tripped up constantly. The ratio debt test - that first paragraph of the Debt covenant that everyone focuses on- it's not a cap. It's just one permission. Then you've got all these permitted debt baskets, giving you even more capacity on top of that.

And here's a hard-learned lesson: write down the clause numbers for every single debt basket. I know it sounds tedious, but when you get to the liens analysis and the document starts throwing around cross-references instead of saying "general debt basket," you'll thank me. I've had to redo entire analyses because I skipped this step, and trust me, you only make that mistake once.

The Restricted Payments Trap

This is where I see analysts do half the job and think they're done. You can't just look at the Restricted Payments covenant and call it a day. You need to check out the Permitted Investments definition too, or you're missing huge chunks of capacity.

Here's what really gets people: nearly all Restricted Payments capacity can be used for Unrestricted Subsidiary investments. Don't just focus on that one specific basket - you need to add up everything to understand what the borrower can really do.

Change of Control Got Clever

Remember when Change of Control covenants actually meant something? These days, "portability" has basically flipped the script. Borrowers can get sold to new owners as long as they hit a leverage ratio threshold.

But here's the kicker - that leverage calculation? It's not what you see in the financial statements. Between all the debt deductions and EBITDA add-backs, you could be looking at a 1.5x difference. Makes you wonder if you're really comfortable with that change of control happening, doesn't it?

The Reclassification Trick That Nobody Talks About

This one catches even experienced analysts off guard. If a borrower can meet its ratio debt test at any point, nearly all those permitted debt baskets it’s used previously will automatically get treated as if they were incurred under the ratio test.

What does that mean? If you calculate that a borrower could hit its ratio test, assume ALL the permitted debt baskets are available. Yeah, it's a bit of a game-changer.

Not “Cov-Lite” – Now It’s “Cov-Light”

Sure, maintenance covenants are basically extinct in broadly syndicated loans. But "cov-light" has taken on a whole new meaning. These covenants are like reading tea leaves - they tell you what's possible, what the borrower might do next, how they might manage their capital structure down the line.

They're not just restrictions anymore. They're strategic tools wrapped up in legalese.

What You Should Actually Do

Look, covenant analysis isn't rocket science, but it does require a system:

·      Start with the big picture - capital structure and credit support first

·      Track those clause numbers religiously (seriously, just do it)

·      Add up all the restricted payments capacity - don't miss any buckets

·      Remember covenant math is different from financial statement math

·      Use all this as a crystal ball for what the borrower might do next

The full course is coming soon to the Fox Legal Training platform, and honestly, these provisions make a lot more sense when you'reworking through deal docs with a solid foundational understanding of how the terms work.

Missed the session? The full recording is available to Fox Legal Training clients, along with our full suite of resources including our flagship course, the Leveraged Finance Covenant Training course.

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