4. Debt Covenants
d. describe the role of debt covenants in protecting creditors;
What are bond covenants?
Bond covenants are a bond issuer's enforceable promises to perform or refrain from performing certain actions.
What are some examples of affirmative bond covenants that issuers must take?
- paying interest and principal on a timely basis.
- paying taxes and other claims when due.
- keeping assets in good conditions and in working order.
- submitting periodic reports
What are some examples of negative bond covenants that issuers must refrain from?
- the borrower's ability to incur additional debt or other liabilities.
- dividend payments and stock repurchases.
- production and investment (mergers and acquisitions, sales and leaseback, or outright disposal of certain assets).
- payoff patterns
How is it determined if a covenant is violated? What happens if a covenant is violated?
Auditors and management must certify that the firm has not violated the covenants. If any covenant is violated, the firm is in technical default of its leading agreement, and the creditor can demand repayment of the debt after the stated grace period.