loan-covenant-review

Loan Covenant Review Skill

Covenants are the bank's smoke detectors — but only if someone reads them as trends, not snapshots. This skill runs the quarterly discipline: where is each covenant now, which direction is it moving, when does the trend cross the line, and what do we do before it does.

What This Skill Produces

• A covenant compliance table: required vs actual vs headroom, with trend
• Trajectory-to-breach analysis for any tightening covenant
• Waiver/amendment options with typical pricing implications
• Qualitative early-warning indicators checked
• A watch-list / risk-grade recommendation

Required Inputs

Ask for what's missing; with partial data, compute what's computable and mark the rest [awaiting financials]:

• Facility & covenant package — each covenant's definition, required level, test frequency, cure rights
• Current-quarter financials and at least 2–4 prior quarters for trend
• Compliance certificate figures if the borrower has submitted one
• Relationship context — prior waivers, recent management contact, sector conditions

Review Framework

1. Covenant table. For each covenant: required level, actual, headroom % = (actual − required) ÷ required (sign-adjusted so positive = compliant for both maximum-leverage and minimum-coverage covenants). Recompute actuals from the definitions in the agreement — borrower certificates use borrower-friendly add-backs; note any definitional divergence.

2. Headroom bands:

Headroom	Status	Response
>20%	Comfortable	Routine monitoring
10–20%	Monitor	Note trend; quarterly attention
<10%	Early warning	Trajectory analysis, proactive borrower dialogue
Breached	Breach	Reservation of rights, waiver/amendment track, risk-grade review

3. Trajectory-to-breach. For anything under 20% or trending down 2+ quarters: extend the trend 2–4 quarters and state the projected breach quarter with the assumption ("on the last 3 quarters' EBITDA slope, leverage crosses 3.5x in Q2"). Label it a trend projection, not a forecast. Seasonality: compare year-on-year quarters before calling a trend.

4. Options if breach is likely or occurred. Frame the menu with typical pricing logic (calibrate to institution practice): one-off waiver (waiver fee, often bps on commitment); reset/amendment (amendment fee + margin step-up, often with tightened baskets, added reporting, or a sweep); equity cure if documented; standstill/reservation of rights while options are assessed. Note: accepting payment or staying silent after a known breach can prejudice rights — flag "reserve rights promptly" whenever a breach exists.

5. Early-warning indicators (qualitative). Check: late or requalified financials, auditor change or going-concern language, CFO/management turnover, maxed revolver utilisation creep, stretched payables, delayed compliance certificates, adverse sector news. Two or more present → recommend watch-list consideration even with numeric compliance.

Output Format

Covenant review: [borrower / facility / test date]

1. Summary verdict — compliant / early warning / breach, one paragraph. 2. Covenant table — covenant | definition source | required | actual | headroom % | 4-quarter trend | status. 3. Trajectory analysis — projected breach quarter and assumptions, per tightening covenant. 4. Early-warning indicators — checklist with evidence. 5. Options & pricing implications — if relevant: waiver / amend / cure / reserve rights, with trade-offs. 6. Recommendation — grade/watch-list action, borrower conversation points, next review date.

End with: "This review is analytical support, not a credit or enforcement decision. Waivers, grading, and rights reservations follow your institution's credit policy and applicable regulation."

Quality Checks

• Headroom computed with correct sign for max vs min covenants
• Actuals recomputed from agreement definitions, or the reliance on borrower certificate is stated
• Every <20%-headroom or 2-quarter-declining covenant has a trajectory projection with stated assumptions
• Seasonality considered before a trend is called
• Any existing breach triggers an explicit reservation-of-rights flag
• Qualitative indicators reviewed, not just the numbers

Anti-Patterns

• Do not report compliance as a snapshot — a compliant covenant with three quarters of decay is the finding
• Do not accept borrower add-backs without checking them against the agreement's EBITDA definition
• Do not project a breach without stating the assumption the projection rides on
• Do not stay silent on a known breach — flag reservation of rights immediately
• Do not recommend a waiver without naming what the bank gets for it (fee, margin, information, structure)