Loan covenant monitoring is the process by which a lender tracks whether a borrower is keeping the promises, or covenants, made in its loan agreement. A financial covenant sets limits on measures such as leverage, interest cover or the debt service coverage ratio, tested at regular dates.
In practice, the lender records each covenant and its test dates in a tracking system when the loan is set up. The borrower then delivers financial statements and a compliance certificate showing the calculations, which credit staff review and recalculate. The cushion between the result and the limit, called headroom, is tracked as an early warning of deterioration. A failure is a covenant breach, which gives the lender the right to act but more often leads to a negotiated covenant waiver or amendment. For property loans the main test is the loan-to-value covenant.