Loan Covenant Waiver

A loan covenant waiver is a lender's written agreement to give up the rights it would otherwise have because a borrower has breached, or is expected to breach, a covenant in a loan agreement. Without a waiver, a breach of a financial covenant or another undertaking is usually an event of default that lets the lender stop further lending and demand early repayment. The waiver removes that threat, either for a single test date or for a defined period.

Waivers are a routine part of corporate and commercial lending and the most common outcome of a covenant breach. They are related to, but narrower than, an amendment, which permanently changes the terms, and a standstill, in which lenders agree not to enforce for a period while a debt restructuring is negotiated. In a syndicated loan the agreement sets out which group of lenders must consent.

Think of a gym membership with a rule that you must attend at least twice a month or lose your discount. One month you are ill and miss the target. You call the gym, explain, and they agree in writing that this one month will not count against you, perhaps asking you to sign up for an extra class in return.

A covenant waiver is that phone call and that letter. The borrower has missed, or is about to miss, a target it promised the bank. The bank agrees not to treat it as a default this time, usually in exchange for a fee or some tighter conditions, so the relationship carries on instead of ending in a dispute.

The process normally starts before the breach shows up in the compliance certificate. Treasurers track headroom against covenant levels and approach lenders early when forecasts point to a shortfall.

1. Request. The borrower, often with advisers, sends a waiver request explaining the cause of the breach, updated forecasts and proposed terms.
2. Lender review. Lenders assess the borrower's credit risk, the likely path of the ratios and whether to seek better protection in return.
3. Consent. In a bilateral loan the single lender decides. In a syndicated loan the agreement sets the threshold: most covenant waivers need majority lender consent, defined by a share of commitments, while changes to principal, interest, fees or maturity typically need all affected lenders.
4. Documentation. The parties sign a waiver letter or amendment that states exactly what is waived, for which period, and any new conditions.

Because a breach can also trigger a cross-default clause in the borrower's other debt, borrowers often need matching waivers from bondholders, derivative counterparties or other lender groups at the same time.

• A waiver fee. Usually a one-off payment expressed in basis points on each consenting lender's commitment.
• Higher pricing. A step-up in margin, sometimes temporary until the ratios recover.
• Tighter terms. Lower limits on dividends, acquisitions or new debt, more frequent reporting, or a reduction in undrawn commitments.
• New support. Additional security or guarantees, or an equity injection by the owners, which some agreements permit as an equity cure.
• A covenant reset. Instead of waiving one test, lenders may reset the levels for future periods, which turns the waiver into an amendment.

Lenders weigh these gains against the alternative. Accelerating a loan to a business that is still paying interest can destroy value, so a waiver on stricter terms is often the better outcome for both sides. Borrowers with covenant-lite loans rarely need maintenance waivers, which is one reason sponsors favour that structure.

The timing of a waiver matters for the borrower's accounts. Under IFRS, as amended by the IASB's "Non-current Liabilities with Covenants" changes to IAS 1 that apply to annual periods beginning on or after 1 January 2024, a loan in breach at the reporting date must be shown as a current liability unless the borrower already has the right to defer settlement for at least twelve months. A waiver obtained after the reporting date, even before the accounts are approved, does not change that classification. US GAAP has its own rules in ASC 470-10. Moving long-term debt into current liabilities can weaken the balance sheet and raise going-concern questions for auditors.

For banks, a single waiver to a sound borrower is ordinary credit management. Repeated waivers, or waivers granted because the borrower is in financial difficulty, can amount to forbearance, which supervisors such as the European Central Bank expect banks to identify and report. Forborne loans attract closer monitoring, may move into a higher-risk stage for expected credit loss (ECL) under IFRS 9, can increase the bank's loan loss provision, and in some cases are classified as a non-performing loan. A waiver therefore often signals a rise in the lender's estimate of probability of default, even when no payment has been missed.

• IFRS Foundation
• Loan Market Association (LMA)