gabrielmoreira 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)