Quick answer
A loan covenant is a specific condition in your facility that you must keep meeting until the loan is repaid, such as holding the loan below a set share of the property's value, sending accounts by a deadline or not taking on more debt without consent. Each type of facility uses different covenants, and breaking one can put you in default even if every repayment has been made.
Key points
- The covenants you face depend heavily on the type of facility and lender
- Many are tested on fixed dates, often through a signed compliance certificate
- A loan-to-value covenant can be breached by a lower valuation alone
- Talking to the lender before a test date usually leads to a waiver or a reset
The broad idea of a covenant is simple: an ongoing promise in your loan. What matters in practice is which promises your particular facility contains, when they’re tested and how much room you have. A loan covenant is that promise as it actually appears in the agreement you sign.
What covenants does each type of lender use?
| Facility | Covenants you’re likely to see | How it’s usually checked |
|---|---|---|
| Bank commercial property loan | Maximum loan-to-value ratio, insurance, rental income levels | Revaluations, annual reviews |
| Larger bank term loan or overdraft | Debt service cover, interest cover, annual accounts by a deadline | Compliance certificate with yearly accounts |
| Equipment finance | Keep the asset insured, maintained and in Australia; don’t sell or sublease it | Insurance certificates, occasional inspections |
| Invoice finance | Concentration limits, ageing limits on invoices, all customer payments banked to the nominated account | Monthly ledger reports, debtor audits |
| Caveat or private loan | No further charges on the property, rates and insurance paid, repay by the exit date | Title searches, exit date |
Small business loans from banks that follow the Banking Code mostly avoid financial ratio covenants these days, apart from specialised lending such as property development. That leaves loan-to-value and reporting conditions as the ones small businesses meet most often.
How do covenant tests work?
Most covenants are checked at set points, not every day. Financial tests often fall on 30 June figures, with accounts due a few months later. Loan-to-value tests happen when the lender orders a new valuation, often at a review or when you ask for more money. Behavioural covenants, like insurance or not borrowing elsewhere, apply all the time.
The test dates matter because headroom can disappear without any change in how the business trades. A new valuation, a single customer making up too much of your ledger or late accounts can all trip a test. Diarise each date and run the numbers a month ahead.
If a covenant breach has already pushed your bank to withdraw a facility, let us know what happened and we’ll look at who might refinance it.
Worked example: a lower valuation breaches the LVR
An illustrative Newcastle engineering firm owns its warehouse, bought with a $1.2m bank loan when the property was valued at $2m. That’s a loan-to-value ratio of 60%, comfortably inside the 65% covenant.
At the five-year review, the bank’s valuer puts the warehouse at $1.75m. The loan is now about 68.6% of the value. Not a single repayment has been missed, but the covenant has been broken.
To get back to 65% on the new value, the loan must fall to $1,137,500, a paydown of $62,500. The owner’s options include:
- paying down $62,500 from cash reserves
- offering extra security, such as equity in another property
- asking the bank for a waiver until the next valuation, possibly in exchange for a fee or quarterly reporting
- refinancing with a lender whose maximum LVR is higher
In the end the owner negotiated a waiver, supported by a cash flow forecast showing the loan balance would fall below 65% within 18 months through scheduled repayments. Our LVR calculator shows how close your own facility is to its limit.
Related terms
- Covenant: the general concept and the Banking Code limits
- Debt service coverage ratio: the most common financial test
- Loan agreement: where every covenant is written
- Default: where an uncured breach can lead
Covenant trouble with your current lender?
Being in breach doesn’t mean the business is failing. Often it just means the facility no longer fits, and another lender with different terms can step in. Our enquiry form is short, about a minute’s work, and we don’t run a credit check when it comes through. Your details are kept for our use, not mailed out across the industry. Someone on our team, not a bot, studies the details and phones you to talk about the covenant problem and what can replace the facility. Please list your existing debt and security accurately so the options we raise actually work.
Frequently asked questions
What is a compliance certificate?
A short signed statement, usually from a director, sometimes backed by your accountant's figures, confirming that each financial covenant has been met at the test date. Larger facilities often ask for one every year or every quarter.
What is a covenant waiver?
A written agreement from the lender not to act on a particular breach, usually for one test period. Lenders may ask for something in return, such as a fee, extra reporting or a partial repayment.
What is a cure period?
The time allowed to fix a breach before the lender can act on it. Under the Banking Code, subscribing banks generally must give small business customers at least 30 days to remedy a non-payment default that can be fixed.
Do unsecured online loans have covenants?
They usually have only general ones, such as keeping the business trading, notifying the lender of changes and not giving false information. Lenders mostly manage risk through short terms and frequent repayments instead.
Can a covenant breach affect my credit file?
A covenant breach on its own isn't typically reported like a missed payment. If it leads to default and enforcement, that can later show up through defaults or court actions.