What restrictive covenants appear in bond indentures?

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AcadiFi · Accepted Answer

Restrictive (or 'negative') covenants limit borrower actions to protect bondholders. Core covenants in high-yield indentures:

1. **Limitation on debt (leverage covenant)**: Incurrence test — can only add debt if pro-forma leverage below specified ratio (e.g., 4.5x Total Debt/EBITDA). Or fixed-charge coverage above threshold (e.g., 2.0x).
2. **Limitation on restricted payments (RP)**: Dividends, share buybacks, investments in unrestricted subsidiaries limited to a 'builder basket' (50% of net income since issue) plus general baskets.
3. **Limitation on liens**: Can't grant security on assets without equally and ratably securing existing unsecured bonds.
4. **Limitation on sale-leaseback**: Curbs financial engineering around asset-based debt.
5. **Limitation on transactions with affiliates**: Arms-length pricing for related-party deals, board approval, fairness opinions above thresholds.
6. **Change of control (CoC)**: Bondholder put at 101% if change triggers credit deterioration (usually ratings downgrade).
7. **Asset sale covenant**: Requires prepayment with net proceeds or reinvestment within specified window (e.g., 365 days).

Example: Corvallis Packaging issues $500M senior notes at 7.5%. Indenture key covenants:
- Leverage < 5.0x for debt incurrence
- RP basket: 50% of net income + $50M general basket
- Asset sale: reinvest within 540 days or repay bonds at par
- CoC put at 101%

Covenant-lite trend: many newer HY deals have weakened builder baskets, permitted-investment carveouts, and EBITDA adjustments (cost savings, synergies) that effectively loosen leverage tests. The iShares US HY covenant quality has declined since 2015.

For analysts: model specific covenant headroom and calculate distance-to-cure when stressed.

What restrictive covenants appear in bond indentures?

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