Covenants #3 of 3: Covenants Shouldn’t Be a Surprise to Borrowers

𝗖𝗼𝘃𝗲𝗻𝗮𝗻𝘁𝘀 𝗦𝗵𝗼𝘂𝗹𝗱𝗻'𝘁 𝗕𝗲 𝗮 𝗦𝘂𝗿𝗽𝗿𝗶𝘀𝗲 𝘁𝗼 𝗕𝗼𝗿𝗿𝗼𝘄𝗲𝗿𝘀

In the last two weeks, I've shared some thoughts on a topic that trips up even well-run financial institutions: financial covenants for commercial loans. Here are some considerations for being transparent with borrowers, because 𝙘𝙤𝙫𝙚𝙣𝙖𝙣𝙩 𝙘𝙤𝙢𝙥𝙡𝙞𝙖𝙣𝙘𝙚 𝙬𝙤𝙧𝙠𝙨 𝙗𝙚𝙨𝙩 𝙬𝙝𝙚𝙣 𝙩𝙝𝙚 𝙡𝙚𝙣𝙙𝙚𝙧 𝙖𝙣𝙙 𝙗𝙤𝙧𝙧𝙤𝙬𝙚𝙧 𝙖𝙧𝙚 𝙤𝙣 𝙩𝙝𝙚 𝙨𝙖𝙢𝙚 𝙩𝙚𝙖𝙢, 𝙣𝙤𝙩 𝙤𝙣 𝙤𝙥𝙥𝙤𝙨𝙞𝙩𝙚 𝙨𝙞𝙙𝙚𝙨 𝙤𝙛 𝙖 𝙧𝙚𝙦𝙪𝙞𝙧𝙚𝙢𝙚𝙣𝙩.

Every commercial loan agreement includes covenants. Too often, the borrower can't name them. They're buried in loan documents signed in a rush at closing, alongside a dozen other things competing for the borrower's attention:

• Financial covenants
• Reporting requirements
• Negative covenants

The result is often a borrower who nods along at the closing table, doing their best to keep up with unfamiliar language in the middle of a high-stakes process, without a clear sense of what they've agreed to monitor, avoid, or deliver.

That's a problem for everyone. Borrowers who don't understand their covenants can't manage toward them. Lenders who don't ensure that understanding are setting up avoidable defaults, awkward conversations, and eroded trust down the road.

𝗧𝗿𝗮𝗻𝘀𝗽𝗮𝗿𝗲𝗻𝗰𝘆 𝘀𝘁𝗮𝗿𝘁𝘀 𝗯𝗲𝗳𝗼𝗿𝗲 𝗰𝗹𝗼𝘀𝗶𝗻𝗴, 𝗯𝘂𝘁 𝗶𝘁 𝗱𝗼𝗲𝘀𝗻'𝘁 𝗲𝗻𝗱 𝘁𝗵𝗲𝗿𝗲.
Ideally, covenants get walked through in plain language during commitment and closing — not just buried in loan documentation. But realistically, closing day rarely sinks in. Borrowers are focused on getting funded, not on debt service coverage ratios. The deeper conversation (what a covenant measures, why it exists, what happens if it's missed) is usually more productive a few weeks after funding, once the immediate stress of closing has eased.

That conversation is often most effective when it's concrete. For example, a simple worksheet where the borrower fills in their own numbers and calculates the covenant themselves. Nothing builds understanding like watching the math work. And it doesn't have to fall solely on the lender: an experienced analyst or credit team member can often deliver it just as clearly, freeing the lender to focus on the broader relationship.

𝗔𝗻𝗱 𝘁𝗵𝗲𝗻: 𝗺𝗼𝗻𝗶𝘁𝗼𝗿 𝗮𝗻𝗱 𝘁𝗲𝘀𝘁. 𝗘𝘃𝗲𝗿𝘆 𝘁𝗶𝗺𝗲.
Transparency isn't just about explaining covenants once. It's about consistently tracking them because borrowers will respect what you inspect. A covenant that's explained but never tested implies that it doesn't really matter. A covenant that's monitored, tested, and discussed at every review sends the opposite message: this is a real commitment, and we're paying attention together.

The institutions that do this well don't just avoid surprises. They build credibility with borrowers, with examiners, and with their own credit culture.