The convenants in debt issues (known as conditions, or clauses in Spanish) are a set of rules and rules to follow established between the issuer and the investor.
These agreeants intend to prevent and avoid irresponsible channels of the issuer that may harm the holders of debt.
Conflicts of interest
There is a conflict of interest between debt issuers and investors. On the one hand, debt issuers try to obtain great flexibility in their financing strategy in order to be able to act with greater freedom. This could lead them to act in an irresponsible manner, compromising the repayment of the debt. On the other hand, investors, on the other hand, try to minimize the risk assumed in their investment decisions. In order to do so, they try to keep the company in an adequate performance framework that respects certain liquidity and solvency parameters.
This conflict of interest gives meaning to the establishment of clauses that adapt and level the interests of both groups. Therefore, the covenants in debt issuance is the term in English that describes the clauses that aim to keep the issuer within a more responsible course of action that provides greater protection to the investor
Although these covenants seek to limit the actions of issuers and channel them into more responsible management. However, in no case can they give the debt holders significant control over the business strategy. Nor can they act to the detriment of the value of the company.
Examples of covenants in debt issues
The amount and type of covenants that can be established in relation to an issuer may vary depending on the type of issue and the financial health of the issuer. Here are some examples.
- Restrictions and / or limitations of payments in the form of a dividend to shareholders or repurchases of shares.
- Limitation in mergers and acquisitions or cash salutations for different reasons.
- Option to sell the debt securities in the event of change of control shareholders.
- Maintenance of certain ratios such as, for example, the relation of debt and own funds or certain interest coverage ratios.
- Limitations to make new debt issues.