Springing covenant
Capital MarketsA financial test that applies only once a condition is met, typically when revolver drawings pass a stated threshold.
Also written: springing leverage covenant, springing test
A springing covenant sits dormant. It is tested only when something happens, most commonly when drawings under the revolving credit facility exceed a percentage of the commitment at a quarter end. Below that threshold there is no financial test at all.
It is the compromise that made covenant lite structures acceptable. Term loan investors gave up their quarterly maintenance test, but revolving lenders, who are usually relationship banks with money at risk on demand, kept a trigger that activates precisely when the company starts leaning on its liquidity line.
The detail that matters is who benefits. A springing covenant is frequently for the revolving lenders only, so a breach gives them rights while term lenders have none, which shapes who sits at the table in a renegotiation and who is merely told about it afterwards.
It changes borrower behaviour in a way worth knowing. A company approaching the drawing threshold near a quarter end has an obvious incentive to fund itself another way or to repay just before the test date, which is why lenders negotiate both the threshold and the testing mechanics rather than only the ratio.
Worked example
A credit agreement has no maintenance test on the term loan, and a springing net leverage covenant on the revolver that applies only if drawings exceed 40% of the commitment at a quarter end.
The company draws 30% and no test applies, whatever leverage has done. Draw 45% and the leverage test applies for that quarter.
The predictable consequence is a borrower managing its drawings around the test date, which is why the threshold, and whether undrawn letters of credit count toward it, get negotiated as hard as the ratio itself.