Bond Covenant

What is a 'Bond Covenant'

A bond covenant is a legally binding term of agreement between a bond issuer and a bond holder. Bond covenants are designed to protect the interests of both parties. Negative or restrictive covenants forbid the issuer from undertaking certain activities; positive or affirmative covenants require the issuer to meet specific requirements.

BREAKING DOWN 'Bond Covenant'

All bond covenants are part of a bond's legal documentation and are part of corporate bonds and government bonds. A bond's indenture is the portion that contains the covenants, both positive and negative, and is enforceable throughout the entire life of the bond until maturity. Possible bond covenants might include restrictions on the issuer's ability to take on additional debt, requirements that the issuer provide audited financial statements to bond holders and limitations on the issuer's ability to make new capital investments.

When an issuer violates a bond covenant, it is considered to be in technical default. A common penalty for violating a bond covenant is the downgrading of a bond's rating, which could make it less attractive to investors and increase the issuer's borrowing costs. For example, Moody's, one of the major credit rating agencies in the United States, rates a bond's covenant quality on a scale of 1 to 5, with five been the worst. This means that a bond with a covenant rating of five means that covenants are being violated consistently. In May 2016, Moody's reported that overall covenant quality in the market declined to 4.56 from 3.8 the previous month. The downgrade is attributed to a high amount of junk bonds being issued, ones with strict covenants that are easier to default.

An Example of a Bond Covenant

On June 23, 2016, Hennepin County, Minnesota, issued a bond to help finance a part of the ambulatory outpatient specialty center at the county's medical center. Fitch ratings gave the bond a AAA rating, because the bond is backed by the county's full faith, credit and unlimited taxing power. Additionally, the rating agency gave the county's outstanding Hennepin County Regional Railroad Authority limited tax GO bonds (HCRRA) a AAA rating for the same reasons, including the fact that the county can pay the debt using ad valorem taxes on all taxable property.

The HCRRA bond debenture contained a covenant stipulating that Hennepin County can levy taxes to fund the debt service at 105% annually. The debenture also stipulated that the maximum tax rate provides strong coverage of the debt service of 21.5x MADS.

RELATED TERMS
  1. Negative Covenant

    A bond covenant preventing certain activities, unless agreed ...
  2. Affirmative Covenant

    A type of promise or contract which requires a party to do something. ...
  3. Covenant

    A promise in an indenture, or any other formal debt agreement, ...
  4. Restrictive Covenant

    Any type of agreement that requires the buyer to either take ...
  5. Running With The Land

    The rights and covenants in a real estate deed that remain with ...
  6. Debt Limitation

    A bond covenant that limits or restricts any additional debt ...
Related Articles
  1. Markets

    Corporate Bonds and the Importance of Covenants

    Any type of investor, private or institutional, should be acquainted with the significance of covenants in corporate bond agreements.
  2. Investing

    Understanding Covenants

    A covenant is a term placed in a loan that requires the borrower to either maintain or refrain from certain business activities.
  3. Personal Finance

    Municipal Bond Tips For The Series 7 Exam

    Learn to distinguish between general obligation and revenue bonds to ace this test.
  4. Financial Advisor

    Advising FAs: Explaining Bonds to a Client

    Most of us have borrowed money at some point in our lives, and just as people need money, so do companies and governments. Companies need funds to expand into new markets, while governments need ...
  5. Markets

    Corporate Bond Basics: Learn to Invest

    Understand the basics of corporate bonds to increase your chances of positive returns.
  6. Markets

    Why Bad Bonds Get Good Ratings

    Credit ratings are not the only tool to rely on when assessing bonds. Find out why they sometimes fall short.
  7. Personal Finance

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
  8. Managing Wealth

    A Guide to High Yield Corporate Bonds

    The universe of corporate high yield bonds encompasses multiple different types and structures.
  9. ETFs & Mutual Funds

    Bonds

    What bonds are: Debt securities where you lend money to an issuer (e.g., a corporation or government) in exchange for interest payments and the future repayment of the bond’s face value. ...
  10. Managing Wealth

    The Basics Of Bonds

    Bonds play an important part in your portfolio as you age; learning about them makes good financial sense.
RELATED FAQS
  1. Why do companies issue debt and bonds? Can't they just borrow from the bank?

    Companies issue bonds to finance operations. Most companies can borrow from banks, but view direct borrowing from a bank ... Read Answer >>
  2. Is buying bonds on the secondary market safe with what the market is doing?

  3. What is the risk of holding a bond trading at a discount until maturity?

    Let’s say a corporate bond who was quoting 95 is now quoting 70 because of increased fear regarding the company. The ... Read Answer >>
  4. Which factors most influence fixed income securities?

    Learn about the main factors that impact the price of fixed income securities, and understand the various types of risk associated ... Read Answer >>
  5. Where can I find information about corporate bond issues?

    Learn information about corporate bond investments, including where investors can access information about new corporate ... Read Answer >>
  6. What are the risks of investing in a bond?

    The most well-known risk in the bond market is interest rate risk - the risk that bond prices will fall as interest rates ... Read Answer >>
Hot Definitions
  1. Bond Ladder

    A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of ...
  2. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  3. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  4. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  5. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  6. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
Trading Center