The purpose of covenants is to protect creditors by means of the realistic definition of goals (yield and credit repayment).
Real estate related covenants are:
- Loan to Value Ratio ([LTV]1, 2, 3, 4
- Loan to Cost Ratio ([LCR]5, 6
- Interest Cover Ratio ([ICR]7
- Debt Service Coverage Ratio ([DSCR]).
The following can also be found under this heading:
- Reservation of agreement on changes of members of the company
- Reservation of agreement on agreements relevant to cash flow
- Verified financial reports on company and real estate
- Entitlement to valuation at the expense of the debtor
- Prohibition of loan repayments to company members
Balance sheet related covenants are agreements on:
- Minimum net worth
- Minimum asset value
- Minimum ratio of current assets and liabilities, less intangible assets
- Minimum liquidity
- Violation of covenants can lead to the termination of credit agreements.
1 The lower the calculated percentage value, the lower the risk of loss to the creditor.
2 Estimated value: It is recommended to obtain the definition of how the estimated value was derived.
3 Side effect: The ratio determines how much of its own resources the debtor has to invest to finance the purchase.
4 Material structure: Real estate value definition as the reference value for the ratio, ratio for fixing the loan value (static? control? costs?), constant ratio (ratio as upper limit, otherwise the debtor has the right to automatic loan increase /in the case of amortisation loans the residual value as the upper limit), additional ratio for falling property value despite stable profit situation to prevent an event of default, parameters for fixing a higher value.
5 Purchase of an existing property: investment costs can be determined in purchase contract.
6 Construction financing: precise review of cost ratios (hard and soft factors) / dependence of ratio on advanced sales or rentals.
7 Structuring options such as definition of net operating income, relevance of ratio (payout date only or for the entire term of the loan?), ratio changes (none? sliding scale? increase?), determination of ratio (forward looking covenant or ex post looking covenant?), check intervals, dividend payouts to shareholders (highest interest coverage ratios, earliest term etc.?)
