Covenant monitoring: how lenders check each certificate against the financial statements

Covenant monitoring is how a lender checks that each borrower still meets the terms of its loan agreement. The borrower sends its financial statements and a compliance certificate, most often each quarter. The lender's credit team recomputes each covenant from the statements. It then compares the results with the certificate and with the limits in the agreement.

What lenders test in covenant monitoring#

A covenant is a condition in a loan agreement that the borrower must meet. The FDIC, a US bank regulator, splits covenants into financial and non-financial ones in its examination manual. Financial covenants set limits in dollar amounts or ratios, such as a cap on debt compared with earnings. Non-financial covenants cover matters such as management changes, guarantees and asset sales. Other terms in the agreement say what the borrower must report, and by when.

Banks, private credit funds and asset-based lenders all run these tests. On company loans, the ratio tests usually measure earnings as EBITDA. EBITDA means earnings before interest, taxes, depreciation and amortization. Real estate loans use the property's net operating income instead. A liquidity test uses no earnings at all, only cash and unused credit. The table shows four common financial covenants and where each input comes from.

These are common formulas, not fixed rules. Each credit agreement defines its own terms. The OCC is another US bank regulator. Its handbook on real estate lending says debt service coverage for a covenant test may differ from the DSCR used in underwriting. The OCC's handbook on asset-based lending says the definition of fixed charge coverage can vary by borrower. On real estate loans, the inputs come from the property's rent roll and its trailing 12-month (T12) operating statement. The CRE underwriting page covers those documents.

EBITDA itself is defined in each agreement. The agreement lists the costs a borrower may add back to its earnings, such as restructuring or deal costs. These items are called add-backs. The law firm Sidley Austin notes that lenders often cap some add-backs, frequently as a percentage of EBITDA. A St. Louis Fed working paper looked at syndicated loans. It found that EBITDA as the loan agreement defines it often differs from EBITDA under standard accounting rules (GAAP). It also found that add-backs have become more common. So recompute each covenant with that borrower's own definitions, because a generic formula can give a different answer.

What the borrower sends each quarter#

The covenants a lender tracks each quarter are maintenance covenants. The borrower must meet them at every test date. Incurrence covenants are different. They're tested only when the borrower wants to take a step such as borrowing more or paying a dividend.

In private credit, Sidley Austin says maintenance covenants are typically tested each quarter. The borrower reports the results in a compliance certificate, which it sends with its financial statements. The certificate typically arrives 45 to 60 days after the quarter ends. The OCC says the company's principal financial officer usually completes the certificate. The borrower usually has to send supporting data too. The agreement also says whether the annual statements must be audited or reviewed by an accountant.

Asset-based loans add more documents, and they arrive more often. The borrower sends a borrowing base certificate and its accounts receivable (AR) aging reports, often weekly or monthly. The section on borrowing base certificates below explains both.

Each borrower's package looks a little different. S&P Global Market Intelligence sells a covenant monitoring service. S&P warns that breaches are easy to miss when covenants are written in nonstandard agreements and in documents with no set format.

A worked example: Tollmere Fabrication's second-quarter certificate#

Tollmere Fabrication is an example borrower for this walkthrough. It's a metal fabricator with a term loan and a revolving line of credit. Its agreement has three financial covenants, each tested at quarter end. The two ratios use the last 12 months of results, and liquidity uses the balances on the test date. Ratios are written as multiples, so 3.50x means debt is 3.5 times EBITDA.

The agreement sets a debt-to-EBITDA ratio of 3.50x or less and fixed charge coverage of 1.20x or more. It also requires liquidity of at least $3.0 million. Liquidity here means cash plus the unused part of the revolving line. EBITDA is net income plus interest, taxes, depreciation and amortization. The borrower can also add back restructuring costs, up to a cap. The cap is 10% of EBITDA before any restructuring costs are added back.

Tollmere's certificate for the quarter ended June 30, 2026, reports EBITDA of $10.5 million and debt of $35.0 million. It shows a debt-to-EBITDA ratio of 3.33x and marks all three covenants as met. Here is how the credit team checks it.

1. Read the certificateNote the test date and every figure it reports. Its EBITDA of $10.5 million adds back all $1.5 million of restructuring costs.
2. Rebuild EBITDA from the statementsAdd up the last four quarterly income statements. Net income was $3.4 million. Interest of $2.6 million, taxes of $1.0 million, and depreciation and amortization of $2.0 million bring the total to $9.0 million before add-backs.
3. Apply the agreement's capThe cap is 10% of $9.0 million, which is $0.9 million. Only $0.9 million of the restructuring costs counts, so EBITDA for the covenant is $9.9 million.
4. Check debt against the balance sheetThe balance sheet shows $26.0 million on the term loan, $7.0 million drawn on the revolving line and $2.0 million of finance leases. The total, $35.0 million, matches the certificate.
5. Recompute and compareDivide $35.0 million by $9.9 million, and the ratio is 3.54x. That's above the 3.50x maximum. The certificate showed 3.33x.

One line of the agreement explains the breach. The certificate added back the whole restructuring cost, but the agreement caps it. The lower EBITDA also cuts fixed charge coverage, since that ratio starts from EBITDA too. Start from the recomputed EBITDA of $9.9 million. Subtract $1.3 million of equipment spending that wasn't paid for with new borrowing, and $1.0 million of cash taxes. That leaves $7.6 million. Divide it by $5.6 million of interest and scheduled principal, and the ratio is 1.36x, which still passes. The certificate started from its $10.5 million EBITDA, with the full add-back. That gave $8.2 million divided by $5.6 million, or 1.46x.

Liquidity doesn't use EBITDA. It's $4.2 million in both columns, made up of $1.2 million of cash and $3.0 million unused on a $10.0 million line.

Tie-outs to run on every certificate#

A tie-out checks one figure against the document it came from. Run the same tie-outs for every borrower each quarter, and keep the results with the certificate.

• The period matchesThe certificate's test date and 12-month period should match the statements that came with it.
• EBITDA matches the income statementsRebuild EBITDA from the last four quarterly income statements. It should equal the certificate's figure before add-backs.
• Each add-back is allowed and within its capCheck every add-back against the agreement's list and limits. Tollmere's test failed here.
• Debt matches the balance sheetCount every kind of debt the definition includes, such as finance leases and drawn credit lines.
• The certificate's own math worksRecompute each ratio from the certificate's own inputs. A typing error in one ratio can hide a breach.
• An officer signed itThe OCC says the principal financial officer usually completes the certificate. Check who signed it and when.
• It arrived on timeLog the date it came in. The agreement sets a delivery deadline and sometimes a grace period.

Our take. An analyst shouldn't spend time retyping a certificate that ties out. Software agents can read each package and run these tie-outs before an analyst looks. The analyst should then see only what failed, such as Tollmere's debt-to-EBITDA test. The analyst should get that failed test with the add-back line, the agreement's cap and both calculations side by side.

Borrowing base certificates and AR aging reports#

Asset-based loans work differently. The lender advances money against the borrower's receivables and inventory, up to a limit called the borrowing base. The OCC says asset-based lenders often require borrowing base certificates and supporting documents weekly or monthly. Some borrowers send them daily, depending on their risk and their collateral.

The borrowing base certificate lists the borrower's receivables and takes out the ones that can't count. These are called ineligible. Then it applies an advance rate. The advance rate is the share of eligible receivables the lender will lend against. The AR aging report lists each customer's unpaid invoices by how long they've been open. The main tie-out is simple. The certificate's total receivables should equal the aging report's total for the same date. For example, a certificate shows $8.4 million of receivables, but the aging report totals $8.1 million. The team needs an answer for the $0.3 million gap before it relies on the amount the borrower can draw.

The aging report also shows which invoices are too old to count toward the borrowing base. The OCC says an invoice is normally ineligible once it's past due by three times its payment terms. Its example is 90 days for 30-day terms. Most agreements also exclude all of a customer's invoices once some of that customer's invoices become ineligible. The OCC calls this cross-aging. When an asset-based loan has a financial covenant, the OCC says it's typically a minimum fixed charge coverage ratio. Some agreements test it only when the amount the borrower can draw falls below a set level. This is called a springing covenant.

When a covenant fails#

A failed test is a breach of the loan agreement. The credit team records the breach and its cause. For Tollmere, the cause is the cap on one add-back.

What happens next is the credit team's decision. The lender can waive the breach, agree to an amendment with the borrower or use its rights under the agreement. The OCC's asset-based lending handbook asks lenders to analyze each violation to find its root cause and the right corrective action. It says a decision to waive covenant requirements should be documented and well supported. It also warns that failing to spot violations, or waiving them regularly, may weaken the lender's ability to enforce the covenants later.

Sponsor-backed private credit loans often have one more option, called an equity cure. The sponsor is the private equity firm that owns the borrower. Sidley Austin describes the cure as the sponsor's right to restore compliance by putting in more equity. The cure money counts as EBITDA for the covenant test only. Tollmere would need EBITDA of $10.0 million to meet 3.50x on $35.0 million of debt. If Tollmere had a sponsor with a cure right, $0.1 million would cover the shortfall.

Whatever the outcome, record it next to the test result. Next quarter's test starts from the same agreement, plus any amendment or waiver.

How to automate covenant monitoring#

Most of the work above is reading and arithmetic. Software can take over both, and your credit team keeps the decisions.

Docsumo reads compliance certificates and borrowing base certificates, along with the financial statements and aging reports behind them. It handles any document type, not only the types it has pre-built models for. Certificates that arrive as email attachments can go to Docsumo's inbox for emails. Tables that run across pages, such as a long AR aging report, are joined into one table with the headers mapped.

You set up the checks as steps in the workflow. A Python step runs a short piece of your own code. The step can recompute each covenant with the agreement's definitions, then compare the result with the limit. On the Enterprise plan, cross-document checks compare the certificate with the financial statements. They can also compare a borrowing base certificate with its AR aging report.

When Docsumo isn't sure it read a field correctly, it sends that field to a person for review. Clicking a field shows the line in the document it came from. Docsumo sends the checked figures to your covenant tracker or loan system through the API and webhooks, which pass data between systems. You can also download them to Excel. Keep the covenant schedule and the waiver history in the system you use today.

The lending page shows the other documents in a loan file that Docsumo reads. If your analysts also spread each borrower's statements, see financial spreading and our guide to spreading financial statements. For the extraction side, read how to extract data from financial statements. AI in lending covers other uses of AI across the life of a loan.

Start with last quarter's certificates#

Pick a quarter your team has already finished checking. Include a borrower that needed a waiver. Run that quarter's borrower packages through the software and compare what it flags with what your analysts found. Count the covenants it recomputed correctly and the fields a person had to fix. Those two counts show how much of next quarter's checking the software can do.

Book a demo with a few of your borrowers' certificates and statements, or start a free trial.

Frequently asked questions#