Covenant headroom is the gap between your actual ratio and the level the facility agreement allows. An agent can compute it every month on the agreement's own definitions, project it from the forecast and warn the treasurer early. A person confirms how each definition is read, and a director signs every compliance certificate before it goes to the lender.
What is covenant monitoring, and who owns it?
A loan or revolving facility usually carries financial covenants: leverage (debt against an adjusted earnings measure), interest cover, minimum liquidity or net worth, and sometimes capital expenditure limits. Each is tested at set dates, often quarterly, and the borrower sends a compliance certificate signed by a director. A breach can let lenders demand repayment or reprice the loan.
The treasurer or group financial controller owns monitoring. The CFO owns the conversation with lenders. Legal or external counsel is often involved in reading definitions, because the covenant's "EBITDA" is whatever the agreement says it is: it may add back restructuring costs, exclude certain gains, include acquired businesses for a full year or cap some adjustments.
This is the borrower's side. Lenders watch the same numbers from the other end, as in monitoring early warning signals in a loan book.
What are the steps, and who acts at each one?
- Agent, depth 1: extracts the covenant terms. From each signed facility agreement and its amendments: tests, levels, test dates, definitions, permitted adjustments, cure rights and certificate deadlines.
- Person, treasurer with counsel where needed: confirms the reading. Every definition the agent extracted is approved line by line and becomes the agent's covenant model. Evidence: a signed definitions register.
- Agent, depth 1: computes actual ratios each month. From closed management accounts and the ledger, applying the approved definitions, with every adjustment shown separately.
- Agent, depth 1: projects headroom. Using the approved forecast, to each future test date, with headroom as an amount and as the earnings or cash movement that would cause a breach.
- Agent, depth 2: drafts alerts. When projected headroom falls below the internal warning level the treasurer sets, it drafts a note explaining the driver.
- Agent, depth 2: drafts the compliance certificate. Calculations, schedules and the certificate text in the agreement's required form.
- Person, CFO or director: reviews and signs the certificate. The agent never sends it to the lender or agent bank.
- Person, CFO: decides any response. Waiver requests, amendments, equity cure, or changes to the plan.
| Step | The agent does | Depth | Stays with a person |
|---|---|---|---|
| Extract terms | Reads agreements and amendments | 1 | Nothing |
| Confirm definitions | Nothing new | none | Treasurer and counsel approve |
| Compute actuals | Applies approved definitions | 1 | Nothing routine |
| Project headroom | Uses approved forecast | 1 | Owning the forecast |
| Alert | Drafts the warning | 2 | Treasurer acts |
| Certificate | Drafts calculations and form | 2 | Director signs |
| Lender response | Nothing | none | CFO decides |
Which controls matter, and what evidence do they leave?
Definitions from the signed agreement only. Draft term sheets and summaries are not sources. Evidence: document reference and version for each term.
Adjustments shown, not netted. Each add-back appears as its own line with its support and any cap. Evidence: the adjustment schedule.
Reconciliation to the accounts. The covenant earnings figure reconciles to reported profit through the listed adjustments. Evidence: a reconciliation on every calculation.
Forecast version stated. Projections name the forecast version and its approval. Evidence: version reference on each projection.
Warning level set by a person. The internal warning level sits above the covenant level and is set by the treasurer, not by the agent. Evidence: the warning level version on each alert.
Certificate sign-off. Evidence: the signed certificate and the calculations it rests on, filed together.
What should you measure?
- Headroom by covenant over time, actual and projected, as the treasurer's main view.
- Months of warning between the first alert and any test date where headroom was thin.
- Differences between the agent's calculation and the final certificate. Each is a definition or data issue to resolve.
- Certificates delivered on time.
- Definitions changed by amendment and confirmed before the next test.
Where does it usually go wrong?
Accounting definitions instead of agreement definitions. The agent computes leverage from reported earnings. The agreement allows add-backs worth a lot of headroom, or excludes gains the accounts include. Confirming each definition before the first calculation prevents this.
Amendments missed. A waiver letter changed a level for two quarters. It was emailed and never filed with the agreement. Keep all amendments with the agreement and make the agent list the documents it read.
Pro forma adjustments for acquisitions. Many agreements let you include an acquired business's earnings for the full period. The agent needs the acquired business's figures and the date it was acquired; without them, it should flag that the test is incomplete.
Cure rights forgotten. An equity cure or a deemed earnings cure may exist. The agent should list them when headroom is thin, so the CFO knows the options.
Lender view differs. The lender reads the definitions differently. That is a negotiation, not a calculation. Lenders' own provisioning, as in preparing loan loss provision workpapers, depends on how they see your covenants.
Monitoring here means numbers in agreements, not people. Whether an agent should monitor staff communications for misconduct is a separate question with its own rules.
Where Pryme fits
In Pryme, extracting terms, computing ratios and drafting certificates are separate capabilities, certified on your own past test periods. Ledger figures arrive sealed, the signed agreement arrives as a signed source, and management adjustments are declared, so the certificate draft shows what each number rests on. The finance bounds are in AI agents for finance.
Questions people ask
Can the agent tell lenders about a likely breach?
No. What to tell lenders, and when, is a decision for the CFO and the board, often with counsel.
How often should headroom be computed?
Monthly on actuals, and whenever the forecast changes. Testing only at the quarter misses the warning time that makes monitoring useful.
Does the agent need the full facility agreement?
Yes, with every amendment, side letter and waiver. Definitions often refer to other clauses, so extracts are not enough.