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have going to learn and tutorial on debt covenants bond covenant and some of the examples some of the advantages and disadvantages of the same at the very
first inception thing you know what you can see over here is that in simple
words that covenants are the restrictions very important imposed by
the lenders which are your investors or creditors on the borrower’s of the
company or the daters so what exactly is that governance as from the definition
you know debt covenants definition debt covenants are the restrictions imposed
by the lenders on the borrower’s so Ideally when the
lenders lend the money to the borrowers they sign an agreement so and under
these agreement the borrower have to maintain certain restriction so that the
interest on the lender is basically protected there’s an example over here
that however the agreement you know this is an extract from the agreement that
how things may work out see it’s shown that the net interest-bearing debt dual
total asset does not exceed point 65 the net secured debt to total asset
does not exceed 0.55 and the ratio of the adjusted profit before taxes on the
total interest expense exceeds 1.40 so this are all this is the
basically debt covenants of the bond covenants can be called in many names
though the most popular names are banking covenants and the financial
covenants actually they all mean the same thing so my next question I’m gonna
ask you questions and you are going to try and figure out why are debt
covenants necessary very important in other words you can say why pawn
covenants lenders would restrict the borrowers from doing something the bond covenants lenders don’t want to pressurize the borrowers with the rules and restrictions however if they don’t bind the borrower’s with few terms or
condition they may not get their money back exactly that’s a point so it is
also very important to notice that you know the debt covenants also helps the
borrower’s yes even after being restricted and when the agreement between the
borrower’s and the lenders is signed the terms and condition you have every time
you see this tnc terms and condition are discussed and if the borrower by the terms they may need to pay a lower interest rate that is basically the cost
of borrowering to the lenders let’s take some of the example so that you may get
a clearer idea of what we are talking about so let’s get into the example
let’s say that icebreaker is this come he called
icebreaker and company let’s say it has taken a a debt or a loan from a bank and
the bank has offered a company a loan of let’s say around 1 million this is in
millions ok this is $1 million loan stating that until the company pays
of the bank the principal plus interest of 10% the company won’t be able
to take any additional loan from the market now the restriction that is over
here that has been imposed by the bank on the Icebreaker company would be
called as the born governor right but why the bank would do such a thing
let’s analyze it first of all the banks would do it on its own due diligence
before lending at the amount of the Icebreaker and company second if the
bank finds that the Icebreaker company does not have a good risk profile the
lending amount would be risky too for a bank and in this case if the company
goes out and also borrows a million here and another million there and goes
belly-up says the bank will not get its money back I mean the bank will not get
back its money in in in totality cases thinking about the future
the bank may restrict the company from barring any additional loan
until the loan of the bank is being paid off in full in full
let’s understand the next thing that is the metrics the bond covenants metrics
have new lenders get to know what Bond covenants they need to impose upon the
borrower so here are some of the metrics that the lenders a borrower needs to
look at before imposing the bond covenants the first thing is the total
assets now a company that has a good enough
AUM remember this word AUM asset under management would have good financial
health at least on the surface so to know whether the company can pay off its
debt the lenders need to look at the next ratio second the debt to the assets
ratio now this is simple ratio that every lender needs to look at before
lending any money to the borrower at this ratio basically lends to the
investor understand whether the company has enough assets to pay off its debts
like for example if they have lower total assets than the debts then the
company may have lend into a big problem or else if the company has a pretty low
debt that is let’s say that is 10% of the total assets the company will be
playing to safe third the debt divided by the equity
that’s the next metric even if the equity shareholders would get paid off
after the debt holders would get the money still it’s important for the
investor to know the debt equity ratio of the company by looking at the ratio
they would be able to see how much debt and how much equity the company has
taken and what’s the risk of the debt holder to lose out
forth this is really I I consider this is really good reassured debt to EBITDA
ratio evidence preferred over EBIT this is one of the most important metric the
lenders should look at since EBITDA is basically owning before
interest tax depreciation and amortization and can really show whether
the company has the financial stability to pay off its debt which includes not
only the interest but the principal plus interest in the to time fifth the interest
coverage ratio now this is another measure that is so so very important
that interest coverage ratio compares the EBIT by EBITDA with the interest
so higher the ratio you can say higher the ratio is would be better or for the
lenders and if the ratio is lower than the lenders may not we may need to think
about the offering loan to the company the sixth metric is the dividend DP
ratio dividend payout ratio now why is this ratio even important
it’s it’s because the dividend payout ratio decides how much a dividend the
company would declare at the end of the year so if the dividend payout is too
high it may enhance that risk of the lenders and that’s why one of the most
common debt covenant is restricting the borrowers from paying the huge dividend
now there is a thing called positive covenant and there is everything called
negative covenant so let’s understand each of the positive debt covenant are
the thing that a borrower must do to ensure that they get the loan below like
you know positive covenants are like you know the aim at the specific range of
certain financial ratios like positive debt covenant is very important for the
lenders to note that they are protected to ensure that they’ll the lenders may
ask for the borrower to reach a specific range for a certain financial ratio to
evade the loan second basically to ensure the accounting practices are as
for the gap now this is the basic ask but an important one the lenders wasn’t
sure that the borrower’s are entering to the generally accepted accounting
principle the third is a present yearly audited financial statement a positive
debt covenant lenders must ensure whether the financial statement had
accurate and represents the right picture of the company’s financial
affairs and that’s why a yearly audit will definitely help now let’s discuss
the negative debt covenants the negative debt covenants are the things the
borrower cannot do below which the things cannot be done like you know the
first one this is only example don’t pay cash dividend or certain you can say
extend say if firm gives awar firm gives away the majority of its earning
in cash to it and how would it be of the money they owed to the lenders and
that’s why the lenders impose a restriction on the borrower’s that they
cannot pay cash dividend over the certain extent second don’t take any
additional additional loan so the negative debt covenant is
borrowers should not take more loans before they pay off the due to the
lenders and it helps to protect the interest of the lenders and don’t sell
specific asset negative debt covenants lenders may also restrict the borrows
from selling certain until the debt is being paid full so
doing so will compel the borrowers to generate more earnings to pay off the
debts so the negative debt covenants will protect both the lenders and the
borrowers in the long run if you have learned and you know liked the video if
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