How to Answer “What’s the difference between maintenance covenants and incurrence covenants?” in Investment Banking Interviews
In investment banking interview prep, this is a common credit question because it tests whether you understand how lenders control risk through maintenance covenants vs incurrence covenants. When an interviewer asks, “What’s the difference between maintenance covenants and incurrence covenants?”, they want a clean definition, the practical implication for the borrower and lender, and one quick example.
At an analyst level, aim to explain when each covenant is tested, what happens if it’s breached, and where you typically see each structure (e.g., bank-style term loans vs high-yield bonds), without getting lost in legal drafting.
What Interviewers Test in IB Technical Interview Questions on Covenants
They’re checking whether you can translate legal/credit language into business impact. In Investment Banking, you’ll often summarise covenant packages for senior bankers, clients, or investors, so clarity and precision matter as much as the definition.
They’re also testing applied financial analysis: which ratios are typically used (e.g., leverage, interest coverage, FCCR), how headroom can tighten or loosen through performance, and why covenant design changes borrower behaviour.
Finally, this is a communication screen typical of IB technical interview questions—can you deliver a structured 60–90 second explanation, then go deeper only if prompted (e.g., equity cure, baskets, builder baskets, restricted payments)?
Maintenance Covenants vs Incurrence Covenants: Answer Framework
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Step 1: Give the one-line distinction (tested vs triggered)
Start with a direct contrast the interviewer can’t misinterpret:
- Maintenance covenants are tested regularly (usually quarterly) against a financial ratio or threshold, regardless of whether the company takes a specific action.
- Incurrence covenants are tested only when the borrower tries to take an action—like issuing more debt, paying dividends, making an acquisition, or granting liens.
Then add the key implication: maintenance covenants can force an earlier conversation with lenders if performance deteriorates, while incurrence covenants allow more operating flexibility until the company wants to do something that requires covenant capacity.
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Step 2: Explain how each one works in practice (headroom, breach, remedies)
Briefly walk through mechanics in “deal reality” terms—this is where covenants explained for interviews becomes practical.
For maintenance packages, you’ll often see ratio tests like Total Net Leverage ≤ X.0x or Interest Coverage ≥ Y.0x measured on LTM EBITDA and tested at quarter-end. If the ratio fails, it’s typically an event of default (subject to cure/waiver), which can lead to pricing step-ups, tighter terms, or acceleration.
For incurrence packages, think “permission slips”: the borrower can operate freely day-to-day, but must pass a test (often a leverage test) at the time of the action to incur more debt, make restricted payments, or execute certain investments—otherwise they can’t take that action (but they’re not automatically in default just because performance is weak).
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Step 3: Link to where you see them (loan vs bond; sponsor vs non-sponsor)
Add market context to show judgment—an important part of investment banking interview strategies.
- Maintenance covenants are more typical in bank-style credit agreements, especially revolving credit facilities and some term loans, because banks want ongoing monitoring and earlier intervention.
- Incurrence covenants are common in high-yield bond indentures, where investors generally accept fewer ongoing tests and rely more on pricing and structural protections.
You can also mention the trend: many leveraged loans have moved toward “covenant-lite” structures (fewer/no maintenance tests in the term loan), but there may still be a springing maintenance covenant tied to the revolver when it’s meaningfully drawn.
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Step 4: Give a 10-second numeric example and a takeaway
Close with a simple example to prove you can apply it.
Example: If a credit agreement has a maintenance covenant of Net Leverage ≤ 5.0x, it gets tested every quarter. If EBITDA drops and leverage jumps to 5.5x, the company may be in breach even if it raises no new debt.
For an incurrence covenant, the company might be allowed to incur additional debt only if Pro Forma Net Leverage ≤ 4.5x at the time of issuance. If it’s at 5.5x today, it simply can’t issue that incremental debt (or pay a dividend) unless there’s basket capacity—but it isn’t automatically in default just for being at 5.5x.
End with the takeaway: maintenance = ongoing early-warning system; incurrence = action-gating constraint.
Maintenance vs Incurrence Covenants Interview Answer (Analyst-Level)
Maintenance covenants are tested periodically, incurrence covenants are tested only when you take a specific action.
In more detail, maintenance covenants require the borrower to stay within a financial threshold—like net leverage, interest coverage, or fixed charge coverage—typically tested quarterly based on LTM results. If performance weakens and the ratio fails, that can trigger a default unless it’s cured or waived, so they act as an early-warning and control mechanism for lenders.
Incurrence covenants don’t get checked every quarter. Instead, they’re tested only when the borrower wants to do something, like issue additional debt, pay a dividend, make an acquisition, or grant a lien. If the company can’t satisfy the test at that point—often a pro forma leverage test—it usually can’t take the action, but it’s not automatically in default just because the business is underperforming.
You typically see maintenance covenants more in bank credit agreements—often with a revolver—while incurrence covenants are more common in high-yield bond indentures. A quick example: a quarterly maintenance test might require net leverage ≤ 5.0x; if EBITDA drops and leverage becomes 5.5x, that could be a breach. An incurrence test might require leverage ≤ 4.5x to raise incremental debt; at 5.5x, the company just can’t raise that debt unless it has basket capacity.
- Open with a crisp one-line contrast: “tested periodically” vs “tested on action.”
- Use one concrete ratio example (net leverage or coverage) to show you can apply it.
- Mention typical instrument context (loan vs bond) without overclaiming—keep it “generally” and “typically.”
- Avoid drifting into niche indenture concepts unless asked; keep depth on standby.
Common Pitfalls When Covenants Explained for Interviews
- Mixing up the trigger: saying incurrence covenants are “tested every quarter” or implying maintenance covenants only matter when new debt is raised.
- Describing incurrence covenants as “no restrictions”—they still constrain actions via leverage tests and baskets.
- Skipping the consequence: maintenance breaches can create default/waiver dynamics; incurrence failures usually just block the action.
- Over-lawyering the answer (baskets, carve-outs, builder baskets) before you’ve nailed the core distinction.
- Failing to anchor in a ratio example (e.g., net leverage) so the answer stays abstract.
- Claiming absolutes (e.g., “all loans have maintenance covenants”) instead of acknowledging covenant-lite and springing structures.
Likely Follow-Ups and Credit Agreement Nuance
Where do you most commonly see a springing maintenance covenant, and what makes it “spring”?
A springing covenant is often tied to the revolver and only becomes active when revolver utilisation exceeds a set threshold (e.g., >30–35%), at which point a leverage/coverage test begins.
What are typical maintenance covenant ratios in leveraged loans?
Common tests include total or net leverage and interest coverage or fixed charge coverage, defined on LTM EBITDA and measured quarterly against a step-down schedule.
If an incurrence test fails, can the company still do the transaction?
Not under the tested covenant, but it may still proceed if it has sufficient capacity under relevant baskets/carve-outs or can structure the action differently (e.g., permitted investments).
Why do lenders care about maintenance covenants from a risk perspective?
They create earlier intervention points and information rights, pushing borrowers to address deteriorating credit metrics before liquidity becomes critical.
How would you explain “covenant-lite” in an interview?
It generally means the term loan has few or no ongoing maintenance tests, though there may still be a springing covenant on the revolver and other negative covenants limiting actions.
How to Prepare for Investment Banking Technical Questions on Covenants
- Build a 60–90 second “out loud” version: definition → when tested → consequence → where seen → one numeric example.
- Practise translating to client language: “ongoing early-warning test” vs “permission slip for actions.”
- Drill one leverage example and one coverage example so you can adapt to the interviewer’s prompt.
- Use AceTheRound to run this as a timed prompt and get feedback on structure, precision, and whether you answered at the right depth for analyst-level IB technical interview questions.
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