The use of financial covenants in tradable bonds in Israel
Regulation of long-term savings managers in Israel instructs the use of financial covenants—contractual terms restricting borrower behavior and specifying sanctions in case the borrower deviates from certain financial measures of performance.
Regulation of long-term savings managers in Israel instructs the use of financial covenants—contractual terms restricting borrower behavior and specifying sanctions in case the borrower deviates from certain financial measures of performance. This research analyzes the structure of frequently used financial covenants in corporate bond agreements, examines the probability of their violation, and estimates their impact on the price of debt.
• According to the research’s findings, the financial covenants common in tradable corporate bonds in Israel are not particularly limiting and the probability of their violation is low.
• Actual violations of financial covenants occur rarely, and an initial violation generally does not lead to severe consequences to the borrowing company in accordance with the terms of the bond contract: during the COVID-19 crisis, only about 9 percent of potential bonds increased interest payments as a result of violating a financial covenant. The increase in the interest rate as required by the terms of the bond was moderate compared to the increase in the yield to maturity of the bond that occurred at the same in the bond market.
• An estimate of the price effect based on a comparison between bonds that include financial covenants and similar unrestricted bonds indicates that integrating financial covenants in an indenture does not have a marked impact on the debt financing cost.
• The research concludes that the use of financial covenants, which became widespread due to the regulatory guidance, does not serve sufficiently as an incentive for tighter monitoring of tradable bonds by institutional investors, or more frequent engagement of lenders with borrowers outside of default.