Lesson 4 of 8
The covenant that never mattered
A facility's filed borrowing capacity, what headroom means, and why a test agreed years ago starts to bind without anyone renegotiating it.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- A covenant is a test the company agreed to, on a definition written in the agreement rather than in the accounting standards.
- Borrowing capacity is disclosed and dated; the test levels usually are not tagged, so the arithmetic has to be assembled by hand from the agreement.
- A covenant binds when earnings fall towards the level, and nothing about the agreement has to change for that to happen.
Most covenants do nothing for years. That is what makes them easy to ignore and what makes the year they start to matter surprising to the people who ignored them.
One filer's maximum borrowing capacity under its credit facilities, ten filed year ends
- Maximum borrowing capacity
Show the numbers
| Maximum borrowing capacity | |
|---|---|
| FY16 | 1,460$m |
| FY17 | 1,681$m |
| FY18 | 1,493$m |
| FY19 | 1,628$m |
| FY20 | 1,850$m |
| FY21 | 2,774$m |
| FY22 | 4,094$m |
| FY23 | 4,562$m |
| FY24 | 4,276$m |
| FY25 | 3,053$m |
What the filed figures give you
Capacity is disclosed. The chart above is one filer's maximum borrowing capacity under its credit facilities at each of ten fiscal year ends, and it moves a great deal: from 1,460 million dollars at the end of fiscal 2016 to 4,562 million at the end of fiscal 2023, then down to 3,053 million at the end of fiscal 2025.
Capacity is not headroom. It is the size of the facility, not the amount the company is permitted to draw after the tests in the agreement are applied. A facility can be large and largely unavailable.
What the filed figures do not give you
The test definitions. A credit agreement defines its own terms, and the definitions rarely match the accounting ones: a covenant may add back charges the income statement does not, exclude subsidiaries the consolidation includes, or measure over a period the accounts do not report.
Those definitions live in the agreement, which is filed as an exhibit rather than tagged as data. So the arithmetic below is assembled by hand from the agreement and from the accounts, and it cannot be automated from tagged figures. That is a real limit on what any screen, including this one, can do about covenants.
Why this is a credit reading rather than an accounting one
Because the covenant was agreed at a moment and tested continuously afterwards. The level in the agreement reflects the terms available when it was signed, and it does not adjust.
So a company can sign a comfortable agreement, operate for several years without approaching the test, and then find the test binding in a year when nothing about its debt changed. A reader who noted the covenant at the time and never looked again will meet it as news.
What to write down
Three things, from the agreement and the accounts together: which ratio is tested, on what definition, and at what level. Then the headroom as a percentage fall in the denominator, recomputed at each filing.
A condition written on that percentage is a real condition, but it is one the product cannot evaluate for you, because the defined earnings measure is not a tagged figure. The guardrails course is explicit about which conditions can be automated and which have to be checked by hand, and this is the clearest example of the second kind.
Check yourself
What is the difference between borrowing capacity and headroom?
- They are the same figure under two names
- Capacity is the size of the facility; headroom is how much room is left before a test fails
- Capacity is disclosed annually and headroom quarterly
Show the answer
Answer: B.
A facility can be large and largely unavailable. Capacity is tagged in filings; the test definitions usually are not.Net debt is unchanged at 3,000 across three years while defined earnings fall from 1,500 to 860. What happened to a 3.5 times leverage covenant?
- Nothing, because the debt did not change
- It went from 43 percent of headroom to 0.3 percent, entirely through the denominator
- It was renegotiated automatically
Show the answer
Answer: B.
A leverage covenant binds through its denominator far more often than through its numerator, and no borrowing decision is involved.Why can a covenant condition not be evaluated automatically here?
- Because covenants are confidential
- Because the agreement defines its own earnings measure, which is not a tagged figure in any filing
- Because the test is quarterly and filings are annual
Show the answer
Answer: B.
Credit agreements are filed as exhibits rather than tagged as data, and their definitions rarely match the accounting ones.Sources
- Toll Brothers, Inc., annual reports on Form 10-K for fiscal years 2016 through 2025, for maximum borrowing capacity under credit facilities as tagged at each fiscal year end; fiscal 2025 accession 0000794170-25-000112, filed 19 December 2025.
- The covenant lesson of the distressed and capital structure course, for how headroom is computed and what a breach triggers.
What this leaves out
- This is a heterodox tradition. The mainstream account of the same phenomenon differs, and nothing here is a forecast or a view on any security.
- The headroom table is invented round arithmetic so the calculation can be checked by hand. No company's covenant is described by it, and no company's covenant level is stated anywhere in this lesson.
- Maximum borrowing capacity as tagged is the size of the facilities. It is not the amount available after the agreement's tests are applied, and the two can differ substantially.
- Nothing here is a view on Toll Brothers or on any security.