Underwriting concepts
Covenant
Two distinct meanings on UK commercial mortgages: (1) a tenant's financial standing, (2) a contractual undertaking in the loan agreement that the borrower must meet on an ongoing basis.
Covenant is a word used in two distinct ways on UK commercial mortgages, and brokers should not assume which one is meant in a sentence. Both matter.
Meaning one: tenant covenant
On an investment commercial mortgage, tenant covenant is the lender’s view of the tenant’s financial standing and ability to keep paying rent for the duration of the lease. Lenders grade tenant covenants roughly as:
- AAA / strong covenant: Plc-listed, government-backed, multinational on a long lease. Light underwriting treatment, lowest ICR thresholds, best pricing.
- Strong covenant: established corporate (5+ years trading, profitable, asset-backed). Standard underwriting.
- Moderate covenant: SME with two to three years of profitable trading. Tighter ICR thresholds, more documentation.
- Weak covenant: newco, recently incorporated, loss-making, sole trader. May require deposit or guarantee, or be declined.
Lenders take a credit search and accounts review on the tenant before sign-off. On a multi-let property, the covenant grading is weighted across tenants by rental contribution.
Meaning two: loan covenant
In the facility agreement, a loan covenant is a contractual undertaking the borrower must meet on an ongoing basis. UK commercial mortgage facility agreements typically include:
- Financial covenants: ongoing tests of ICR, DSCR, LTV or debt yield. Tested quarterly, semi-annually or annually. Breach triggers an event of default, which can entitle the lender to accelerate the loan.
- Information covenants: borrower must provide management accounts, audited accounts, tenancy schedules and other documents on a schedule.
- Insurance covenants: property must be insured for full reinstatement value with the lender noted as composite insured.
- Use covenants: property must continue to be used for the agreed purpose (commercial, semi-commercial), not converted without consent.
- Negative covenants: no further security granted, no major lease changes, no material disposals without lender consent.
A breach of a loan covenant does not always trigger enforcement. Most UK commercial mortgage lenders use covenant breaches as a trigger for renegotiation, repricing or covenant waiver rather than calling the loan immediately. The right to call exists, the appetite to call is usually limited.
Why both meanings matter to brokers
Tenant covenant drives lender selection and ICR threshold. Loan covenant drives the ongoing relationship and the lender’s flexibility if performance slips. Both are negotiable to varying degrees: tenant covenant by varying the lender, loan covenant by negotiating the facility agreement directly.