Direct lending: The covenant compliance trap

1. Credit agreement parsing: structure and pricing

Credit agreements are dense legal documents where economic terms are scattered across 100+ pages of definitions, schedules, and exhibits. The challenge: extracting a complete term sheet without missing conditionality or cross-references.

What Omega extracts automatically:

• Facility structure — term loan vs revolver, tranches, commitments, availability
• Pricing grids — base rate + spread, leverage-based step-downs, SOFR floors
• Fees — upfront, commitment, unused line, amendment, prepayment penalties
• Maturity and amortization — final maturity date, mandatory repayment schedule, cash sweeps
• Collateral package — first lien vs second lien, asset coverage, guarantor entities

Example: Pricing grid with leverage ratchet

A typical middle-market unitranche agreement might specify:

"Applicable Margin shall be determined based on the Total Net Leverage Ratio as of the most recent Test Date: (i) <3.00x: SOFR + 5.50%; (ii) ≥3.00x but <4.00x: SOFR + 6.00%; (iii) ≥4.00x: SOFR + 6.75%."

Omega identifies: Three leverage tiers, extracts defined terms "Total Net Leverage Ratio" and "Test Date" with full definitions, and flags that pricing increases with deteriorating leverage (common in direct lending, unusual in broadly syndicated loans).

2. Financial covenant monitoring and compliance certificates

The real work in credit investing happens after closing. Quarterly compliance certificate review is where defaults emerge — but manual tracking across multiple portfolio companies creates coverage gaps.

Key financial covenants to monitor:

• Leverage ratios — Total Debt / EBITDA, Senior Debt / EBITDA, Net Debt / EBITDA
• Coverage ratios — EBITDA / Interest Expense (fixed charge coverage), EBITDA / Debt Service
• Liquidity tests — minimum cash, revolver availability, quick ratio
• Capex limits — annual budgets, growth vs maintenance splits, carryforward provisions
• EBITDA adjustments — add-backs for non-recurring items, pro forma treatment, caps and baskets

What Omega does:

Upload quarterly compliance certificates and Omega:

• Reconciles covenant calculations — verifies EBITDA add-backs against permitted adjustments in the credit agreement
• Trends covenant headroom — tracks cushion vs breach thresholds over time
• Flags early warning signals — declining coverage, increasing leverage, approaching caps
• Cross-checks EBITDA definitions — ensures compliance cert uses the contractual definition, not a creative interpretation

3. Amendment tracking and consent rights analysis

Credit agreements rarely stay static. Amendments modify covenants, extend maturities, add/release collateral — and each amendment changes your risk profile. The problem: amendments reference prior amendments, creating a multi-layer document stack.

Critical amendment provisions:

• Covenant waivers — temporary relief vs permanent modification, financial vs operational covenants
• Pricing adjustments — increased spreads in exchange for covenant relief (common in workouts)
• Maturity extensions — amend-and-extend transactions, fees, pro-rata vs non-pro-rata
• Incremental facilities — accordion features, pari passu vs subordinated, required lender vs unanimous consent
• Collateral releases — asset sales, guarantor releases, lien priority changes

Example: Covenant amendment cascade

A portfolio company breaches its leverage covenant in Q4 2024. The lender group approves Amendment No. 3, which:

• Waives the Q4 breach
• Increases the leverage covenant from 4.0x to 4.5x for FY2025
• Steps down to 4.25x in FY2026, then 4.0x in FY2027
• Increases the spread by 50bps during the relief period

Omega tracks: All modified covenant levels by test period, pricing changes, and flags that the step-down schedule requires operational improvement — not just covenant relief.

4. Intercreditor agreements and lien priority

In multi-tranche capital structures, your recovery rights depend on intercreditor agreement terms, not just your credit agreement. Understanding payment waterfalls, action restrictions, and lien priorities is critical for downside analysis.

What Omega extracts from intercreditor agreements:

• Lien priority — first lien vs second lien vs unsecured, shared collateral pools
• Payment subordination — when can junior lenders receive payments? Standstill periods after default
• Voting and control — which tranche controls bankruptcy decisions, enforcement actions, amendment consents?
• Purchase rights — can junior lenders buy out senior debt? Pricing mechanisms, timelines
• Refinancing restrictions — limitations on refinancing junior debt, maturity requirements, pricing caps

Example: First lien / second lien structure

A $50M unitranche is later split into a $30M first lien revolver and a $20M second lien term loan. The intercreditor agreement specifies:

"Second Lien Lenders shall not receive any payments (other than permitted refinancing proceeds) until First Lien Obligations are paid in full. Second Lien Lenders have no voting rights on amendments affecting collateral, maturity, or pricing without First Lien Lender consent."

Omega flags: Second lien holders are structurally subordinated, have no control over key terms, and face payment blockage until the revolver is repaid — critical for recovery analysis in downside scenarios.

The Omega workflow for direct lending

1. Upload credit agreement and intercreditor docs — Omega parses structure, pricing, covenants
2. Extract covenant matrix — financial and operational covenants with test dates and thresholds
3. Ingest compliance certificates — automated covenant calculation verification
4. Track amendments — version control across the amendment stack with change highlighting
5. Build risk dashboard — covenant headroom trends, upcoming maturities, amendment history

Time savings: Manual credit agreement review = 20-30 hours per deal. Quarterly compliance monitoring = 2-4 hours per portfolio company. With Omega: Initial review in 1-2 hours, ongoing monitoring automated.