Covenant math (DSCR, LTV, debt yield)
Every senior debt agreement contains financial covenants — tests the borrower must pass quarterly or annually, or face accelerated remedies. The three that matter for hotels: DSCR (debt service coverage ratio), LTV (loan-to-value), and debt yield. Each measures something different. Each can blow up the deal in a different way.
DSCR: cash-flow coverage
DSCR = NOI divided by annual debt service. It measures whether the property is generating enough cash flow to cover principal and interest payments. Typical hotel senior debt covenant: 1.25x DSCR maintenance, with cure provisions if it dips below; some aggressive lenders push to 1.35-1.45x for more conservative deals.
Where it breaks: a hotel running €5.0M NOI with €4.0M annual debt service has a 1.25x DSCR — exactly at covenant. A 5% NOI drop (€250k) takes it to 1.19x — covenant breach. Hotels are operationally volatile; 5-8% NOI swings are routine. A deal underwritten to 1.25x is one bad quarter away from a covenant call.
The defensive position: negotiate a 1.20x covenant or 1.25x with a 4-quarter rolling average. The rolling average smooths out the seasonal and one-off swings that would otherwise trigger a covenant call on a property that is fundamentally fine.
LTV: collateral coverage
LTV = loan balance divided by current appraised value. It measures whether the asset still backs the loan if it had to be sold. Typical hotel covenant: 65-70% LTV maintenance, tested annually against a third-party appraisal.
LTV covenants are dangerous because they depend on appraised value — a number that is somewhat outside the borrower's control. In a soft market, the appraisal comes in 8-12% below the prior year, the loan balance has barely amortized, and the covenant trips. The borrower then either pays down debt (pulling cash out of the operation when cash is needed) or finds new capital.
The defensible LTV covenant has either a wider cushion (65% covenant on a deal originated at 58% LTV gives you a 7-point buffer) or an appraisal-frequency provision that requires LTV to be tested only at refinance or sale, not annually. Annual LTV testing in a volatile market is a structural problem.
Debt yield: the modern hotel covenant
Debt yield = NOI divided by total loan balance. It is a measure of how much yield the lender's capital is earning on the asset. Typical covenant: 8.0-9.5% debt yield maintenance, with breaches triggering cash trap (excess cash flow held in a reserve account rather than paid to equity).
Debt yield is more useful than LTV because it is appraisal-independent. The lender does not care what the market says the building is worth this year — they care whether the building is generating cash. A 10% debt yield covenant on a €60M loan means the property must produce €6M NOI every year. A 7% NOI drop trips the covenant.
Most institutional senior lenders now lead with debt yield as their primary maintenance covenant. The smart borrower agrees, because debt yield gives the borrower more control: NOI is a function of operations, not external markets.
What happens when a covenant trips
First step: cash trap. The lender directs the property's cash to a sweep account rather than allowing it to flow to the equity holder. This continues until the covenant is cured. Second step: cure rights. The borrower has 60-180 days to cure (pay down debt, post additional equity, or restructure). Third step: technical default. If not cured, the lender can accelerate the loan, foreclose, or force sale.
Most covenant trips do not get to step three. They settle at step one or two with a fee, a forbearance agreement, and tighter monitoring. But the trip itself materially damages the property's refinancing options and the equity's distribution capacity for 12-24 months. Avoid the trip; do not assume you can cure your way through.