when an issuer violates a bond covenant it is considered to be in technical default a common penalty for violating a bond covenant is the downgrading of a bond s rating which could make it less attractive to investors and increase the issuer s borrowing costs 
for example moody s one of the major credit rating agencies in the united states rates a bond s covenant quality on a scale of 1 to 5 with five being the worst this means that a bond with a covenant rating of five is an indication that covenants are being violated consistently the quality of bond covenants tracked by moody s weakened by 36 basis points to a record high of 4 47 in q4 2020 as a resurgent market amid the economic recovery allowed borrowers to refinance on terms much more friendly than what was available in the first half of 2020 1affirmative bond covenantsan affirmative or positive covenant is a clause in a bond that requires the issuer i e borrower to perform specific actions examples of affirmative covenants include requirements to maintain adequate levels of insurance requirements to furnish audited financial statements to the lender compliance with applicable laws and maintenance of proper accounting books and credit rating if applicable a violation of an affirmative covenant ordinarily results in outright default certain bond issues may contain clauses that provide a grace period to remedy the violation if not corrected creditors are entitled to announce default and demand immediate repayment of principal and any accrued interest negative bond covenantsnegative or restrictive bond covenants are put in place to make issuers refrain from certain actions that could result in the deterioration of their credit standing and ability to repay existing debt the most common forms of negative covenants are financial ratios that an issuing firm must maintain as of the date of the financial statements for instance a clause may demand the ratio of total debt to earnings not to exceed some maximum amount which ensures that a company does not burden itself with more debt than it can afford to service another common negative covenant is an interest coverage ratio which says that earnings before interest and taxes ebit must be greater in proportion to interest payments by a certain number of times the ratio puts a check on a borrower to make sure that he generates enough earnings to afford paying interest example of bond covenanton june 23 2016 hennepin county minnesota issued a bond to help finance a part of the ambulatory outpatient specialty center at the county s medical center fitch ratings gave the bond a aaa rating because the bond is backed by the county s full faith credit and unlimited taxing power additionally the rating agency gave the county s outstanding hennepin county regional railroad authority limited tax go bonds hcrra a aaa rating for the same reasons including the fact that the county can pay the debt using ad valorem taxes on all taxable property the hcrra bond debenture contained a covenant stipulating that hennepin county can levy taxes to fund the debt service at 105 annually the debenture also stipulated that the maximum tax rate provides strong coverage of the debt service of 21 5x mads 