Limitation on Indebtedness: Definition | Bondfish
Limitation on indebtedness is a bond covenant that restricts how much additional debt the issuer may incur, typically allowing new borrowing only if the issuer passes a financial ratio test or fits it within a permitted exception.
What it means
Found mainly in high-yield bond indentures, this covenant (also called a debt incurrence covenant) stops the issuer from piling new debt on top of the bonds you already hold. New debt is usually allowed only if:
- A ratio test is met — most commonly a minimum fixed-charge coverage ratio (often around 2.0x earnings to interest) or a maximum leverage ratio; or
- It fits a “permitted debt” basket — carve-outs for specific needs such as credit facilities, refinancing existing debt, or capped general-purpose amounts.
It is an incurrence covenant, not a maintenance covenant: the issuer only has to pass the test when it takes on new debt, not continuously.
Why it matters for bond investors
Every euro of new debt added ahead of, or alongside, your bond dilutes your claim and raises credit risk — more leverage means a higher chance of default and a smaller share of assets to go around. A tight limitation on indebtedness preserves the issuer’s credit profile; weak versions with large baskets let leverage creep up, which can hurt the bond’s price and its position in the bond rank waterfall. Covenant quality is part of a bond’s value — read it, or check research that does.
Related terms
This definition is for general information only and is not investment advice. Bond investing involves risk, including possible loss of principal.