Restricted Payment Baskets and Covenant Capacity
A restricted payment basket is the pool of capacity a loan or bond's covenants allow a borrower to use for dividends, buybacks, or other payments to shareholders, and tracking how full it is tells you how much a company can pay out before breaching its debt agreements.
Prerequisites: Term Loan A vs Term Loan B
Leveraged loan and high-yield bond agreements restrict how much cash a borrower can pay out to its owners, since every dollar sent to shareholders is a dollar no longer available to repay lenders. Rather than banning payouts outright, most agreements define a restricted payment (RP) basket: a running allowance of how much can be paid as dividends, distributions, or share buybacks.
The basket typically grows over time — often as a percentage of cumulative net income plus a fixed starter amount plus proceeds from new equity issuance — so it is a moving, cumulative capacity, not a one-time number, and covenant-savvy borrowers track exactly how full it is before board meetings on dividends.
What fills and drains the basket
Common builder components include a fixed "starter" basket set at closing, a running credit equal to some percentage (often 50%) of cumulative net income since closing, and full credit for cash raised from new equity issuances. Every dividend or buyback the company actually pays draws the basket down dollar for dollar. Many agreements also allow unlimited restricted payments once a leverage ratio test is met, giving a healthy borrower an alternative, uncapped route around the basket entirely.
Worked example
A credit agreement sets a $50 million starter basket plus 50% of cumulative net income since closing. Two years in, the company has earned $80 million cumulative net income, adding $40 million of capacity, for a total basket of $90 million. If the company has already paid $30 million in dividends, it has $60 million of remaining capacity — meaning its board can approve up to $60 million more in dividends or buybacks before triggering a covenant default, all else equal.
Further reading
- Loan Syndications and Trading Association, credit agreement covenant primers