Meaning
Protection mechanisms in credit agreements activate automatic cash transfers from a borrower’s operational accounts to the lender to pay down debt. A springing cash sweep is triggered when the borrower’s financial health deteriorates or when a specific covenant is breached. This ensures that excess cash is used to reduce the lender’s exposure during high risk periods.
It remains inactive during normal operations when the borrower is in compliance.
Activation Trigger
Lenders use financial ratios like the debt service coverage ratio to monitor the performance of the borrower. If this ratio falls below a defined threshold, the springing cash sweep becomes active. This transition is communicated to the depositary bank under the control agreement.
Cash Management
Operational cash is routed away from the borrower’s control once the sweep is active. The springing cash sweep requires all excess cash flow to be transferred directly to the loan balance. This limits the borrower’s ability to make unapproved capital expenditures.
Debt Reduction
This acceleration of debt repayment helps restore the leverage ratios of the company to safer levels. It protects the lender by reducing the principal amount of the loan during a downturn. The sweep is deactivated once the borrower returns to compliance for a specified period.
