Lev fin covenant
Say a structure is cov loose with 1 net leverage covenant set at 40% headroom, what does this mean?
40% of what? Like does this mean 40% below opening leverage?
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That would mean a 40% decline in EBITDA.
what do you mean by ebitda?
opening ebitda?
and thank you!
Right. Covenants are meant to grant lenders access to remedies if performance or liquidity declines. So if you’re setting covenants to a 40% headroom / cushion, you’re setting it so that the covenant would be violated and lenders could exercise remedies if EBITDA decline by 40% from the level at close. More practically, covenants are typically set at cushions to the sponsors projection model.
okay that makes sense. thank you
40% from opening ebitda is quite a large underperforme, particularly given ebitda is usually forecast to increase after Close
let me know if I've misunderstood
I think that’s it. One way to think about the covenant cushion is how far can ebitda decline before the company will no longer generate positive free cash flow after its debt service. So if ebitda can decline 40% but still cover fixed charges like principal amortization, interest, caped, etc., then that could be an ok covenant cushion. But if a 40% decline in ebitda means that they can’t pay their interest expense anymore, then that might be too much of a cushion.
Sounds like you are referring to a springing covenant where it begins testing once there is 40% utilization of the revolver. The actual leverage covenant associated with that is usually 40-50% outside closing leverage
This is also a possibility should be pretty clear in the documentation and refer to “springing” or “RCF utilization” or something to that effect.
I recently underwrite a deal with a 35% RCF springer set at a 40% cushion to closing leverage lol — absolutely zero teeth but that’s what the big boy sponsors can get done in the syndicated market (at least I hope it clears the market LOL)
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