Covenant use
Hello everyone,
I had a quick questions regarding the 3 most used bank covenants used in a LBO transaction (namely interest coverage, fixed charge and leverage ratio) and their relevance.
While the use of the fixed charge ratio seems to be quite straightforward (FCF / Debt Service), I was wondering why didn't we also use FCF / Interests Expense instead of EBITDA / Interest Expense when calculating interest coverage. It seems more natural to use FCF and more logical to be homogeneous in the numerator used. I might be mistaken on that but these are my thoughts.
This could also be applied to EBITDA / Net Debt no?
I also would like to add another point: do we take NET interest expense and NET debt amortization since I have come across different ways to calculate these ratios. This may be explained by the information available in accounts (only netted interest expense and/or debt amortization netted by issuance of new debt) but I was wondering of it was linked to the quality of the accounts.
Thanks for your point of view on these subjects
HKR.
I personally have never seen it as FCF/Debt Service, rather (EBITDA - Capex - Taxes) / Cash Debt Service (no pik)...
FCF is good, but to use it in actuallity poses problems for businesses that experience wild W.Cap fluctuations every quarter... that's why these ratios try to exclue W.Cap from a FCF type numerator... A retail business that stocks up on inventory in preparation for the holiday season may vary the ratio you're suggesting wildly as they bulk up inventory over the quarter / month...
In Europe they use the exact ratio you're referring to, and most commonly that's the first to breach for the reason I mentioned above... In a dowturn working cap goes haywire for the first few quarters while they reset themselves to a smaller size.
FCF / Net Debt is close, I've seen FCF / Debt but only as a calculation for modeling purposes, never for covenants and it's a % not a multiple.
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