Key takeaways
- DSCR must be calculated from CFADS, not from profit before interest, and you should know how each agreement defines it.
- The headroom formula must be reversed depending on the type of Covenant. In the example, a DSCR of 1.42x against a 1.25x threshold gives headroom of 13.6%, while CFADS can fall by 12.0% before a breach.
- Request a waiver 3–6 months in advance, because once a breach has occurred your bargaining power is much weaker.
What DSCR is based on
DSCR = CFADS ÷ Debt Service
CFADS = EBITDA − tax paid − change in working capital − maintenance CAPEX
Debt service is the scheduled interest plus principal for the period. Some documents define DSCR as profit before interest divided by debt obligations, which is only a rough approximation because profit is not cash. Commonly seen minimum thresholds are 1.20–1.50x.
During the grace period, debt service consists of interest only, so DSCR looks high and then falls once principal repayments begin. Forecast the figures across this turning point before signing.
Projects that sell units to buyers have irregular CFADS, so periodic DSCR explains only so much. Read it together with presale coverage, which is the transfer proceeds from contracts already sold compared with the outstanding debt, and with the release price.
Common financial covenants
| Covenant | Formula | Typical threshold | Frequency |
|---|---|---|---|
| DSCR | CFADS ÷ Debt Service | ≥1.25x | Quarterly |
| LTV | Debt ÷ asset value | ≤70% | Annual |
| LTC | Debt ÷ total cost | ≤70% | By milestone |
| ICR | EBITDA ÷ interest | ≥2.0x | Quarterly |
| Net Debt/EBITDA | Net debt ÷ EBITDA | ≤4.0x | Quarterly |
| Current Ratio | Current assets ÷ current liabilities | ≥1.0x | Quarterly |
| Equity Ratio | Equity ÷ total assets | ≥25% | Annual |
| Min. Tangible Net Worth | Net equity not below the threshold | Per contract | Annual |
Non-Financial Covenants
Must do
- Submit financial statements and a compliance certificate
- Maintain insurance policies
- Pay all taxes in full
- Comply with the law
- Allow the bank to inspect
- Notify significant events
Must not do
- Incur additional debt beyond the limit
- Grant security to other creditors
- Sell significant assets
- Lend to related parties
- Pay dividends above the permitted amount
- Change the core business, merge or restructure
Watch out for change of control, material adverse change and key person clauses, as they are often drafted broadly, and for cross-default, which allows a problem in one facility to spread to others. A group of companies should prepare a table showing which agreements refer to each other.
Calculate headroom in the right direction
Minimum Covenant: headroom = (actual − threshold) ÷ threshold
Maximum (ceiling) Covenant: headroom = (threshold − actual) ÷ threshold
Example
| Covenant | Criteria | Actual | Headroom |
|---|---|---|---|
| DSCR (minimum) | 1.25x | 1.42x | 13.6% |
| LTV (ceiling) | 70% | 55% | 21.4% |
| ICR (minimum) | 2.0x | 3.2x | 60.0% |
| Net debt/EBITDA (ceiling) | 4.0x | 2.8x | 30.0% |
Headroom shows the distance from the threshold, but the question that matters for management is how far CFADS can fall.
Allowable CFADS decline = 1 − (1.25 ÷ 1.42) = 12.0%
If CFADS falls by 15%, DSCR drops to 1.21x, which is a breach.
Internal early-warning system
| Status | Headroom | Action |
|---|---|---|
| Safe | More than 15% | Monitor as normal |
| Watch | 5–15% | Increase reporting frequency |
| Alert | 0–5% | Open communication with the bank proactively |
| Breach | Less than 0% | Immediate crisis management |
The monthly Covenant report should include actual figures, headroom, a 3–6 month forecast, scenarios and required actions. The key point is to look forward rather than report what has already passed.
When a breach is near
| Type | Characteristics | Severity |
|---|---|---|
| Technical Breach | Late or incomplete document submission | Low |
| Financial Covenant Breach | Ratio not met | High |
| Payment Default | Failure to pay when due | Critical |
| Material Adverse Change | Significant deterioration in financial position | Very high |
| Cross-Default | Default to other creditors | Very high |
Steps for requesting a waiver
- See it 3–6 months ahead from the Covenant forecast
- Analyse the cause and identify the size and duration
- Prepare a remedial plan specifying the additional equity to inject or the sales to accelerate
- Talk to the relationship manager first before any formal documents
- Submit a waiver request with figures and the plan
- Negotiate the terms, including fees and new Covenants
- Sign the waiver letter and then check the effect on other agreements
In exchange, banks commonly ask for a waiver fee of around 0.25–0.75% of the outstanding balance, a margin increase of 0.25–0.50%, additional security, new Covenants, more frequent reporting and restrictions on dividend payments.