Part Art, Part Science
Key Takeaways from FLT’s Calculating Covenant Capacity In-Person Training
Last week we invited FLT students and other covenant lovers to The Ned for our September In-Person Training event, Calculating Covenant Capacity. Both sessions were full and guests were deeply engaged in the topic, asking questions and offering input throughout the presentation.
The bottom line is that lenders will never get their estimations of capacity 100% accurate because management has access to all data and significant discretion on how to calculate it. Indeed, it’s very likely that their law firm will do the calculating – and two different law firms may well get two different numbers.
The “right” numbers can be elusive, but that doesn’t mean the exercise isn’t worth learning. Better-informed lenders make better investment decisions, and better-informed advisers negotiate and draft better terms.
The session was designed to teach the art of the possible when it comes to calculating covenant capacity.
Here are some key takeaways from the session:
- Any covenant calculation should start with the Financial Calculations / Certain Compliance Calculations covenant, which contains provisions that influence most – if not all – calculations of covenant capacity.
- Determining when the calculation could be made – and thus the correct financial statements to source the numbers –highlights the significant discretion given to management on this point. Ctrl-F for Limited Condition Transactions, for a start.
- The nearest financial statement line item to “Consolidated Net Income” is probably Net profit / (loss) after extraordinary items, and will likely deduct anything that does not reflect cash, since this defined term intends to encapsulate cash generated from normal business activities.
- EBITDA will inevitably be a higher number than the one disclosed due to add-backs for pro forma synergies and cost savings, which will be given run-rate effect.
- Indebtedness very likely deducts receivables financings, revolving credit facilities, debt used for working capital, and hedging. Secured debt probably only includes debt secured on the transaction collateral.
- Consolidated Interest Expense is best understood as interest paid, but when used for the Fixed Charge Coverage Ratio, will likely exclude interest on the RCF and working capital facilities.
These are all sweeping generalisations, of course, and each document will have its own nuances.
Understanding what’s possible empowers leveraged finance market participants to engage effectively on these topics, and our new Excel-based tools for students to track and calculate covenant capacity on a quarter-by-quarter basis offers additional support.
If you missed the session, don’t worry – the recorded material will be edited and uploaded onto our online platform as a 9th module in our Leveraged Finance Covenant Training course. Get in touch to schedule a demo and discover if our bespoke, online, on-demand covenant education platform is right for your team.