Financial Covenants
This Clause contains the financial covenants, comprising the following:
• Cashflow Cover, defined as Cashflow to Debt Service. The Cashflow Cover ratio compares the Group’s cashflow to its debt service obligations. It measures the ability of the
Group to generate enough cash to service its debts. The required Cashflow Cover ratio is almost invariably 1:1.
• Senior Interest Cover/Interest Cover, defined as EBITDA to [Senior] [Net] Finance Charges. The Interest Cover ratio measures EBITDA against the Group’s interest obligations. The Interest Cover ratio confirms the ability of the Group to generate enough profit to cover its interest payment obligations. Clause 26.2 includes both an Interest Cover ratio and a Senior Interest Cover ratio. Senior Interest Cover is sometimes seen in deals with a subordinated or mezzanine element and measures the Group’s profits (EBITDA) against its interest obligations in relation to the senior debt only. Clause 26.2 also includes the option to calculate the Interest Cover ratio on a gross basis or net of any interest receivable.
• Senior Leverage/Leverage, defined as [Senior] Total [Net] Debt to EBITDA. The Leverage ratio measures the Group’s profits (again, usually consolidated EBITDA) against its total debt. Clause 26.2 provides the option to measure Total Debt on a gross basis or net of any Cash or Cash Equivalent investments held by the Group. As with the Interest Cover ratio, if the financing includes a subordinated or mezzanine element, a Senior Leverage ratio may apply which measures the Group’s profits against its total senior debt, and the LMA drafting incorporates this option.
Leverage ratios are often adjusted to take account of acquisitions and disposals made by the Group during the testing period, so that any resulting increase or decrease in EBITDA can be taken into account. The LMA drafting contains optional language to make such adjustments to the Leverage ratio (see definition of “Adjusted EBITDA”, discussed at Clause 26.1 (Financial Definitions) above).
Limits on Capital Expenditure and Finance Leases
This Clause also sets out applicable limits on the Group’s Capital Expenditure and exposure under finance and capital leases. The Capital Expenditure limits are set as annual monetary amounts of permitted capital expenditure. Exposure under finance or capital leases treated as such by the Accounting Principles (see definition of “Finance Leases”) is expressed as an
aggregate financial cap. If the Group wishes to spend more or less than the document permits, Lender consent will be required.
Borrower Notes
In setting Capital Expenditure limits, Lenders are seeking to balance sufficient cashflow being available for debt service and sufficient cash being available to the Group to generate profits and to grow the business. The Capital Expenditure limits are therefore usually negotiated in some detail. The LMA drafting does include some of the more common concessions granted to Borrowers, although Borrowers commonly seek further flexibility, for example:
• The Capital Expenditure limits do not apply to Capital Expenditure funded from sources which the Lenders are not relying on for debt service. The specified list includes the proceeds of insurance, disposal and Recovery Claims which are not required to be applied to mandatory prepayment and New Shareholder Injections. The list of exclusions may be extended beyond those mentioned, for example the proceeds of any capital expenditure
facility may be included, Permitted Financial Indebtedness or Retained Excess Cashflow. See also “Capital Expenditure”, discussed at Clause 26.1 above.
• The LMA drafting permits unused Capital Expenditure amounts to be carried forward for use within a designated period. Some carry-forward rights in respect of capital expenditure allowances are common but are usually quite tightly confined both in monetary amount and in terms of the number of periods such unused amount can be carried forward. Financial limits on carry-forward rights are usually expressed in terms of a percentage of the previous/following year’s budget. In the September 2008 update of the Leveraged Facilities Agreement optional drafting was inserted to the effect that carry forward amounts may be carried forward for one year only. Typical carry-forward rights might be somewhere around fifty to one hundred per cent. of the current year’s budget, to be carried forward for one to two years.
• Borrowers may also seek rights to use future years’ Capital Expenditure amounts in the current year (“carry-back rights”). These are becoming more common but are not included in the LMA drafting. Typical carry-back rights might be around twenty to fifty per cent. of the following year’s budget, although such rights have become harder to achieve over the past year.
Borrowers should be aware that the LMA drafting does not contemplate any increase in Capital Expenditure limits as the Group expands (unless this is reflected in the monetary limits). If acquisitions are planned, the Borrower may argue that Capital Expenditure limits should increase in proportion to the increase in EBITDA resulting from any acquisition. It is not a provision seen in every facility agreement but is a useful device for a Borrower whose business plan contemplates acquisitions.