Financial covenant series

Today we’re launching a series on financial covenants that might be found in loan documents. Lenders will rely on you meeting certain financial targets, with any breaches giving them certain rights. These could be as benign as having to provide them with information, extending up to restrictions on dividends or capital spending and increasing loan repayments, all the way through to defaulting the loan. So knowing what you’re really getting into when you agree a suite of covenants is crucial.

Topics we’ll cover

Throughout this series, we’ll discuss what some of the different types of covenants are, some of the inputs and some of the variations of them. Topics we’ll cover, in no particular order are:
Debt Service Cover Ratio
Interest Cover Ratio
Loan Life Cover Ratio
Project Life Cover Ratio
Reserve Life Cover Ratio
Fixed Charge Cover Ratio
Net vs gross debt
Cashflow vs profit
Calculating an average
Senior or total
Current and quick ratios
The series will not cover what level of covenants you should expect to see in your loan documents, as these are heavily subject to market conditions, what type of business/project it is, any negotiating leverage either side to a transaction has and interplay with other covenants or conditions.

Cashflow available for debt service

Cashflow available for debt service (sometimes cash available for debt service, abbreviated to either “CFADS” or “CADS”) is used in most cashflow based covenant calculations, such as DSCR, ICR, LLCR and PLCR. It seeks to measure the true ability of a business to repay its debts, whether in the one period or over time, without

Current and quick ratios

Current and quick ratios are indicators of a company’s immediate liquidity and its ability to pay its short term liabilities (such as accounts payable and short term debt) through using only its current assets (cash, accounts receivable, inventory). The difference between the two ratios is that “quick” only includes the most liquid assets in the

Senior or total debt

Whether senior or total debt (senior + subordinated/mezzanine) debt is used for covenants will depend on the financial structure of the borrower and which lender you are talking about. Subordinated/mezzanine lenders, if they have financial covenants at all, are most likely to be interested in total debt, plus potentially having a senior debt covenant if

Net versus gross

A number of the covenants we have looked at can be calculated on either a net or gross basis, such as Debt / EBITDA, DSCR, ICR, LLCR and PLCR. Net debt Most leveraged finance transactions seem to use a net debt definition in the covenants. Any cash on hand or in bank accounts (sometimes inclusive

Debt service reserve accounts

A debt service reserve account (“DSRA”) is a special purpose bank account set up to provide additional security and is usually only contained in project finance transactions. Borrowers are required to maintain a minimum target balance within the account, with the target balance usually set as a fixed number of months of debt servicing costs

Debt service cover ratio

The debt service cover ratio, or DSCR, is a measure of how easily a business or project can make its debt repayments. It is the ratio of the cashflow available for debt service (or “CFADS”) to the amount of debt service (principal repayments plus interest). A higher number is obviously better, both for you and

Interest cover ratio

The interest cover ratio, or ICR, is a measure of how easily a business or project can make it interest payments on its debt. There are at least two different versions of the ICR, one based on cashflow and one based on profit. Cashflow ratio The cashflow based calculation of ICR is nearly always used

Loan life cover ratio

The aim of the loan life cover ratio (“LLCR”) is to measure how easily a loan can be repaid over the full life of the loan, rather than just in one period (such as with a DSCR). It is very common in project finance, but may also be used in leveraged finance or corporate transactions.

Project life cover ratio

The Project Life Cover Ratio (“PLCR”) looks at how much cash a project will generate over its full life compared to its debt balance. Its calculation is almost identical to the Loan life cover ratio except that all CFADS amounts are included rather than just for the life of the loan.

Fixed charge cover ratio

The Fixed Charge Cover Ratio (“FCCR”) is very similar to an ICR except that certain fixed expenses are shifted from above the line to below the line. The typical representation is EBITDAR / (interest + rent)


This is a ratio beloved in leveraged finance and corporate transactions and is often referred to simply as the “leverage ratio.” Unlike other covenants such as the DSCR or ICR which directly measure serviceability of debt, leverage ratios are more of a proxy for debt repayment. It is the number of years it would take

Reserve life cover ratio

The Reserve Life Cover Ratio (“RLCR”) is used only for mining and oil & gas projects (inclusive of fossil fuel generators tied to a particular mine/gas development). Unlike the other covenants we’ve looked at, the RLCR does not look at any cash flows or balances. This makes it easy to calculate and means you don’t


The challenge with gearing, is that when a banker mentions it, you don’t actually know what they’re talking about as it has a couple of different versions which result in very different results. In principle, it always relates to the proportion of debt that is used to fund the development of a business, but the

Cashflow versus profit

“Turnover is vanity, profit is sanity, but cash is reality,” or more simply, “cash is king.” This is especially true when banks are assessing and monitoring loans. Banks have had plenty of experience in seeing seemingly profitable businesses experience distress or become insolvent through not managing their cashflow properly. For this reason, a number of

Calculating an average

Calculating an average ratio sounds simple – add up all the ratios in every relevant period and divide by the number of periods. This is an “arithmetic average.” But this simple concept can create some misleading results. Here, the average DSCR of 1.80 looks quite respectable, despite three of the four years having very low

Brendan WalpoleFinancial covenant series