Debunking Common Covenant Myths #3 –Management Covenant Calculations
Another common covenant myth that we hear all the time at FLT is that management must calculate capacity at the time an action is taken, that is, when debt is incurred, or a dividend is declared.
That is definitely not true!
The current vintage of covenant packages provides wide flexibility for management to decide when, and how, to calculate covenant capacity.
This flexibility carries significant implications for lenders, as they must grapple with the uncertainty of imprecise capacity calculations – will management use last quarter’s numbers, or the one before?
At FLT, we recommend in our Calculation Mechanics module that lenders assume management has the ability to cherry pick the best numbers – so, the highest EBITDA figure, or the lowest debt figure –so they should identify those and use them in their estimates.
To find this flexibility, lenders should look for:
- The Financial Calculations covenant (sometimes called Certain Compliance Calculations)
- Terms like “Designated Amounts” or “Designated Commitments”
- Provisions relating to “Limited Condition Acquisitions”
We have two modules on covenant capacity calculations – one reviews the basics, and the other applies them to areal-life borrower, and its actual reported results.
Understanding how, and when, a borrower can calculate covenant capacity is a critical skill for leveraged finance market participants, whether buyside, sell side or legal. If you’d like to equip your team with this knowledge, get in touch for access to our taster course and to schedule a demo.
by Sabrina Fox