TOOL L7
Key Questions / Considerations
- Are the systems in place to easily produce the information for these complex covenants?
- Are we really controlling Debt Service Capacity (DSC)? Have the component parts of the ratios been defined correctly? (see separate tool). If not drawbacks are more severe than stated below
- Has the model, which will produce projected numbers, been independently audited?
- If it is not possible to negotiate cash flow covenants remember setting the repayment schedule tightly against the projected cash flow places the company under indirect pressure to meet its forecasted DSC
| Protection | Reason |
| Business Risk | Any deterioration in the business risk (4M’s) will be reflected quickly in the cash flow |
| Gives the bank tight control | Cash flow covenants trigger before other financial covenants |
| Completion Risk | DSCR (Debt Service Capacity Ratio) and LLCR (Loan Life Coverage Ratio) should be tested at the end of the completion period. If covenant levels not met then equity holders should be required to reduce debt until covenant levels met. This protects against: 1. Cost overruns 2. Time delays 3. Deteriorating business risk during the construction period |
| Accounting Policies | If working capital, capex and non-cash / non-operational items are included in the definition we are protected against: 1. Depreciation 2. Inventory valuation 3. Provisions 4. Extraordinary 5. Capitalised costs However consolidation, revenue recognition and off balance sheet contingents and commitment could still cause a problem. |
| Holding Company Risk | If the DSCR is tested at the unconsolidated holding company level, this forces the subsidiaries to upstream cash to the holding company (in the form of dividends, interest etc). In this case transfer pricing works to the Bank’s advantage |
