Incurrence Covenant Baskets, Explained
The question
A loan has an incurrence-based covenant package: $1 debt and lien basket, and a fixed charge coverage ratio (FCCR) of 2.0x for any incremental debt. The company’s EBITDA is $100M, existing debt $500M, cash interest $40M, and capital expenditures $20M. Can the company incur an additional $100 million of debt under an FCCR test? Assume new debt would carry an 8% interest rate and no principal amortization in the test period.
General educational practice only. This is not an actual, confidential, leaked, or firm-provided interview question. Check important technical details against primary learning materials.
Study explanation
FCCR is typically calculated as (EBITDA - capex) / (interest expense). Current fixed charges coverage = ($100M - $20M) / $40M = $80M / $40M = 2.0x. If the company incurs new $100M debt at 8%, incremental interest = $8M. Pro forma interest = $48M. Pro forma FCCR = ($80M) / $48M = 1.67x, which is below the 2.0x threshold. Therefore, the company would NOT be able to incur the additional debt under this incurrence test.
It might need to rely on other baskets like the builder basket or general basket if available, provided other conditions are met.
Follow-up pressure:
- If the company classified $15M of capex as “expansionary” and excluded it from FCCR per the credit agreement, how does the answer change?
- Compare the flexibility under this incurrence test to a maintenance covenant of 2.0x where the test is quarterly.
- The company wants to do an add-on acquisition funded with debt. How would the loan’s ECF sweep provision potentially force prepayment of that new debt in the following year?
Yield curve: normal vs. inverted
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