Covenants
Interest cover
Interest cover measures earnings against the interest bill alone. It is the covenant most exposed to the cost of money rather than to trading, which is why a rate rise can move it when nothing about the business has changed.
Also called interest cover ratio · ICR · interest coverage ratio · EBITDA to interest
Cover is decided by the instrument before trading gets a say. The same earnings cover interest twice as well on bank debt as on a fund facility.
| Structure | Interest cover |
|---|---|
| Bank senior 3.0x | 4.94x |
| Bank senior 3.5x | 4.23x |
| Unitranche 4.5x | 2.12x |
Derived arithmetic on £2m of EBITDA at published leverage and all-in costs: bank senior 3.0x and 3.5x at about 6.75%, unitranche 4.5x at the midpoint of the published 9.25-11.75% band. These are what the ratio computes to, not levels any lender requires; the guides publish no interest-cover threshold.
What the ratio measures
Interest cover divides earnings by the interest bill, expressed in the covenant suite as EBITDA to interest. It answers one question: how many times over could the business pay its interest out of its earnings.
A related formulation looks at the ratio of cash generated to interest paid, which is stricter because it starts from cash rather than from an earnings measure. Which of the two your facility uses is a definitional point worth settling early, since the same business produces different numbers under each.
The distinguishing feature is what the ratio ignores. Interest cover takes no account of the principal you have to repay, so a heavily amortising facility and a bullet facility with the same interest bill produce identical interest cover and very different actual burdens.
What level lenders set
We do not publish one, and you should be sceptical of anyone who does without saying where it came from.
Interest cover levels vary too widely by instrument, sector and structure for a single number to be useful, and the guides deliberately describe the test qualitatively rather than quoting a threshold. A cover level that is comfortable on an amortising bank facility can be tight on a bullet fund facility with no principal repayment at all, because the two structures are asking the ratio to do different jobs.
What is more useful than a target number is the relationship between the level and the structure. Ask what the covenant implies about how far the interest bill can rise or earnings can fall before it fails, and compare that with the same calculation on the leverage and debt service tests. The binding constraint is what matters, not the headline on any one covenant.
Both cover tests are calibrated at drawdown rates. A rise in the cost of money compresses the ratio without anything happening to trading.
| Reference rate | Interest cover |
|---|---|
| At drawdown (6.75% all-in) | 4.94x |
| One point higher | 4.30x |
| Two points higher | 3.81x |
Derived arithmetic: £6m of floating bank senior at an all-in near 6.75%, being a 3% margin over a 3.75% reference rate, with the reference rate one and two points higher. The pound cost of a one-point rise by facility size is charted on /library/sonia; this is the effect on the ratio.
How it differs from DSCR
The denominator, and the difference is larger than it sounds.
Interest cover counts interest. Debt service cover counts interest plus scheduled principal repayment. On a facility repaying meaningful principal, debt service can be several times the interest bill, which is why the two ratios can point in opposite directions on the same business.
A worked case makes it concrete. On a fully-amortising five-year facility, the annual principal repayment is roughly three times the interest bill at typical rates. So a business with comfortable interest cover can have debt service cover close to or below one times, and it is the debt service test that fails first.
That is the practical reason a facility sized on a leverage multiple usually carries a bullet or a partial bullet. It is also why interest cover on its own is a poor guide to whether a structure is affordable: it is measuring the smaller half of the obligation.
How it differs from leverage
Leverage is a stock measure and interest cover is a flow measure, and they respond to different things.
A leverage covenant compares net debt with EBITDA, so it moves when the debt balance or the earnings move. It is indifferent to the price of the debt. Interest cover compares earnings with the cost of the debt, so it moves when earnings move or when rates or margins move.
The consequence is that the two tests can diverge sharply. A business can pass its leverage test comfortably while interest cover deteriorates, purely because the reference rate has risen. Nothing about the amount borrowed has changed and nothing about trading has changed, and the covenant package still tightens.
Why the instrument decides it
Because leverage and pricing move together, and both land on this ratio.
On £2m of EBITDA, three times leverage on bank senior terms means £6m of debt at an all-in cost near 6.75%, so interest of about £405,000 and cover of 4.94 times. At three and a half times it is £7m, about £473,000 and 4.23 times. On a unitranche at four and a half times, it is £9m at around 10.5%, so about £945,000 and cover of 2.12 times.
The business is identical in all three cases. Cover more than halves between the first and the last, because higher leverage and a higher rate compound on the same line rather than offsetting.
This is worth understanding before choosing a structure rather than after. The additional leverage a fund facility offers is real, and so is the reduction in interest cover that comes with it, and the second is easy to miss when the conversation is about how much can be borrowed.
The denominator is a defined term, not a number from your accounts. What it sweeps in decides the ratio as surely as trading does.
| Cost | How commonly included |
|---|---|
| PIK interest (accrued, not paid) | Most contested |
| Amortised original issue discount | 25–50 on the scale |
| Commitment fee on undrawn | 45–70 on the scale |
| Hedging costs | 60–85 on the scale |
| Cash margin | Always |
How commonly each cost is captured by an interest definition. Illustrative of market practice; the guides publish no standard definition and facilities vary. Worth settling at term-sheet stage.
What a rate rise does
It compresses the ratio without touching the business, which is the property that makes this covenant distinctive.
Both cover tests are calibrated at drawdown rates. A sharp rise in the reference rate lifts the interest bill, compresses the cover, and pushes a performing credit towards a covenant it never breached on trading, purely on the cost of money.
On £6m of floating bank senior at an all-in of 6.75%, interest of about £405,000 covers 4.94 times. One point on the reference rate takes the all-in to 7.75% and cover to 4.30 times. Two points takes it to 8.75% and 3.81 times. Every point moves straight onto the line, because a floating rate resets with the market and the margin sits on top of whatever it resets to.
This is the mechanism behind the hedging requirement that appears in most facility agreements as a condition rather than a suggestion. Hedging converts an unknown future rate into a known one on the hedged slice, which takes the tail off exactly this exposure.
What the definition sweeps in
More than the interest line in your accounts, and the drafting is where the ratio is really set.
The cash margin is always in. Hedging costs on the swapped portion are usually in. The commitment fee on undrawn amounts is often in, which means an undrawn revolver can tighten a ratio it contributes no drawn debt to.
Two items are worth arguing about. Amortised original issue discount is sometimes swept in and frequently overlooked, since it is a cost that was deducted at drawdown rather than paid during the period. And payment-in-kind interest, which accrues onto the balance rather than being paid in cash, is the most contested of all: including it tightens the ratio for money that never leaves the business in the period being tested.
None of these appear in the headline covenant level, which is why comparing two offers on their stated cover requirements alone can mislead.
What to negotiate
The definition first, the level second, and the hedging requirement alongside both.
On the definition, the priorities are whether PIK interest is included, whether amortised discount is swept in, and whether the commitment fee on an undrawn revolver counts. Each of those tightens the ratio without changing what the business pays in cash.
On the level, the useful frame is headroom rather than the number: how far can earnings fall, and how far can rates rise, before this test fails, and does it fail before or after the leverage and debt service tests. If interest cover is the first to break, the structure carries more rate risk than the headline suggests.
And on hedging, the amount and tenor of the required hedge determine how much of the ratio is exposed to rates at all. A facility with a substantial hedged proportion has largely fixed the denominator of this test for the hedged period, which is worth more than a slightly looser covenant level.
Common questions
What is interest cover?
Earnings divided by the interest bill, expressed in a covenant suite as EBITDA to interest. It measures how many times over the business could pay its interest out of its earnings. A stricter formulation compares cash generated with interest paid.
What interest cover do lenders require?
We publish no threshold, and any figure quoted without a source should be treated with caution. Levels vary too widely by instrument, sector and structure for one number to be useful. A level that is comfortable on an amortising bank facility can be tight on a bullet fund facility, because the ratio is doing a different job in each.
How is interest cover different from DSCR?
DSCR counts interest plus scheduled principal repayment; interest cover counts interest alone. On a fully-amortising five-year facility the principal is roughly three times the interest bill, so a business with comfortable interest cover can have debt service cover near or below one times.
Why does my interest cover fall when rates rise?
Because the test is calibrated at drawdown rates and a floating rate resets with the market. On £6m at an all-in of 6.75%, cover on £2m of EBITDA is 4.94 times; one point on the reference rate takes it to 4.30 times and two points to 3.81 times, with no change to trading.
Does a unitranche hurt interest cover?
Materially, because higher leverage and a higher rate compound. On £2m of EBITDA, bank senior at three times gives cover of about 4.94 times; a unitranche at four and a half times at around 10.5% gives about 2.12 times. The extra leverage is real and so is the cost of it.
What counts as interest in the covenant?
The cash margin always, hedging costs usually, and the commitment fee on undrawn amounts often. Amortised original issue discount is sometimes swept in and frequently overlooked. PIK interest is the most contested, because including it tightens the ratio for money that never leaves the business in the period.
Can an undrawn revolver tighten my interest cover?
It can, where the definition includes the commitment fee on undrawn commitments. The facility contributes no drawn debt and still adds to the denominator, which is a good reason to check the definition before sizing an undrawn line generously.
Should I hedge to protect interest cover?
Hedging is the direct answer to this exposure and usually appears in the agreement as a condition rather than a choice. It converts an unknown future rate into a known one on the hedged slice, which fixes most of the denominator for the hedged period. The proportion and tenor are worth negotiating alongside the covenant level.
The full treatment sits in the guide: loan covenants explained.
This page explains a term as it is used in the UK lower-mid-market. It is general information, not advice on any particular facility. Terms vary between lenders and between deals, and the drafting in your own agreement governs.