Balance Sheet Capacity - Cover Ratios

Ratio 44. Net Interest Cover

Surplus before net interest and tax divided by total interest paid less interest received.
Interest cover based on the Income and Expenditure Statement is probably the most widely used of all credit measures especially in loan covenants. The norm for commercial property lending would be 1.25/1.35 because of the contractual, stable nature of income plus good asset quality. However for housing associations where no dividends and minimal corporation tax are paid, it can be argued that an equivalent minimum would be 1.1/1.2.

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Ratio 45. Cash Interest Cover (times)

Cash flow before debt service (operating cash flow after tax but before capex and interest), divided by net cash interest paid. The reciprocal of Ratio 39.
A cash flow measure of cover, which is arguably more directly relevant than I&E interest cover. It is used to reflect the adequacy of operating cash flow, rather than surplus, to cover interest payments. But the non-cash adjustments, capitalised repairs and maintenance, or working capital movements for RSLs usually make cash flow better than operating surplus.

If the ratio is less than 1.0 this means that the excess interest, loan repayments and capex have to be funded by new borrowing. This is not sustainable in the long run. 1.1 might be a prudent minimum, so that at least part of capex or loan repayments is covered by internally-generated funds. A ratio of 1.0 means that all maturing debt has to be re-financed, with the associated refinancing risk, and net capex has to be 100% debt financed, but this is probably the way to maximise development potential.

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Ratio 46. Cash Debt Service Cover (times)

Cash flow before debt service, as above, but divided by the net interest paid plus scheduled debt repayments.
This ratio measures the borrower’s ability to service the debt interest and also cover scheduled repayments from internally generated cash flow. If this is less than 1.0 then a proportion of current maturities has to be re-financed with new debt rather than met by internally-generated funds. If Ratio 45 is at 1.0 and all maturing debt is being re-financed, this ratio might be as low as 0.7 given 7% interest rates and 30-year term debt.

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