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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