A NAV facility can sit comfortably inside its loan-to-value covenant and still run out of cash to pay its interest; the coverage test is where that shows.
Interest coverage on a NAV facility is the portfolio's recurring cash receipts divided by the cash interest, commitment fees and agency fees on the facility. On an illustrative 150 drawn against 750 of NAV at a 9.5 per cent all-in rate, 22.5 of receipts cover 14.85 of cost 1.52 times. A 1.25 times covenant breaks at an all-in rate of 11.6 per cent, or after a 17.5 per cent fall in receipts, while the loan-to-value is still only 20.0 per cent.
Worked in full in The Fund Finance Professional by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
An illustrative private equity fund late in its life has a NAV facility secured on a diversified portfolio. Rates and fees are illustrative, not market quotes. Figures in millions.
| Input | Value |
|---|---|
| Portfolio NAV | 750 |
| Facility commitment | 200 |
| Drawn | 150 |
| Base rate | 4.0% |
| Margin | 5.5% |
| All-in rate on drawn amount | 9.5% |
| Commitment fee on undrawn amount | 1.0% |
| Agency fee, per year | 0.10 |
| Recurring receipts as yield on NAV | 3.0% |
| Interest coverage covenant | 1.25x |
Receipts = NAV × recurring yield = 750 × 3.0% = 22.50
Cash cost = drawn × all-in rate + undrawn × commitment fee + agency fee = 150 × 9.5% + 50 × 1.0% + 0.10 = 14.25 + 0.50 + 0.10 = 14.85
Interest coverage = 22.50 / 14.85 = 1.52x
Break-even all-in rate = (receipts / covenant − commitment fee − agency fee) / drawn = (22.50 / 1.25 − 0.50 − 0.10) / 150 = 11.6%
In Excel, with NAV in C3, yield in C4, drawn in C5, commitment in C6, rate in C7, fee in C8, agency in C9 and covenant in C10: =C3*C4/(C5*C7+(C6-C5)*C8+C9) for coverage and =(C3*C4/C10-(C6-C5)*C8-C9)/C5 for the break-even rate.
Inverting the test is more useful than computing it. A coverage ratio of 1.52 says little on its own; a break-even rate of 11.6 per cent says the facility can absorb 210 basis points on the base rate, to 6.10 per cent, before the covenant fails. At 1.00 times, where receipts no longer pay the interest at all, the break-even all-in rate is 14.6 per cent.
| Lever | At 1.25x | At 1.00x |
|---|---|---|
| All-in rate rises to | 11.6% | 14.6% |
| Receipts fall to | 18.56 | 14.85 |
| Fall in receipts | 17.5% | 34.0% |
| Recurring yield on NAV falls to | 2.48% | 1.98% |
The third lever is the drawn amount. Solving the same formula for it, the fund can draw 187.1 of its 200 commitment before coverage reaches 1.25 times at today's rate. The last 12.9 of the facility is available on paper only.
Coverage and loan-to-value test different things. LTV asks whether the portfolio is worth enough to repay the loan; coverage asks whether it produces enough cash to service it until it does. A late-life portfolio of growing but non-yielding companies can pass the first easily and fail the second.
Coverage on 150 drawn, by recurring yield on NAV and all-in rate:
| Yield on NAV | 7.5% | 8.5% | 9.5% | 10.5% | 11.5% |
|---|---|---|---|---|---|
| 2.0% | 1.27 | 1.12 | 1.01 | 0.92 | 0.84 |
| 2.5% | 1.58 | 1.40 | 1.26 | 1.15 | 1.05 |
| 3.0% | 1.90 | 1.69 | 1.52 | 1.38 | 1.26 |
| 3.5% | 2.22 | 1.97 | 1.77 | 1.61 | 1.47 |
| 4.0% | 2.53 | 2.25 | 2.02 | 1.83 | 1.68 |
The stresses compound. A 200 basis point rise in the base rate alone, to an all-in 11.5 per cent and 17.85 of cost, takes coverage to 1.26 times. A 15 per cent fall in receipts alone, to 19.12, takes it to 1.29. Together they give 1.07: a breach, with the LTV unchanged at 20.0 per cent. Rates and portfolio dividends tend to move against a borrower at the same time, which is why a combined test is more informative than either limb.
The common error is to treat coverage as a formality because the LTV is low. On these numbers the facility costs 1.98 per cent of NAV a year, and most of the portfolio's cash return goes to the lender before any distribution. The second error is leaving fees out of the denominator: on interest alone coverage is 1.58 times, which overstates headroom against a definition that usually includes fees, as the book's does. Read the definition, then compute the break-even rate and the break-even yield, and report those alongside the ratio.
Divide recurring receipts by cash interest and fees, then invert the formula to find the rate and the receipts at which the covenant fails. Here 1.52 times becomes a break-even all-in rate of 11.6 per cent and a tolerable 17.5 per cent fall in receipts. The book's coverage case, built on the rate at which coverage reaches 1.00 times for any recurring yield, is in the free workbooks for this book. For the value side of the same facility, see how far NAV can fall before an LTV breach.
Usually recurring cash from the portfolio: dividends, interest on shareholder loans and fees received, as the credit agreement defines them. Exit proceeds are often excluded or capped because they are lumpy. In the illustrative case recurring receipts are 3.0 per cent of a 750 NAV, or 22.5 a year.
Yes. At 150 drawn on 750 the illustrative LTV is 20.0 per cent, well inside most covenants, yet a 200 basis point rise in the base rate takes coverage from 1.52 to 1.26 times, and adding a 15 per cent fall in receipts takes it to 1.07, below a 1.25 covenant.
Solve the coverage formula for the drawn amount. With 22.5 of receipts, a 9.5 per cent rate, a 1.0 per cent fee on undrawn commitments and a 1.25 times covenant, the illustrative fund can draw up to 187.1 of its 200 commitment before the test fails.
This article is one calculation from The Fund Finance Professional. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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