Case 064Private credit and direct lendingCore

Private credit case: a veterinary clinic group asks for a unitranche at 5.5x EBITDA with a discount and call protection. Compute the lender's yield if repaid after three years and propose the covenant set.

The situation

Orvessa Veterinary, a growing chain of animal clinics owned by a sponsor, asks for a unitranche loan of 5.5x its EBITDA of Rs 60 crore, Rs 330 crore. The price is the benchmark rate plus 600 basis points; take the benchmark as 6.5%, so the coupon is 12.5%, paid yearly. The loan is funded at 98, a 2% discount.

Call protection: if Orvessa repays in years 1 or 2 it pays 102, in year 3 it pays 101, and from year 4 it pays par. The sponsor expects to sell or refinance after three years. Depreciation and maintenance capex are Rs 6 crore each, tax is 25%, and there is no scheduled amortisation.

Your task

What yield does the lender earn if the loan is repaid at the end of year 3, how does that change with the exit date, and what covenants would you ask for?

Quick check

Repaid at the end of year 3 at 101, bought at 98 with a 12.5% coupon, roughly what does the lender earn?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Repaid at the end of year 3 at 101, the lender earns about 13.65% on a 12.5% coupon. The 2 point discount and 1 point premium add about 1.1% a year. Repaid in year 1 at 102 the yield would be 16.84%; held five years at par, 13.07%. But at 5.5x, interest takes 69% of EBITDA, cover is only 1.45x, so pair the pricing with tight covenants or lend nearer 5.0x.

Step 1Where does the extra yield come from?

Think of lending a friend Rs 98 on a promise of Rs 100 back plus interest, and a Rs 1 thank-you if they repay early. If they repay next month, those extra rupees are a big return for a month; if they repay in five years, they barely register. Discount and call premium are fixed rupee amounts, so the shorter the loan's life, the more yield each point adds. For Orvessa, the lender pays 98, receives 12.5 a year, and on a year-3 exit receives 101: 3 points of extra gain over three years.

Fees and call premiums matter most when the loan leaves earlyPay 98Day 012.5Year 112.5Year 212.5 + 101Year 3includes a 1 point call premium2 points of discount keptYield if repaid in yearYear 1, at 10216.84%Year 2, at 10214.66%Year 3, at 10113.65%Year 5, at 10013.07%
The lender pays 98, receives 12.5 in each of three years and 101 of principal at the year-3 exit, a yield of 13.65%; the same loan repaid in year 1 at 102 would yield 16.84%, and held five years at par 13.07%.
Repaid at end of yearRepayment priceLender's yieldUplift over 12.5% coupon
110216.84%4.34%
210214.66%2.16%
310113.65%1.15%
410013.17%0.67%
510013.07%0.57%
The same 2 points of discount and the call premium add 4.34% a year if the loan leaves in year 1 but only 0.57% if it runs five years to par.
Step 2Is 5.5x a sensible amount to lend?

Now the credit, which matters more than the yield. At 5.5x and 12.5%, interest is Rs 41.25 crore against EBITDA of Rs 60 crore, cover of only 1.45x, and free cash flow after capex and tax is about Rs 9.6 crore a year. The loan cannot be paid down from cash flow in any meaningful time; the lender is relying on EBITDA growth from new clinics and on a sale or refinancing in year 3. A 15% fall in EBITDA takes cover to 1.24x. Vet clinics have steady demand, which is why a lender considers this at all, but a roll-up depends on new clinics performing like old ones. Lending 5.0x, Rs 300 crore, would lift cover to 1.60x.

Step 3Which covenants would you ask for?

Four, each tied to the risk just found. A maintenance covenant on total net leverage, set around 6.5x and stepping down to 5.0x by year 3, so the lender gets a seat at the table if growth stalls. A minimum interest cover of about 1.25x. A cap on acquisitions funded with debt, and a requirement that any acquired clinic's EBITDA is counted only once it has a year of trading. And an equity cureA right for the sponsor to inject equity to fix a covenant breach, usually limited in how often it can be used. limited to two uses over the life. The view: attractive at 13.65% only with this covenant package; without it, offer 5.0x.

Where candidates lose it

The usual error is quoting the coupon, 12.5%, as the lender's return, or adding the full 3 points to a single year. The discount and premium are spread over the loan's actual life, which is why they matter far more on a short loan.

The bigger miss is stopping at the yield. At 5.5x the interest takes most of the EBITDA, and an interviewer wants to hear that before any covenant list.

What the interviewer asks next

  • What is the lender's yield if Orvessa refinances after 18 months?
  • How would a PIK toggle on part of the interest change the lender's risk?
  • Why do private credit lenders accept call protection that falls away after three years?

Company names and figures are illustrative.