Case 066Private credit and direct lendingHard

A direct lender is offered a Rs 350 crore unitranche at 11% with 5% annual amortisation to a bearings maker earning Rs 90 crore of EBITDA. Can the loan be serviced and repaid if EBITDA falls 20%, and what cover does the lender have each year?

The situation

A sponsor is buying Chakradhar Bearings, a maker of industrial bearings for pumps and conveyors, and has asked a direct lending fund for a single unitrancheOne loan that replaces the usual senior and junior layers, priced between the two, usually from a direct lender rather than a bank syndicate. loan of Rs 350 crore. It pays 11% interest on the opening balance, amortises 5% of the original amount, Rs 17.5 crore, every year, and the balance falls due as a bullet at the end of year 5.

EBITDA is Rs 90 crore. Capex is Rs 20 crore a year, depreciation Rs 15 crore, and tax is 25% of profit after interest. The sponsor's plan has EBITDA growing 5% a year. The credit committee wants a downside in which EBITDA drops 20%, to Rs 72 crore, in year 1 and stays there. The company starts with no spare cash, any surplus stays on its balance sheet, and any shortfall must come from a revolver or the sponsor. At maturity, assume a new lender would refinance up to 4.0x EBITDA.

Your task

Work out the cash available for debt service and the cover in each year under the plan and the downside, then say whether the bullet can be refinanced and what loan size the lender should offer.

Quick check

In the downside year 1, EBITDA is Rs 72 crore against Rs 56 crore of interest and amortisation. Is debt service covered?

Worked solution

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

30-second answerThe answer to give first

On the plan the loan works, with cover rising from 1.15x to 1.61x and an easy refinancing; in the downside it does not, with cover below 1.0x in every year and net debt of about Rs 291 crore at maturity against Rs 288 crore of refinancing capacity. The downside burns Rs 29 crore over five years. A lender who underwrites the downside offers about Rs 285 crore, or keeps Rs 350 crore only with a sponsor equity cure or lighter amortisation.

Step 1What cash does the lender actually get paid from?

Not EBITDA. Think of a taxi driver who borrows to buy the car: the lender gets paid from fares after fuel, servicing and tax, not from fares. Cash available for debt service is EBITDA less capex less tax, and here that is Rs 64.2 crore in plan year 1 against Rs 56.0 crore of interest and amortisation, cover of 1.15x. The debt service cover ratioCash available for debt service divided by interest plus scheduled principal. Below 1.0x the company cannot meet its obligations from its own cash. is the lender's first number, because it asks whether the company can pay this year without anyone's help. Interest is charged on a balance that falls by Rs 17.5 crore a year, so debt service eases from Rs 56.0 crore to Rs 48.3 crore over the five years.

Year	Plan EBITDA	Plan cash available	Plan cover	Downside cash available	Debt service	Downside cover
1	94.5	64.2	1.15x	47.4	56.0	0.85x
2	99.2	67.3	1.24x	46.9	54.1	0.87x
3	104.2	70.6	1.35x	46.4	52.1	0.89x
4	109.4	74.0	1.47x	45.9	50.2	0.91x
5	114.9	77.6	1.61x	45.5	48.3	0.94x
Five-year surplus or gap		+92.9		-28.7

Rs crore. Debt service is the same in both cases because the loan is the same: interest at 11% on a balance falling by Rs 17.5 crore a year. The plan builds a surplus of Rs 92.9 crore; the downside, with EBITDA flat at Rs 72 crore, leaves a gap of Rs 28.7 crore that a revolver or the sponsor must fill.

Under the plan, Chakradhar's cash available covers debt service from 1.15x in year 1 to 1.61x in year 5; in the downside, cash available of about Rs 47 crore a year falls short of debt service in all five years, with cover between 0.85x and 0.94x.

Step 2Why does a 20% fall in EBITDA do so much damage to the cover?

Because the lender sits behind fixed costs of its own making. A Rs 18 crore fall in EBITDA becomes a Rs 16.9 crore fall in cash available after the tax saving, but debt service does not move at all, so cover drops from 1.15x to 0.85x. Capex of Rs 20 crore and debt service of Rs 56 crore are both fixed, and they take up most of a Rs 72 crore EBITDA. Entry leverage of 3.9x looks moderate; what makes it tight is that only about two thirds of EBITDA turns into cash for the lender, and the loan asks for 5% of principal on top of interest from year 1.

Step 3Can the bullet be repaid in year 5?

Only by refinancing, so test what a new lender would lend. Under the plan, Rs 262.5 crore is still owed, less Rs 93 crore of cash built up, so net debt is about Rs 170 crore against capacity of Rs 459 crore at 4.0x; in the downside, net debt is Rs 291 crore against capacity of Rs 288 crore. The downside gap is small in rupees, but it arrives after five years of funded shortfalls, a covenant breach in year 1, and a business that has not grown. That company is refinanced on the lender's terms, if at all, and the lender's real exposure is a restructuring in which recovery depends on what the bearings business is worth at Rs 72 crore of EBITDA.

At maturity the plan leaves net debt of about Rs 170 crore against Rs 459 crore of refinancing capacity at 4.0x EBITDA, while the downside leaves Rs 291 crore against Rs 288 crore, so the loan is refinanced easily on the plan and not at all comfortably in the downside.

The relationship

\underbrace{72 - 20 - 0.25\,(72 - 15 - 0.11L)}_{\text{downside cash available}} \;\ge\; \underbrace{0.11L + 0.05L}_{\text{interest + amortisation}} \;\Rightarrow\; L \le 285

L	the loan size, Rs crore
72 - 20	downside EBITDA less capex
0.25(72 - 15 - 0.11L)	tax on profit after depreciation and interest; a bigger loan means less tax
0.11L + 0.05L	first-year interest and 5% amortisation

What it says in wordsYear 1 is the tightest year, so the largest loan the downside can service on its own is the one where first-year cash available just equals first-year debt service.

Step 4What would you take back to the credit committee?

A lender underwrites the downside, not the plan. At Rs 350 crore, the loan depends on the plan happening; at about Rs 285 crore, 3.2x EBITDA, the company can service it from its own cash even if EBITDA drops 20% and stays there. If the sponsor needs the larger loan, three structural answers are worth asking for: amortisation of 1% rather than 5%, which removes most of the year 1 gap; an equity cureA right for the sponsor to inject equity to fix a covenant breach, so the lender is protected without forcing a default. backed by a committed sponsor; and a cash sweep in good years so that the plan's surplus reduces the bullet. The limitation to state: a single flat downside is a sketch, and a real committee would also test a sharper drop that then recovers, and whether capex can be cut to Rs 12 to 15 crore for a year or two without harming the plants.

Where candidates lose it

The usual loss is dividing EBITDA by debt service, 72 over 56, and calling the downside covered at 1.3x. Capex and tax come out first, so the true cover is 0.85x and the company is short of cash from the first year.

The second is stopping at annual cover and forgetting the bullet. A loan that amortises 5% a year still has 75% of its principal due in year 5, so the repayment question is a refinancing question, and it has to be answered on the downside EBITDA.

What the interviewer asks next

Amortisation is cut to 1% a year. Rework the downside cover in year 1.
The sponsor offers a Rs 30 crore equity cure. Is that enough to get through the downside, and when would it be used?
What maintenance covenants would you set on this loan, and at what levels?
If the downside happens and the company defaults in year 3, how would you estimate the lender's recovery?

Company names and figures are illustrative.