Glossary
Credit and risk
What is coverage ratio?
Earnings divided by interest cost.
The margin for error. Above 2.5x the borrower can absorb a bad quarter; near 1.2x a rate move or a lost contract stops the payments. The most honest number on a credit paper.
A worked example
EBITDA of $40m against $16m of annual interest is 2.5x interest coverage. If rates rise and interest climbs to $22m, coverage falls to about 1.8x, which is roughly where lenders start picking up the phone.
Where it catches you in the game
- Positions below roughly 1.3x coverage are flagged and are the ones that breach.
It comes up most on the private credit desk.
Related terms
Learn it by using it
Definitions stick once they've cost you money. Take a seat, make three calls a year and watch what coverage ratio does to your returns.