DSCR, leverage and FCCR: the covenant ratios lenders watch

Open almost any middle-market credit agreement and you will find the same short list of financial covenants. They look like simple ratios. The subtlety is in how each one is built — and the build is where compliance is quietly won or lost.

EBITDA: the number underneath everything

Three of the four common covenants are driven by EBITDA, and EBITDA is not a GAAP line. Your agreement defines it: a starting line (net income or operating income) plus a specific set of add-backs — interest, taxes, depreciation, amortization, and often explicit one-time items.

Two lenders can look at the same P&L and compute different EBITDA, because they negotiated different add-backs. Always compute the covenant with your agreement's definition, not a textbook one.

Debt Service Coverage Ratio (DSCR)

DSCR = (EBITDA − cash taxes − unfinanced capex) ÷ total debt service

DSCR asks a blunt question: after taxes and the capex you have to fund yourself, does the business generate enough cash to cover principal and interest? A typical floor is 1.20× — meaning $1.20 of coverage for every $1.00 of debt service. Below the floor is a breach.

Total leverage

Total Leverage = total funded debt ÷ EBITDA

Leverage is a maximum covenant — you breach by going above the cap, often 3.5× for a healthy borrower. Note what makes leverage dangerous: it has two moving parts. Debt amortizes down slowly, but EBITDA can soften fast. A flat debt balance against a declining trailing EBITDA pushes the ratio up even when you have done nothing wrong.

Fixed-Charge Coverage Ratio (FCCR)

FCCR = (EBITDA − unfinanced capex) ÷ (debt service + fixed charges)

FCCR is DSCR's stricter cousin: it adds rent and other fixed obligations to the denominator. A company that passes DSCR comfortably can sit much closer to its FCCR floor (commonly 1.10×) once leases are included.

Liquidity and capex

Rounding out the package:

• Minimum liquidity — unrestricted cash plus undrawn revolver must stay above a floor. A minimum covenant.
• Maximum capex — trailing capital expenditure must stay under an annual ceiling. A maximum covenant, and an easy one to breach late in the year as projects close out.

The watch band

A good monitoring practice does not wait for the breach line. Set a cushion — say 10% of the threshold — and treat anything inside that band as watch. A DSCR of 1.25× against a 1.20× floor is technically a pass, but it is one bad quarter from trouble. The watch band is where you still have time to act.