Covenant Stress, FX Exposure and Refinancing Risk in Cement
You are a credit analyst at a Pakistani bank reviewing a PKR 15 billion term loan to a listed cement producer. FY24 EBITDA is PKR 6.00 billion on revenue of PKR 30 billion. Net debt is PKR 15.00 billion. Of the debt, 60% is floating-rate PKR debt priced at 22% and 40% is USD debt priced at 9%; the PKR/USD rate is 278. The loan covenants are net debt/EBITDA ≤3.25x and DSCR ≥1.20x. A PKR 2.00 billion principal instalment is due in six months, and capex of PKR 3.00 billion is committed. The SBP policy rate is 22%, and the bank's base case assumes a 300 bps increase in floating PKR rates and a 15% PKR depreciation over the next year. Tax is 29% and working capital needs are PKR 0.30 billion. The company has no FX hedge.
1. Calculate pro forma net debt/EBITDA and interest coverage after the 300 bps rate rise and 15% PKR depreciation.
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Original debt split: PKR debt = 60% × 15.0 = PKR 9.0bn; USD debt = 40% × 15.0 = PKR 6.0bn. After 15% depreciation, USD debt = 6.0 × 1.15 = PKR 6.9bn; total debt = PKR 15.9bn. Net debt/EBITDA = 15.9/6.0 = 2.65x, below the 3.25x covenant but only 0.60x of headroom.
Interest: PKR debt at 22% + 300 bps = 25%, so 9.0 × 25% = PKR 2.25bn. USD debt at 9% on the higher principal = 6.9 × 9% = PKR 0.62bn. Total interest = PKR 2.87bn. Interest coverage = 6.0/2.87 = 2.09x, down from 2.86x before the shocks.
The covenant is not breached on leverage, but coverage has deteriorated sharply. If EBITDA falls 10% to PKR 5.4bn, leverage rises to 2.94x and coverage falls to 1.88x. A further FX move or a delay in cement demand would push leverage toward the covenant.
2. Calculate DSCR and assess liquidity risk. What happens if the company cuts capex by half?
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Use CFADS = EBITDA − tax − working capital − capex. Tax is approximated at 29% of EBITDA less interest, but for a quick DSCR use PKR 0.50bn tax. CFADS = 6.00 − 0.50 − 0.30 − 3.00 = PKR 2.20bn. Debt service = interest PKR 2.87bn + principal PKR 2.00bn = PKR 4.87bn. DSCR = 2.20/4.87 = 0.45x, far below the 1.20x covenant.
Even if capex is halved to PKR 1.50bn, CFADS = 6.00 − 0.50 − 0.30 − 1.50 = PKR 3.70bn; DSCR = 3.70/4.87 = 0.76x. Still a breach. The company cannot cut its way to compliance because interest alone is nearly half of EBITDA.
Liquidity risk is acute. The PKR 2.00bn instalment is due in six months, and the company has no FX hedge. The bank should not wait for the test date. It should require an immediate cash flow forecast, a commitment to fund the instalment from equity or asset sales, and a standstill on distributions.
3. Recommend a covenant and refinancing package. What are the bank's negotiating priorities?
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Priority one is to extend the principal instalment and reset the DSCR test to a forward-looking 12-month basis, because a 1.20x DSCR is unattainable with the current debt service. In exchange, the bank should require a cash sweep of 50% of excess cash flow, a dividend freeze, and a cap on capex until leverage falls below 2.50x.
Priority two is to hedge the USD exposure. The company should hedge at least 70% of the USD debt service for the next 24 months using forwards or a cross-currency swap. That reduces the FX translation risk on both debt and interest.
Priority three is to fix or cap the PKR floating rate. A 300 bps rise costs about PKR 0.27bn annually on the PKR debt. An interest rate cap or a fixed-rate refinancing of part of the PKR debt would protect coverage.
The bank should also require a sponsor equity injection of at least PKR 2.0bn to cure the DSCR breach. If the sponsor refuses, the bank should negotiate a debt-for-equity swap or a sale of non-core assets. Do not grant a pure waiver: it leaves the bank with the same exposure and no improvement in the risk profile.