Rates up again: re-reading leverage, interest cover and headroom

The ECB's June increase ends the easing cycle. For lender-facing reports, we re-read three things: covenant EBITDA against DD EBITDA, interest cover at +100 bps after hedging, and cash conversion.

On 11 June the ECB raised its three key rates by 25 basis points, effective 17 June. The deposit facility rate moved from 2.00% to 2.25%. This was its first increase since September 2023. It followed eight cuts between June 2024 and June 2025 and a year on hold. The Governing Council pointed to inflation pressure from energy prices: headline HICP was 3.2% in May. Its staff now project 3.0% for 2026 and 2.3% for 2027. It also said it was not pre-committing to any rate path. The next meeting is on 22–23 July.

The move matters less in itself than in what it ends. Most mid-market capital structures put in place since mid-2024 were modelled on rates that were falling, or at worst flat. Three-month Euribor stood at 2.03% at the start of the year. It was 2.31% on 1 July. Twelve-month Euribor reached 2.85% at the start of April. For a floating-rate unitranche, these are not small moves when the margin sits at 5–6%.

This note covers how we are re-reading lender-facing reports this summer, and what we now ask management and sponsors before we sign off.

The financing backdrop

Direct lending margins have not widened yet. Debtwire put the average European unitranche margin at 547 bps in Q1 2026, against 552 bps in Q4 2025. Baird quotes E+525–625 for the traditional mid-market. Valuations are still firm as well. The Argos index for Q1 2026 shows a median of 8.6x EBITDA, and 10.0x for deals done by funds.

Refinancing is still ahead of us. PitchBook LCD estimates that about €60bn of European leveraged loans maturing in 2028 is still to be addressed, with a similar amount for 2029. The 2021 vintage is a large part of it, and it was priced and levered for a world of near-zero rates. Sponsors usually start refinancing around 18 months before maturity. That means the 2028 wall will be negotiated in 2026 and early 2027, on the rate path the ECB has just changed.

So the base rate is rising while margins stay tight, entry multiples stay high and refinancing deadlines get closer. In that setting, any slack in the EBITDA definition gets used up quickly.

1. Covenant EBITDA is not DD EBITDA

The leverage covenant is tested on the EBITDA defined in the facilities agreement. That is rarely the EBITDA in our report. US private credit data from Proskauer shows that only 39% of 2025 deals with non-recurring add-backs capped them, against 66% in 2023. European mid-market documents are generally tighter, but the trend is the same.

Our first deliverable is now a line-by-line reconciliation between the two definitions. It is not a single "adjusted EBITDA" line. Take an anonymised distribution business we reviewed:

The gap is €0.9m, about 11%. Each line has a cause the lender can test. One is a savings plan with no signed contracts. Another is a bolt-on whose pro forma relies on management accounts we have not reviewed. The third is a restructuring cost that has come back every year since 2023. We do not argue that the covenant definition is wrong. We show the lender which part of headroom rests on items that have not yet turned into cash.

Then we measure headroom. With a €40m unitranche, opening leverage is 5.0x on covenant EBITDA. It is 5.6x on our number. A 6.5x covenant gives about 30% cushion on paper, which is in line with current practice. Covenant EBITDA can fall to €6.15m before a breach. That is a 23% fall from €8.0m, but only 13% from €7.1m. The lender should base its credit decision on the second figure.

2. Interest cover at +100 bps, after the hedge

On the same business, the €40m at E+575 with three-month Euribor at 2.31% costs 8.06%, or €3.22m a year. We run the sensitivity at +100 bps. That is not a forecast, only a round figure that a lender can compare across files.

• Unhedged: interest goes to €3.62m. Cover on covenant EBITDA falls from 2.48x to 2.21x. On DD EBITDA it falls from 2.20x to 1.96x.
• 60% swapped: only €16m is exposed, so the extra cost is €0.16m. Cover on DD EBITDA holds at 2.10x.

The hedge makes the difference, so we read the hedge documents, not just the term sheet summary. We look at four points:

1. Notional and amortisation profile against the actual drawn debt, including the accordion and any capex line drawn since closing.
2. Maturity. Many hedges placed in 2024 run for two to three years. A swap ending in 2027 protects the current test dates but not the refinancing.
3. Instrument. A cap at a strike well above the current Euribor protects against a shock but not against a steady climb. A swap fixed in 2024 may be in the money today. That value is debt-like or an asset in the equity bridge, depending on its sign.
4. Termination cost on a refinancing or change of control. It is often missing from the sources and uses table.

3. Cash conversion: capex and working capital are the real limit

Interest cover is calculated on EBITDA, but interest is paid in cash. For the same business, EBITDA of €7.1m becomes €4.1m of cash before debt service. That is after €1.6m of capex, a €0.5m working capital outflow and €0.9m of tax. Cash interest cover is therefore 1.27x today and 1.13x at +100 bps. That is a much thinner margin than the 2x shown in the covenant compliance certificate.

Two lines decide whether the €4.1m holds.

• Capex. We split maintenance from growth capex using the asset register and the age of the fleet or machinery. We do not rely on management's labels. In our experience, "growth" capex that comes back every year is maintenance capex. If capex was deferred in the year before the sale, it will come back as a cash need in the first year of the loan. We quantify it and show it as a debt-like item or a reduction in cash flow, not as a footnote.
• Working capital. We look at the month-end profile, not the year-end. A business that draws its RCF every quarter-end to pay suppliers has a higher real debt level than its closing balance sheet shows. Higher rates also make it more costly for customers to pay late. Lengthening customer payment days are an early sign we now report on separately.

What we recommend now

• Ask for the covenant EBITDA reconciliation with the DD report, line by line, with the evidence for each add-back. Agree with the lender which lines the headroom calculation excludes.
• Run interest cover at +100 bps on the hedged position as it actually stands. Report the hedge maturity next to the debt maturity.
• Report cash interest cover, after normal capex and seasonal working capital, together with the EBITDA ratio.
• For 2021–2022 vintage assets that will refinance before 2028, start this work now, before the refinancing window. Questions a lender asks in a refinancing are easier to answer once the reconciliation already exists.

This note is general information, not advice on a specific transaction.