EBITDA Add-backs in Debt Contracting: A Step Too Far?

58 Pages Posted: 14 Nov 2021

See all articles by Miguel Faria-e-Castro

Miguel Faria-e-Castro

Federal Reserve Bank of St. Louis

Radhakrishnan Gopalan

Washington University in St. Louis - John M. Olin Business School

Avantika Pal

Washington University in St. Louis - John M. Olin Business School

Juan M. Sánchez

Federal Reserve Banks - Federal Reserve Bank of St. Louis; Federal Reserve Banks - Federal Reserve Bank of St. Louis

Vijay Yerramilli

University of Houston, C. T. Bauer College of Business

Date Written: November 11, 2021

Abstract

Financial covenants in syndicated loan agreements often rely on definitions of EBITDA that deviate from the GAAP definition. We document the increased usage of non-GAAP addbacks to EBITDA in recent times. Using the 2013 Interagency Guidance on Leveraged Lending, which we argue led to an exogenous increase in non-GAAP EBITDA addbacks, we show that these addbacks increase the likelihood of loan delinquency and default, and also increase the likelihood of the borrower experiencing a ratings downgrade. Greater use of non-GAAP EBITDA addbacks also makes it more likely that lead arrangers lower their loan share exposures through secondary market sales. Our results highlight that covenants based on customized measures of EBITDA hurt loan performance by worsening lead arrangers' incentives to monitor borrowers and by hampering their ability to take timely corrective actions.

Keywords: Syndicated Loans, Credit Agreement, Financial Covenant, EBITDA, Add-backs, GAAP, Leveraged Lending Guidance, Borrower Performance, Loan Performance, Lead Arranger, Lender Monitoring, Loan Sales

JEL Classification: G21, G23, G28, G32, G34

Suggested Citation

Faria-e-Castro, Miguel and Gopalan, Radhakrishnan and Pal, Avantika and Sanchez, Juan M. and Sanchez, Juan M. and Yerramilli, Vijay, EBITDA Add-backs in Debt Contracting: A Step Too Far? (November 11, 2021). Available at SSRN: https://ssrn.com/abstract=3961696 or http://dx.doi.org/10.2139/ssrn.3961696

Miguel Faria-e-Castro

Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

Radhakrishnan Gopalan

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Avantika Pal (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Juan M. Sanchez

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

Vijay Yerramilli

University of Houston, C. T. Bauer College of Business ( email )

Houston, TX 77204
United States
713-743-2516 (Phone)

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