The reconciliation table nobody treats as a credit decision moves the ratio further than the covenant everybody negotiates.
The six add-backs that lift Halstead Packaging’s statutory EBITDA of 24,600,000.00 to management’s 37,600,000.00 move leverage on 120,000,000 of net debt from 4.8780x to 3.1915x, a distance of 1.6866 turns. The leverage covenant is 4.25x and, on the lender’s own adjusted figure of 28,460,000.00, it leaves 0.0336 of a turn. The bridge is 50.3 times the headroom it is tested against.
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Halstead Packaging is a mid-market manufacturer of rigid packaging, sponsor-owned, with revenue of 285,000,000 and audited EBITDA of 24,600,000.00. It is asking Ferrisbrook Capital for 120,000,000 of net senior debt, priced at 7.40 per cent and amortising at 5.00 per cent a year. The information memorandum bridges the audited figure to 37,600,000.00 across six adjustments, and the loan is being sized on the second number.
Each line is defensible on its own terms, and that is the difficulty. A bridge made of indefensible lines is easy work: strike them and move on to pricing. A bridge made of six arguments that a competent adviser can support and a competent analyst can attack is a credit decision wearing the costume of an accounting reconciliation.
| Line | Character of the claim | Amount | % of statutory |
|---|---|---|---|
| Restructuring described as non-recurring | Characterisation | 3,400,000.00 | 13.8211% |
| Run-rate savings, plant closed in March | Timing and forecast | 2,900,000.00 | 11.7886% |
| Full-year effect of the July acquisition | Perimeter | 4,200,000.00 | 17.0732% |
| Sponsor monitoring fees | Definitional | 1,100,000.00 | 4.4715% |
| Share-based payment | Non-cash, recurring | 800,000.00 | 3.2520% |
| Foreign exchange losses | Volatility | 600,000.00 | 2.4390% |
| Total add-backs | Six claims | 13,000,000.00 | 52.8455% |
The total is 52.8455 per cent of statutory EBITDA and 34.5745 per cent of the number the loan is actually being sized on. Rather more than a third of the earnings supporting 120,000,000.00 of senior debt has been argued into existence rather than audited into it.
Do the divisions. 120,000,000 over 24,600,000.00 is 4.8780x. Over 37,600,000.00 it is 3.1915x. The bridge is therefore worth 1.6866 turns of leverage. Subtracting the two rounded ratios gives 1.6865; the difference of the unrounded ratios rounds to 1.6866, and that is the figure to print, with the reason for the discrepancy beside it.
Ferrisbrook’s quality-of-earnings review disallows 6,940,000.00 of the add-backs and adds a deduction that was never an add-back at all, 2,200,000.00 of capitalised development costs. That lands at 28,460,000.00 and leverage of 4.2164x, against a leverage covenant of 4.25x. Headroom is 0.0336 of a turn. In money, the covenant permits EBITDA no lower than 120,000,000 divided by 4.25, or 28,235,294.12, so the permitted fall is 224,705.88 — 0.7895 per cent.
Set the two quantities against each other. 1.6866 divided by 0.0336 is 50.3. The reconciliation table that arrives with a total already struck is fifty times more consequential than the covenant level over which two sets of lawyers will spend three weeks. Every hour spent moving the test from 4.25x to 4.50x is an hour spent on a fraction of what the definition of EBITDA is worth.
| Measured against | Covenant at 4.25x | EBITDA | Leverage |
|---|---|---|---|
| Statutory EBITDA | breached | 24,600,000.00 | 4.8780x |
| EBITDA as adjusted by management | met | 37,600,000.00 | 3.1915x |
| EBITDA as adjusted by the lender | met | 28,460,000.00 | 4.2164x |
| Cash available for debt service | breached | 18,560,000.00 | 6.4655x |
The largest of the three gaps is the one nobody argues about. Between the lender’s 4.2164x and the cash number of 6.4655x sit 2.2491 turns: maintenance capital expenditure of 6,200,000, working capital absorption of 1,600,000 and cash tax of 2,100,000, or 9,900,000 that leaves the business every year before a lender is paid. Only 65.2143 per cent of the lender’s own EBITDA reaches the point where debt service is met. That gap is invisible not because it is contested but because no leverage test is written on cash.
The first is to quantify every add-back before arguing about it, then rank the lines by amount and allocate time in that order, writing next to each the document that would settle it. The restructuring line alone, 3,400,000.00, is worth 0.4500 turns: conceding it lifts the lender’s EBITDA to 31,860,000 and drops leverage from 4.2164x to 3.7665x, which is thirteen times the headroom. A line for which nobody can name a settling document is not an adjustment. It is a preference.
The second is to write the ratio three ways on one line of the credit paper, each with its denominator stated: 4.8780x on statutory 24,600,000.00, 4.2164x on adjusted 28,460,000.00, 6.4655x on cash 18,560,000.00. A committee shown one number approves a number. A committee shown three approves a range, and then asks which end of it the documentation defends.
The same habit disposes of the belief that the cover test is where the pressure sits. Interest of 8,880,000 and amortisation of 6,000,000 make debt service of 14,880,000, and cash cover is 1.2473x against a covenant of 1.20x, which breaks on a fall in cash of 3.7931 per cent. Leverage breaks at 0.7895 per cent. The test measured on the negotiated number binds first, and it binds because that number carries the adjustments. So invert any leverage ratio handed over: multiply it by the debt, see what EBITDA falls out, and find that figure in the accounts. If it is not there, the difference is a bridge, and the bridge is the credit analysis.
Invert the covenant. At 4.25x, 120,000,000 of net debt permits EBITDA no lower than 28,235,294.12. Halstead has 28,460,000.00 on the lender’s adjusted figure, so the permitted fall is 224,705.88, or 0.7895 per cent. Turns flatter: 0.0336 of a turn sounds like rounding, 0.7895 per cent sounds like a bad quarter.
The largest line on Halstead is the full-year effect of the July acquisition, 4,200,000.00, or 17.0732 per cent of statutory EBITDA. But the restructuring line of 3,400,000.00 is worth 0.4500 turns on its own: conceding it takes the lender’s EBITDA to 31,860,000 and leverage from 4.2164x to 3.7665x.
No. Ranked ascending, the four ratios run 3.1915x on management’s adjustments, 4.2164x on the lender’s, 4.8780x on statutory and 6.4655x on cash available for debt service. Statutory sits third of four, and the measure of what the business can actually carry is more than a turn and a half worse than the audited accounts.
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