Credit Adjustments And Debt Risk
This conversation was generated using Cook'd AI's career assistant and reviewed by Fallon Han from our editorial team for accuracy.
I'm a second-year audit analyst in the U.S. on an H-1B visa, and I'm moving into leveraged finance at a bank. I want you to challenge me on how reported numbers translate into lending risk, especially if the interviewer mixes EBITDA adjustments with debt structure questions.
Great. I will treat this like a real finance interview, not a classroom quiz. I will push on two things at once: what can be added back to EBITDA, and whether those add-backs actually improve credit. First question: a company reports EBITDA of 100. It adds back 15 of restructuring costs, 10 of stock comp, and 8 of run-rate synergies from a recent acquisition. The company also has 500 of total debt, including a 100 revolver, and 3.5x reported leverage. Walk me through which add-backs you would accept, which ones you would challenge, and what the lending risk is if the bank underwrites off adjusted EBITDA.
I would start by separating recurring from non-recurring items. Restructuring costs could be acceptable if they are truly one-time and tied to a real event, but I would ask whether the company has a history of restructuring because then it may not be one-time. Stock comp is non-cash, but I would be careful because it is still a real economic expense and can dilute equity, so I would not give it the same credit as a cash add-back. Synergies are the most aggressive because they are forward-looking and execution-dependent, so I would only include them if they are highly supported and close to realized. On lending risk, if the bank underwrites to adjusted EBITDA, leverage may look lower than it really is, which can make the borrower seem safer than the cash flow actually supports, especially if debt is mostly term debt and the revolver could be drawn under stress.
Good structure. Now go one level deeper. Suppose the interviewer says, 'Fine, but the deal has a first lien term loan and a revolver, and the sponsor wants to use adjusted EBITDA for covenant compliance.' Explain how debt structure changes the risk discussion. In particular, what is the difference between first lien debt and revolver risk, and how would you think about lien priority versus liquidity when the company is under pressure?
First lien term debt has priority over the collateral, so in a downside scenario it benefits from being ahead in the capital structure. A revolver is usually secured too, but it is mainly a liquidity tool, so even if it is senior, the real concern is whether the company can keep drawing on it or whether it becomes blocked by a borrowing base or covenant issue. If the company is under pressure, lien priority matters for recovery, but liquidity matters for survival. So a business can have senior secured debt and still be risky if the revolver is close to fully drawn and there is not enough cash flow to service interest. In that case, adjusted EBITDA can hide the fact that the borrower may be one bad quarter away from a liquidity event.
Better. Let's make it more technical and more awkward, like a real banker would. Assume management claims 20 of EBITDA add-backs for 'run-rate cost saves' from a system migration, but the migration is only 40 percent complete. At the same time, net debt is 400, and the revolver is undrawn but available. How would you push back on the add-back, and how would you explain the difference between net debt and gross debt in the credit analysis?
I would push back by asking how much of the cost saves are actually implemented, whether the remaining 60 percent is contractually committed or just planned, and what expenses still remain during the transition. If only 40 percent is complete, I would not give full credit to the 20 add-back. I might haircut it heavily or only include the portion already realized. For debt, gross debt is the full debt outstanding, while net debt subtracts cash. Net debt can be useful because excess cash can offset leverage, but I would also ask whether the cash is trapped, seasonal, or needed for operations. If the revolver is undrawn and available, that helps liquidity, but I would not treat it as cash because it is a contingent source of funding that could disappear if performance weakens.
Strong. Final round: the company has EBITDA of 100 reported, 120 adjusted, and 90 of cash interest expense. It also has 6.0x adjusted leverage and 7.0x reported leverage. The interviewer asks whether this capital structure is 'bankable.' Give me your answer the way a first-year leveraged finance analyst should: concise, commercial, and credit-focused.