Bond investors balk at use of ‘ebitdac’ to skirt debt restrictions

Bond investors have hit out at the growing trend of companies reporting “earnings before coronavirus”, warning that this new pandemic-era financial metric could allow businesses to use imaginary numbers to raise more debt than they can handle.

Fund managers have long complained about the heavy adjustments riskier companies make to their earnings when borrowing from the high-yield bond market, often as part of an attempt by their private-equity owners to massage leverage levels — or the ratio of debt to operating profits — to make buyouts look safer.

But several companies recently pushed this one stage further by reporting their “ebitdac” — earnings before interest, tax, depreciation, amortisation and coronavirus — for the first quarter of 2020. The number is supposed to reflect profits the companies believe they would have made, were it not for virus-related lockdowns and disruptions to supply chains.

The European Leveraged Finance Association, a group representing investors in higher-risk corporate bonds and loans, has warned that it would be “inappropriate” for companies to use the metric to calculate how much debt they are allowed to raise under their arrangements with lenders.

ELFA, which formed last year to protect the interests of corporate debt investors, added that “reliance on fictitious figures” could lead to a downward spiral of companies raising money that they cannot repay.

Debt deals often include terms and conditions known as covenants, which are designed to protect investors by imposing restrictions that stop businesses from taking on debt they cannot afford to pay back.

Investors are worried that businesses could use “ebitdac” to calculate leverage ratios under these covenants and therefore evade restrictions on how much they can borrow.

“Using ebitdac to paint a rosier picture on an investor presentation would be bad enough, but using it to raise additional debt which [ranks ahead of] the existing investors would simply be inappropriate,” said Brian Abdelhadi, senior portfolio manager at Allianz Global Investors.

German manufacturer Schenck Process last week became the first European company to include the phrase ebitdac in its financial reporting according to 9Fin, a financial data service that tracks about 500 high-yield bond issuers.

The metric allowed Schenck, which is owned by US private equity firm Blackstone, to report a lower leverage multiple than if it had used the traditional ebitda measure, bringing down its ratio of net debt to earnings from 5.3 times to 5 times.

Covenant Review, a research firm that specialises in analysing debt documents, said that the language in Schenck’s presentation indicated that the company “may be intending to use this measure as the basis for testing metrics under its financing documents”.

“Other companies might push the envelope even farther with larger and still more attenuated adjustments,” analysts at Covenant Review warned.

Schenck said ebitdac was included “to give an idea of the estimated impact of the pandemic on the company so far” and that “this did not distort any disclosure”.

The manufacturer added that the metric was “included in relation to covenant compliance where the adjustment is permitted following the stipulations of the contractual framework”.

Investors also voiced concerns about companies raising debt based on coronavirus-adjusted historic earnings figures. Peter Aspbury, lead portfolio manager for European high yield at JPMorgan Asset Management, said this would allow businesses “to basically distort the reality enough to the detriment of creditors”.

He added that loose definitions becoming the norm could allow companies to relax covenant terms for any number of unfavourable events.

“It shows how far the moral compass has deteriorated,” said Tatjana Greil Castro, a portfolio manager at Muzinich & Co. “They’re living in a parallel universe.”

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