Ensuring Accurate EBITDA in Leveraged Lending

Ensuring Accurate EBITDA in Leveraged Lending

Leveraged lending continues to be a focus area for bank regulators due to the heightened credit risk associated with highly indebted borrowers. A key component of leveraged lending analysis is the calculation of EBITDA, which serves as a proxy for a borrower’s ability to service debt. However, some institutions have miscalculated EBITDA by including cash flows from guarantors, leading to inaccurate leverage ratios and improper loan classification. This post outlines regulatory expectations and examiner focus areas related to EBITDA calculations in leveraged lending.

Leveraged lending typically involves borrowers with high levels of debt relative to earnings. Regulatory guidance, including the 2013 Interagency Guidance on Leveraged Lending issued jointly by the OCC, Federal Reserve, and FDIC, emphasizes the importance of consistent and accurate risk identification. One of the most common benchmarks used to identify leveraged transactions is a total debt-to-EBITDA ratio greater than 4.0x or a senior debt-to-EBITDA ratio greater than 3.0x. These ratios are only meaningful if EBITDA is calculated correctly.

EBITDA should reflect the borrower’s recurring cash flow generation. It is not intended to include cash flow from guarantors or other external sources. Including such cash flows can artificially lower leverage ratios, resulting in loans being excluded from leveraged lending oversight. This misclassification can lead to underreporting of risk and noncompliance with regulatory expectations.

Examiners have identified instances where banks included guarantor cash flow in EBITDA calculations, overstating the borrower’s financial strength. This practice can mask the true risk profile of the loan and undermine the integrity of the bank’s leveraged lending framework. Institutions must ensure that EBITDA is calculated based solely on the borrower’s financials, unless the guarantor is a co-borrower or joint obligor with shared repayment responsibility.

Key Regulatory Insights and Examiner Focus Areas

  • Definition Consistency: Ensure that the bank’s internal definition of leveraged lending aligns with regulatory guidance, including leverage ratio thresholds.
  • EBITDA Integrity: Calculate EBITDA using only the borrower’s recurring cash flow. Exclude guarantor cash flow unless the guarantor is legally obligated as a co-borrower.
  • Loan Classification: Properly classify loans as leveraged if they meet the defined thresholds, even if the borrower has external support from a guarantor.
  • Documentation: Maintain clear documentation of EBITDA calculations, including adjustments and exclusions, to support examiner review.
  • Risk Reporting: Accurately report leveraged lending exposures in regulatory reports and internal risk dashboards.
  • Training and Controls: Provide training to credit analysts and implement controls to prevent misclassification of leveraged loans.

Inaccurate EBITDA calculations can have a ripple effect across a bank’s credit risk management framework. From misidentifying risk to underreporting leveraged exposures, the consequences can be significant. Regulators expect banks to apply sound underwriting practices and maintain transparency in how leverage is measured and reported.

As regulatory scrutiny of leveraged lending continues, banks should revisit their EBITDA calculation methodologies and ensure they are aligned with supervisory expectations. A disciplined approach to financial analysis and loan classification will help institutions avoid compliance issues and maintain strong risk management practices.

To learn more about how GLOBAL ABAS can support your compliance program, visit our website or subscribe for future updates.

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