Adjusted Ebitda And The Masking Of Leverage

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Suzanne Gibbons

March 13 2026 6:00 am

Suzanne Gibbons is a partner and head of research at Davidson Kempner Capital Management, a global investment management firm managing more than $38 billion across public and private market assets.

In leveraged credit, a single metric dominates investor conversations: debt-to-EBITDA. The higher the ratio, the greater the potential for excess.

But the meaning of the ratio increasingly depends on how much EBITDA is adjusted — and how optimistic those judgments are. The culprit is the growing use of so-called “add-backs” padding “adjusted” EBITDA with “one-time items” that management deems non-recurring but tend to recur, such as projected synergies from acquisitions and planned cost savings.

Over the past decade, these adjustments have expanded materially. As credit documentation has weakened, the definition of EBITDA in loan agreements has become looser. Market participants have watched the list of adjustments grow steadily over time, but the data now confirms how far the metric has drifted — so much so that an investment analyst from a decade ago might struggle to recognise it.

In leveraged loans, EBITDA add-backs now reduce reported leverage at issuance by roughly 1.2 turns of leverage. In direct lending, the impact is even larger — about 1.9 turns. In both cases the gap is roughly double what it was in 2015.

As a result, the reported new issue debt-to-EBITDA of 4.6x for leveraged loans and 5.0x for direct lending often masks underlying leverage that’s actually 5.9x and 6.9x respectively.

Many of those adjustments are aspirational. Projected synergies fail to materialise, leaving capital structures more fragile than headline metrics suggest. 

Consider a typical private equity deal that is valued at 10x EBITDA. If it borrows at a debt-to-adjusted EBITDA leverage ratio of 4.5x, lenders will have a 55 per cent equity cushion. But if leverage is measured against actual instead of adjusted earnings, the risk profile can change materially. A 1.9x difference in leverage can raise the loan-to-value ratio from 45 per cent to 64 per cent, leaving lenders with a meaningfully smaller cushion.  

The math becomes even less forgiving in sectors such as software, where companies are often acquired at higher than average multiples closer to the mid-teens and with higher leverage. If valuations compress by several turns of EBITDA, mark-to-market loan-to-value ratios rise substantially, leaving equity cushions thin.

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Recent data reinforces the point. An 8-year study by S&P Global found “a clear correlation between the magnitude of EBITDA add-backs issuers incorporated into deal projections and the subsequent magnitude of management projection misses.” They found that “Marketing EBITDA” — which is management’s Adjusted EBITDA — is increasingly bloated and optimistic: 92 per cent of the time companies fail to meet their initial targets within the first year, resulting in leverage that is higher by 2.3 turns in year one and 2.7 turns in year two ing deal inception. The more aggressive add-backs were also concentrated among single-B issuers, suggesting the problem is particularly acute in the direct lending and leveraged loan markets.

Much of this dynamic emerged during the zero-interest rate policy era. Inexpensive capital supported debt-fuelled roll-up strategies by private equity premised on projected synergies and “multiple arbitrage” between smaller acquisition targets and scaled platforms. In theory, scale and integration would generate value. In practice, outcomes have been uneven.

Operational complexity and integration challenges have prevented projected synergies from materialising, and that gap has become harder to ignore. High purchase prices and inconsistent performance have left a growing number of heavily indebted companies facing liquidity pressures.

The data reflects the strain. Within the Kroll StepStone direct lending universe, loans with stressed interest coverage (below 1.5x) have more than doubled from 14 per cent at year-end 2019 to 32 per cent most recently. 

Overall, the expansion of add-backs is symptomatic of weaker credit documentation and increased competition across private and public leveraged credit markets. According to Preqin, direct lending assets under management have grown more than ninefold since 2015. The result has been increased competition across leveraged credit markets. In 2025 alone, $34 billion of direct loans were refinanced into the leveraged loan market, while $37 billion of leveraged loans migrated into direct lending, based on data from PitchBook. 

Borrowers, unsurprisingly, have been the beneficiaries.

Looser credit documents have not only enabled more generous add-backs to EBITDA, but also the rise of liability management exercises. These are transactions which allow owners (including those with companies that are ly balance sheet insolvent) to extend maturities or capture discount on debt — often both — via coercive deals that leave creditors with no good options.  

The combination of generous EBITDA add-backs and liability management exercises that “kick the can down the road” has contributed to declining recovery rates in the syndicated leveraged loan and direct lending markets. In 2025, average leveraged loan recoveries fell to a low of 36 cents on the dollar, continuing the decline from roughly 60 cents a decade ago, according to JPMorgan. The younger direct lending universe is beginning to show similar trends, with recoveries in recent years slipping below 50 cents.

Until the loose definitions of adjusted EBITDA are reined in, leverage ratios will continue to flatter borrowers. The question for investors is simple:

What happens when the add-backs don’t add up?