"Given the significance of EBITDA to overall covenant quality, it is important that investors understand the ways companies can calculate it," says Vice President -- Senior Accounting Analyst Jason Cuomo. "There is no limit to the number or nature of EBITDA adjustments."

EBITDA add-backs allow companies to adjust their reported EBITDA when calculating covenant compliance, determining restricted payments, and considering other important covenant elements. These add-backs are negotiated between debtors and the agents of bondholders, and can be permitted for such things as projected merger synergies or the effects of hedging, Cuomo says. While not all adjustments necessarily boost EBITDA, the majority do. By increasing EBITDA, add-backs can improve leverage or interest coverage ratios, giving companies more flexibility to assume debt or take other actions that could increase their credit risk without breaching their covenants.

According to Moody's, two companies with identical leverage can issue bonds with the same leverage limits in their covenants, yet bear different credit risk. If one company has negotiated a more aggressive set of EBITDA add-backs, the company is likely to have substantially more covenant flexibility. This may translate into a greater capacity to incur debt, distribute more cash to shareholders, or take other actions that are not advantageous to bond holders.

Moody's evaluation of EBITDA add-backs is one sub-component of six risk areas analyzed in coming to an overall Covenant Quality score for a bond covenant package. On a five-point scale, 1 represents the strongest investor protection and 5 the weakest. Of 150 global bonds drawn from Moody's High-Yield Covenant Database, one third were assigned Covenant Quality scores of 4 or 5 for EBITDA add-backs.

"US and private equity-sponsored companies were found to have more EBITDA add-backs than those without private equity involvement or issued outside the US," Cuomo says. "More than 80% of the bonds that scored the weakest for EBITDA add-backs were sponsored by private equity and 88% of deals originated in the US."

Deals with a private equity sponsors had an average EBITDA add-back score of 3.2, compared with 2.2 for bonds that did not. Similarly, deals that originated in the US had an average EBITDA add-back score of 3.0, compared with 1.9 for non-US deals.

Moody's research subscribers can access this report at http://www.moodys.com/research/High-Yield-Bond-Covenants-Arcane-EBITDA-Adjustments-Can-Loosen-Covenant--PBC_145986.

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Jason Cuomo VP - Senior Accounting Analyst Corporate Finance Group Moody'sInvestors Service, Inc.250 Greenwich StreetNew York, NY 10007 U.S.A. JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653 Alexander C Dill VP - Senior Credit Officer Corporate Finance Group JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653 Releasing Office: Moody's Investors Service, Inc.250 Greenwich StreetNew York, NY 10007 U.S.A. JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653(C) 2012 Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved.

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