IBBC CAPITAL ACADEMY / 2027
Private debt: contract protection before headline yield
Independent IBBC Capital draft content for self-study. Not affiliated with or endorsed by CFA Institute. New lessons await subject-matter review. No CFA designation or official PSM credit is awarded.
Learning goals
- Diagnose the case using the stated constraints and quantitative evidence.
- Defend a conditional decision and identify what further evidence could reverse it.
Draft · approximately 65 minutes, excluding further revision.
Decision case · fictional facts
A private borrower hasEBITDA 20 m, total debt 80 m, cash interest 8 m and annual cash available for debt service 12 m. Scheduled principal is 6 m. The lender compares a senior secured loan, unitranche and mezzanine with warrants; the borrower’s EBITDA includes 3 m disputed add-backs.
Match debt to life-cycle and capital structure
Early growth, acquisition, mature operations and restructuring require different debt terms. Leveraged loans, high-yield bonds and convertibles differ in covenants, liquidity, seniority and equity participation. Mezzanine often combines subordinated debt and equity-like upside; unitranche combines financing into one facility but may still allocate priority among lenders contractually.
Underwrite cash and enforceable protection
Debt/EBITDA and EBITDA/interest are screening ratios, not debt-service cash. DSCR uses cash available divided by scheduled cash debt service under an explicit definition. Reconstruct EBITDA add-backs, maintenance capex, tax and working capital. Read collateral perfection, guarantees, restricted payments, amendment rights and covenant headroom; legal recovery depends on jurisdiction and actual documents.
Portfolio income comes with illiquidity
Floating coupons reduce some rate-duration exposure but can increase borrower distress when rates rise. PIK interest compounds principal without current cash. High contractual yield may be offset by default, workout delays, fees and recovery costs. Compare expected net return and correlated downside with private equity, public debt and cash needs; do not equate infrequent valuation with safety.
Private debt terms should follow the financing purpose
Debt for an acquisition must be repaid from combined-company cash or refinancing; growth financing may rely on future expansion cash; restructuring debt may require priority protections. Maturity, amortization, draw conditions and covenants should match the credible funding purpose. A lender should not use one leverage template for every stage.
Loans, bonds and convertibles allocate rights differently
A leveraged loan may provide negotiated covenants and floating-rate exposure; high-yield bonds may offer broader investor access with different covenant and trading terms. A convertible adds an equity option and potential dilution in exchange for different debt economics. Assess seniority, security, call provisions and liquidity for the actual instrument instead of inferring risk from its category.
Formula and assumptions
Leverage=debt/EBITDA;DSCR=CFADS/(interest+scheduled principal)
Compare with the model response after drafting
- Leverage=80/20=4 x; interest coverage=20/8=2.5 x. DSCR=12/(8+6)=0.857 x, showing cash debt service is not covered despite EBITDA ratios.
- Removing 3 m add-backs raises leverage to 80/17≈4.71 x. Reconsider sizing, amortization and covenants before selecting the highest yield.
Errors to catch
- Treating EBITDA as unrestricted cash available for lenders.
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