Incremental Leverage on a Covenant-Tight Packaging Borrower
Northvale Packaging GmbH, a €120m-revenue family-owned converter, holds a €48m senior term loan and a €10m revolver with your bank. FY2025 EBITDA came in at €8.4m, 8% below plan, after a top-three customer cut volumes by a quarter. Net leverage is 5.7x against a 6.0x covenant tested at 31 December; DSCR is 1.15x against a 1.10x floor. The revolver is 60% drawn. Maintenance capex of €3m was deferred in the second half. The CFO now requests €6m of incremental term debt to fund an automated corrugator line, arguing it cuts unit cost by 9%. Separately, the sponsor wants a €4m dividend. Pro-forma leverage on the request is 6.4x. Credit committee meets in five days. The relationship is eleven years old and your bank holds the entire facility at 325bp over Euribor. The CFO has supplied a two-page business case but no independent verification.
1. State whether you would approve the €6m incremental facility as requested, and set out the credit decision you would put to committee, including conditions.
Read the worked answer
Decision: decline as requested; approve a smaller, conditioned facility.
The request bundles two uses of cash with opposite risk profiles. The €6m capex has a plausible return; the €4m dividend transfers value out of a business whose leverage is already 5.7x with 0.3x headroom. Approving both at 6.4x produces a covenant breach at the next test date unless EBITDA grows, so the bank would be lending into a default it has itself created.
Reasoning I would put on paper:
- Normalise EBITDA first. The €8.4m includes roughly €1.2m of one-offs (insurance recovery, FX gain). On a run-rate basis leverage is nearer 7.0x before any new money.
- DSCR on a 7-year amortising €54m is about 1.02x, below the 1.10x floor. The automation benefit is 18–24 months from cash payback, not immediate.
- Customer concentration (top three = 41% of revenue) means the EBITDA miss may not be a trough.
Recommended structure: approve €3m, staged against invoices, with the dividend declined outright until leverage is below 4.5x. Require a €2m sponsor equity injection as a condition precedent. Reset the leverage covenant to 6.5x with step-downs of 0.5x every six months. Take security over receivables and the land, add a 75% excess cash sweep above 4.5x, monthly management information for four quarters, and an independent business review before any further increase. Alternatively, a payment-in-kind tranche sized to the capex could be considered, but only with a sponsor support letter.
2. The CFO argues that deferred maintenance capex, not trading weakness, caused the EBITDA miss and that the automation spend fixes it. How do you test that claim, and what evidence would change your view?
Read the worked answer
Treat it as a hypothesis, not a fact, and require a bridge rather than a narrative.
Tests:
- EBITDA bridge by month. Split the €0.7m miss into volume, price, mix, input cost, one-offs and genuine maintenance deferral. Deferred capex normally shows up as higher repair cost or lower yield, not as lost revenue; if the top-three customer cut is volume-driven, maintenance is not the cause.
- Cost-to-serve and yield data. Ask for machine-level downtime, waste rates and OEE for the last eight quarters. If downtime is flat while volumes fell, the deferral argument fails.
- Customer evidence. Contract or correspondence confirming the lost volumes are temporary. A verbal assurance from the CFO is not evidence.
- The business case arithmetic. 9% unit-cost saving on the addressable cost base, minus depreciation and interest, against a 5-year payback. Stress it at 60% of the claimed benefit and a 12-month delay.
- Counterfactual. If maintenance deferral is the cause, a €3m catch-up capex programme should already restore output. Ask why the automation line is needed as well.
What would change my view: an independent business review confirming the customer loss is one-off; signed volume commitments; audited maintenance logs correlating downtime to the deferral; and a sponsor equity contribution that shares the downside. Without those, I would treat the claim as management optimism and size the facility to the verified capex, not the projected saving.