Q: How do you calculate personal living expenses?
A: Only the borrower or guarantor can provide credible information about personal living expenses if they choose to and if they’re able to do so. Many times, borrowers and guarantors misstate living expenses out of embarrassment because they don’t know, they want to exaggerate, or they wish to keep living expenses confidential.
Since living expenses span a great range of cash outlays, such as food, clothing, travel, lodging, entertainment and more, living expense information can only come from the borrower or guarantor. Under the best of circumstances, this estimate is invariably an extremely rough guess that is never documented. Any estimate of a borrower’s or guarantor's personal cash flow surplus available to support company debt service is, therefore, highly suspect because the living expense component cannot be verified.
Unfortunately, there is no hard and fast general rule for estimating living expenses, and no readily available statistics that link disposable income levels to living expense amounts. Living expenses simply vary greatly by individual and family and their sense of financial responsibility.
One option available to lenders in estimating living expenses might be to build off the concept of disposable income, defined as the amount of money that households have available for spending and saving after all income and other taxes, medical expenses and debt service have been accounted for. In doing so, the lender can estimate the guarantor’s effective income tax rate (federal and state), estimate other taxes the individual is required to pay, and compile the individual’s annual debt service from credit reports. After subtracting these items and estimated savings from gross income, the result could be considered as the amount available to cover the individual’s living expenses. Please be guided by your institution’s policy and practices in doing so.
Once disposable income has been estimated, an analyst can then account for possible savings at the current savings rate to arrive at income available for personal living expenses. It is from this estimate of disposable income that the individual determines his or her lifestyle to include investment decisions or support for company debt service from liquid assets in a crisis.
Q: Why was Mr. Schumacher’s loan to Clovis Supply, Inc. and other contributions to related companies not captured in his personal cash flow?
A: The personal cash flow statement is intended to provide an initial estimate of Mr. Schumacher’s personal cash flow surplus or deficit available to service guaranteed company debt service, invest in equities, or lend to one or more of the guarantor's companies. Our analysis then focuses on the disposition of Mr. Schumacher’s personal cash flow surplus to identify, if possible, how it was used. One of the choices he apparently made was to use of the $1,770,493 surplus to lend $641,122 to Clovis Supply, Inc. This loan and any other loans or capital contribution are post-cash flow surplus activities rather than components of the actual calculation of the surplus.
If it were possible to construct a true and comprehensive personal cash flow statement equivalent to a UCA cash flow statement for a business organization, the lender could identify precisely how any personal cash flow surplus was used by the guarantor. Instead, we must simply separate cash flow activities into groups of pre-surplus and post-surplus events without use of an appropriate template or process.
Note that a true and comprehensive cash flow statement for a business or for an individual requires that all financial data be recorded at historic cost and not at estimates of current market value. Personal cash flow information available to us is a hodge-podge of data recorded at historic cost and data estimated a current market value.
Q: Are the related companies guarantors? Why include them in the global cash flow if they are not legally obligated as guarantors?
A: No determination has been made to this point as to whether the related parties will stand as guarantors of the not yet approved or structured Fresno Properties loan request.
We have chosen to include all related parties in the global cash flow analysis because it has apparently become Mr. Schumacher’s practice to freely move cash between himself and the companies regardless of any guarantor obligations that do or do not exist. Mr. Schumacher has also demonstrated his willingness to move cash between the companies as he deems necessary.
Our intent is to reveal the extent and impact of all the related party cash flows, even in the absence of a guarantee, so we can more readily create covenants or loan structure to mitigate risks to Fresno Properties’ ability to service debt as a result of Mr. Schumacher’s demonstrated willingness to shift cash between the companies he owns and controls. As we noted, some of Mr. Schumacher’s related companies may experience severe cash flow deficits in 2019, which suggests that Fresno Properties may be compelled to survive on the cash flow it can generate from its own activities and not look to a related company or to Mr. Schumacher for cash support.
Q: Regarding “limited guarantees” of the personal obligors, particularly a “carve out” guarantee; would you include those loan obligations in the global cash flow analysis?
We do not include “carve out” global cash flows citing the triggers to force the limited guarantee to a full guarantee are based on fraud and/or misrepresentation. Then and only then would a full repayment guarantee kick in. As a Loan Review function of the bank I’m considering suggesting that carve out guarantee be included because there is a actual limited guarantee document executed and for the reasons you cite of tightening lending standards for CRE in which we are heavily involved in.
A: We'd be inclined to include nonrecourse loans with a carve out guarantee in a global cash flow analysis. It would depend on the specific language in the carve out. but it seems very likely the carve out provisions will increasingly convert non-recourse to recourse loans, especially since lending standards are tightening in commercial real estate lending and expected to tighten more in the second half of 2023. As always, the devil is in the details so I'd approach it on a case by case and carve out by carve out basis.
Course overview: Global Cash Flow