Questions and Answers Global Cash Flow (July 1, 2010)
Q: Why did you include qualified non-recourse financing as a contingent liability when, according to our sources, the definition of non-recourse financing is as follows: “Qualified nonrecourse financing is financing for which no one is personally liable for repayment.” Why did you include this as a contingent liability in the case study?
A: If the partnership activity is real estate focused, then the general definition takes on a qualified meaning. A partner’s “at risk” debt is the sum of a) cash or non-cash contributions to the partnership, b) most recourse borrowings by the business for which the owner has personal liability (and a general partner is liable for all partnership borrowings and obligations), c) the partner’s share of amounts borrowed that are qualified nonrecourse financing, and d) the partner’s share of flow-through income from the partnership. Qualified nonrecourse financing in this instance is defined as recourse debt collateralized with real property used in the business.
As a general partner, Schumacher is liable for more than the amounts listed on his Schedule K-1 (Form 1065). By reference to the company’s financial statements, the amount of obligations on the company’s balance sheet – excluding related party debt – was roughly $25 million. Our use of the “at risk” amounts actually understated Schumacher’s total liability as general partner.
A key point here is that we used the “at risk” amounts as an estimate of the amounts Schumacher actually guaranteed. Footnote 4 to the financial statements specifies that “…all debt facilities are secured by real estate assets and/or the personal guarantee of Fritz Schumacher and Luis Castillo...”, which does not provide a precise dollar amount of Schumacher’s guarantees. We would need to ask him for that information to verify the extent of his personal guarantees for Sequoia Properties’ interest-bearing debt. Regardless of the response, Schumacher is on the hook for roughly $25 million of Sequoia Properties’ debt obligations.
The same set of issues applies to Fresno Properties and the precise dollar amount of Schumacher’s guarantees. Even though there is scattered information in Footnote 3 to that company’s financial statements, it seems highly unlikely that Heller Financial – a finance company – would extend credit without Schumacher’s personal guarantee. Once again, he is the general partner, responsible for all partnership debt obligations.
Q: Can you tell us where you got the $306,676 UCA cash flow figure for Net Cash after Operations on Slide 23?
A: The amount at that point in the Uniform Credit Analysis (UCA) cash flow statement is the amount available in 2007 to pay interest expense and repay long-term debt as scheduled. In this instance, Fresno Properties performed better on a cash than accrual basis, primarily because it was able run down its rents receivable balance, which was an inflow of cash not captured on an accrual income statement. (The last page of the written solutions provides the steps that lead to Net Cash after Operations.)
Q: Is it accurate to use the credit report information compared to the personal financial statements of the guarantor to indicate the amount of annual living expenses to extract the guarantor's personal cash flow?
A: In every case it makes sense to examine information from the credit bureau reports and determine if they match information provided by the guarantor. Even though there are problems with timely information from the credit bureaus, in general the information they provide is very good. Consequently, it is always wise to check any statement made by a guarantor against information collected and reported by the credit bureaus.
Q: Why would the CMLTD for Sequoia jump so drastically?
A: A great question, and one we cannot answer without contacting the borrower or its accountant. Since Sequoia Properties had roughly $19 million in interest-bearing debt outstanding in 2006, it seems highly suspicious that the current maturities in that year were only $70,418. At an average 25-year amortization period for interest-bearing debt, which is a very liberal assumption, 2006 current maturities should be in the neighborhood of $750,000, not $70,418. Yet the massive jump in current maturities in 2007 to $2,284,569 seems extreme at the other end of the spectrum. With ending 2007 interest-bearing debt at approximately $25 million dollars, the 2007 current maturities would logically seem to fall in the $1 million range.
There appear to be definite abnormalities at work, which suggests that Schumacher may have some wiggle room in attempting to renegotiate the 2007 current maturities amount that is due and payable in 2008 – and the amount which is the source of such great concern about 2008 cash flow for the group of companies.
Q: What is the best way to estimate current maturity required on long-term debt if the company does not break it out or indicate it on the balance sheets?
A: Another very good question. One simplistic approach is to identify – if possible – the amount of interest-bearing debt associated with various assets that the debt likely finances. If you match a specific amount of term debt with vehicles and equipment, you could estimate a five to seven year maturity for such debt. With respect to land and improvements on the balance sheet, an average repayment period may be 25 years. And so on.
At the end of the day, however, it’s best to go back to the borrower or to his accountant. They know precisely how much they owe whom and when those amounts are due and payable.
Q: Why did you include qualified non-recourse financing as a contingent liability when, according to our sources, the definition of non-recourse financing is as follows: “Qualified nonrecourse financing is financing for which no one is personally liable for repayment.” Why did you include this as a contingent liability in the case study?
A: If the partnership activity is real estate focused, then the general definition takes on a qualified meaning. A partner’s “at risk” debt is the sum of a) cash or non-cash contributions to the partnership, b) most recourse borrowings by the business for which the owner has personal liability (and a general partner is liable for all partnership borrowings and obligations), c) the partner’s share of amounts borrowed that are qualified nonrecourse financing, and d) the partner’s share of flow-through income from the partnership. Qualified nonrecourse financing in this instance is defined as recourse debt collateralized with real property used in the business.
As a general partner, Schumacher is liable for more than the amounts listed on his Schedule K-1 (Form 1065). By reference to the company’s financial statements, the amount of obligations on the company’s balance sheet – excluding related party debt – was roughly $25 million. Our use of the “at risk” amounts actually understated Schumacher’s total liability as general partner.
A key point here is that we used the “at risk” amounts as an estimate of the amounts Schumacher actually guaranteed. Footnote 4 to the financial statements specifies that “…all debt facilities are secured by real estate assets and/or the personal guarantee of Fritz Schumacher and Luis Castillo...”, which does not provide a precise dollar amount of Schumacher’s guarantees. We would need to ask him for that information to verify the extent of his personal guarantees for Sequoia Properties’ interest-bearing debt. Regardless of the response, Schumacher is on the hook for roughly $25 million of Sequoia Properties’ debt obligations.
The same set of issues applies to Fresno Properties and the precise dollar amount of Schumacher’s guarantees. Even though there is scattered information in Footnote 3 to that company’s financial statements, it seems highly unlikely that Heller Financial – a finance company – would extend credit without Schumacher’s personal guarantee. Once again, he is the general partner, responsible for all partnership debt obligations.
Q: Can you tell us where you got the $306,676 UCA cash flow figure for Net Cash after Operations on Slide 23?
A: The amount at that point in the Uniform Credit Analysis (UCA) cash flow statement is the amount available in 2007 to pay interest expense and repay long-term debt as scheduled. In this instance, Fresno Properties performed better on a cash than accrual basis, primarily because it was able run down its rents receivable balance, which was an inflow of cash not captured on an accrual income statement. (The last page of the written solutions provides the steps that lead to Net Cash after Operations.)
Q: Is it accurate to use the credit report information compared to the personal financial statements of the guarantor to indicate the amount of annual living expenses to extract the guarantor's personal cash flow?
A: In every case it makes sense to examine information from the credit bureau reports and determine if they match information provided by the guarantor. Even though there are problems with timely information from the credit bureaus, in general the information they provide is very good. Consequently, it is always wise to check any statement made by a guarantor against information collected and reported by the credit bureaus.
Q: Why would the CMLTD for Sequoia jump so drastically?
A: A great question, and one we cannot answer without contacting the borrower or its accountant. Since Sequoia Properties had roughly $19 million in interest-bearing debt outstanding in 2006, it seems highly suspicious that the current maturities in that year were only $70,418. At an average 25-year amortization period for interest-bearing debt, which is a very liberal assumption, 2006 current maturities should be in the neighborhood of $750,000, not $70,418. Yet the massive jump in current maturities in 2007 to $2,284,569 seems extreme at the other end of the spectrum. With ending 2007 interest-bearing debt at approximately $25 million dollars, the 2007 current maturities would logically seem to fall in the $1 million range.
There appear to be definite abnormalities at work, which suggests that Schumacher may have some wiggle room in attempting to renegotiate the 2007 current maturities amount that is due and payable in 2008 – and the amount which is the source of such great concern about 2008 cash flow for the group of companies.
Q: What is the best way to estimate current maturity required on long-term debt if the company does not break it out or indicate it on the balance sheets?
A: Another very good question. One simplistic approach is to identify – if possible – the amount of interest-bearing debt associated with various assets that the debt likely finances. If you match a specific amount of term debt with vehicles and equipment, you could estimate a five to seven year maturity for such debt. With respect to land and improvements on the balance sheet, an average repayment period may be 25 years. And so on.
At the end of the day, however, it’s best to go back to the borrower or to his accountant. They know precisely how much they owe whom and when those amounts are due and payable.