Q & A’s, Global Cash Flow Webcast, December 15, 2010
Q: K-1 Question - In what instances should you include contributions/distributions that appear on K-1s not in the individuals name/SS# rather in the name of a business? The pass through income still appears on their schedule E. Is this only for disregarded entities?
A: In this case you are referring to a K-1 issued to a business and not an individual in which there are distributions. As you have noted a business entity can be a partner in a partnership. In that case, those distributions go to the partnership and then on to the partners. We need the partner's K-1 to determine, ultimately, how much cash went to him/her. The point is do not discard anything but, rather, research as much as you can to identify all the linkages and players within a global cash flow structure.
Q: Loans to Owners for purposes of cash flow would only be increases or new loans from the prior year?
A: You are correct. Only new loans to owners or any increase/decrease in existing loans to owners in a given year would affect cash flow for that year.
Q: I'm confused -- how do you get 7.74 standalone DSC for Fresno? (Slide 46)
A: In this example, we are looking at Fresno Properties as if it were a stand-alone company with Fritz Schumacher as a controlling partner. Therefore, we take the 2007 Business Cash Flow for Fresno Properties of $271,172 (see Slide 45) and add Schumacher’s available cash of $1,757,955 to get total cash available for debt service of $2,029,127. We then divide this number by the 2007 debt service for Fresno of $262,046 which gives us a hypothetical stand-alone debt service coverage ratio of 7.74.
Of course, we know that the facts on the ground are quite different in that Schumacher’s personal balance sheet only shows approximately $270,000 in ready cash, and he has approximately $25 million in contingent liabilities.
Q: When risk rating a credit, how much more emphasis do you put on "borrower" DSC vs. "Global" DSC? For example, if a borrower’s DSC is 1x but global DSC is 1.5x, does this justify a criticized risk rating?
A: If the quality of the ready cash were pristine - no doubt about it - then the global cash flow DSC would be relevant, so long as the borrower’s DSC was at least 1.0. If the borrower’s DSC was below 1.0, then the borrower’s risk rating would be on the lower side of any rating scale.
Q: With smaller commercial credits, is there any validity in doing global cash flow? Or is it unreasonable to think that with a smaller entity the personal cash flow would likely not be available as all resources would be used to service personal needs?
A: Conducting a global cash flow is extremely relevant regardless of the size of the credit. That being said, there are cases where bank policy may allow a smaller loan to be made to an excellent, long-standing customer without performing a global cash flow analysis. However, these exceptions should be few in number and always with the approval of the appropriate loan authority.
Q: If this was a real world example, what was the outcome?
A: In this particular case, the lenders involved with this relationship realized the extreme credit risk of these entities and decided that no further new loans were appropriate.
Q: K-1 Question - In what instances should you include contributions/distributions that appear on K-1s not in the individuals name/SS# rather in the name of a business? The pass through income still appears on their schedule E. Is this only for disregarded entities?
A: In this case you are referring to a K-1 issued to a business and not an individual in which there are distributions. As you have noted a business entity can be a partner in a partnership. In that case, those distributions go to the partnership and then on to the partners. We need the partner's K-1 to determine, ultimately, how much cash went to him/her. The point is do not discard anything but, rather, research as much as you can to identify all the linkages and players within a global cash flow structure.
Q: Loans to Owners for purposes of cash flow would only be increases or new loans from the prior year?
A: You are correct. Only new loans to owners or any increase/decrease in existing loans to owners in a given year would affect cash flow for that year.
Q: I'm confused -- how do you get 7.74 standalone DSC for Fresno? (Slide 46)
A: In this example, we are looking at Fresno Properties as if it were a stand-alone company with Fritz Schumacher as a controlling partner. Therefore, we take the 2007 Business Cash Flow for Fresno Properties of $271,172 (see Slide 45) and add Schumacher’s available cash of $1,757,955 to get total cash available for debt service of $2,029,127. We then divide this number by the 2007 debt service for Fresno of $262,046 which gives us a hypothetical stand-alone debt service coverage ratio of 7.74.
Of course, we know that the facts on the ground are quite different in that Schumacher’s personal balance sheet only shows approximately $270,000 in ready cash, and he has approximately $25 million in contingent liabilities.
Q: When risk rating a credit, how much more emphasis do you put on "borrower" DSC vs. "Global" DSC? For example, if a borrower’s DSC is 1x but global DSC is 1.5x, does this justify a criticized risk rating?
A: If the quality of the ready cash were pristine - no doubt about it - then the global cash flow DSC would be relevant, so long as the borrower’s DSC was at least 1.0. If the borrower’s DSC was below 1.0, then the borrower’s risk rating would be on the lower side of any rating scale.
Q: With smaller commercial credits, is there any validity in doing global cash flow? Or is it unreasonable to think that with a smaller entity the personal cash flow would likely not be available as all resources would be used to service personal needs?
A: Conducting a global cash flow is extremely relevant regardless of the size of the credit. That being said, there are cases where bank policy may allow a smaller loan to be made to an excellent, long-standing customer without performing a global cash flow analysis. However, these exceptions should be few in number and always with the approval of the appropriate loan authority.
Q: If this was a real world example, what was the outcome?
A: In this particular case, the lenders involved with this relationship realized the extreme credit risk of these entities and decided that no further new loans were appropriate.