Questions & Answers, Global Cash Flow, January 11, 2012
Q: What if the borrower is a single asset entity owning only the income producing property? Then they are analyzed as essentially one and the same, correct? Also, the principals of that SAE would be your guarantors, correct?
A: They are not one and the same. Our loan would be to the SAE and not the income producing property. The SAE may have additional amounts of debt, and it may have loans outstanding to partners or it may have made significant distributions to partners, which compelled the SAE to borrow to do so. Remember, the property is not the obligor – it does not service the debt. The property owner – SAE – does so.
Q: What about contributions or loans made to the corporation by the owner? Should they also be included in the cash flow?
A: Loans or contributions to the corporation from the owners are a different phenomenon from loans or distributions to the owners from the corporation. Loans and contributions from the owners are usually emergency financing and must be classified as new debt or new equity while loans from the corporation to the owner and distributions from the corporation to owner are operating expenses. Therefore, the two sets of cash flows have very different purposes and need to be classified differently.
Q: Can you please explain the concept of NOI contribution shown on Slide 24 as well as the implications from a negative NOI contribution?
A: To get to business "cash flow" as we've defined it, we need to adjust stabilized NOI of $285,527 by interest expense on the new term debt ($169,017) and depreciation expense on the adjusted market value ($118,750). These two adjustments give us the negative net income of $2,240 that we see on Slide 24, which is the starting point for computing business “cash flow”.
However, to get to business cash flow, we then add back depreciation expense, which contributes to overall projected 2008 business "cash flow" for Fresno Properties of $588,514 on Slide 25.
The key point is that the acquisition provides some help to the overall projected business “cash flow” of Fresno Properties but not as much as we would hope.
If NOI, based on either stabilized assumptions in the appraisal report or on current rent roles, were negative, it would mean that the property in question drains cash from the owner as well as drains cash from the group of related parties that play a role in estimating global cash flow.
Q: If we are relying on the cash flow from these other companies, wouldn't they have to guaranty the loan as well?
A: In theory, yes, we'd like a guarantee from the other companies. But keep in mind that how they perform and the cash they have available all depends on Fritz Schumacher who controls them and makes all the decisions about who gets paid and who does not.
Q: Can you provide further explanation of "Due To" as you cover the different companies.
A: “Due To” means the amount a company owes another party. There may or may not be formal repayment terms. Further, the “Due To” amount could be a current obligation or a long-term obligation. A “Due To” amount within a closely controlled group of companies is likely very informal with no documentation. However, for arms length companies or parties, there would likely be clear documentation that spells out interest rates and repayment terms.
Q: Assuming the NOI of $285,527 is correct and the DS on the property is $228,441 giving you the 1.25 x DSCR and the borrower is a SAE owned 100% by Fritz Schumacher, then this loan would be okay to complete. Correct?
A: Not necessarily, because we need to examine the financial statements of the SAE. However, even if we found a financially healthy company, there is still the issue of pressure on the SAE from Sequoia Properties, which may use up all the SAE cash flow – the critical point we want to stress in our approach to understanding and assessing global cash flow.
Q: Can you set stipulations in the loan documents that they can't move money from the SAE to other related companies?
A: You can indeed write a covenant that prohibits loans to companies or prohibit loans to owners. There can be real value in loan covenants, but they must be monitored and enforced to be effective.
Q: What caused Schumacher to withdraw that much money in one year from the companies?
A: We wish we knew. That is a critical question. We know the money did not end up as liquid assets. We would no doubt want to speak with Schumacher regarding the reasons for the large distributions and loans to him in an attempt to understand if those cash outflows would likely repeat in 2008 and beyond.
Q: Why is the net personal cash flow after debt service being used as part of the global cash flow as opposed to the net personal cash flow before debt service?
A: We're using personal cash flow after personal debt service, which is the amount available to support company debt. The key issue is personal cash flow after personal debt service, which is the amount available to support outside debt.
Q: Given some of the accruals, would you expect to see a difference between UCA and traditional cash flow as we looked at it?
A: We would need to review the sources and uses of cash on the entire balance sheet (not just the accruals) in order to determine the overall impact of the balance sheet on cash flow for the year. At a minimum, we would expect to see differences between UCA cash flow amounts and traditional “cash flow”, unless the balance sheets for all the companies showed little, if any, change from period to year – which rarely occurs.
With respect to the Schumacher group of companies, they actually performed a bit better on a UCA basis in 2007 but they did so in large part because they ran up their accruals – especially true for Sequoia Properties. Such an increase in accruals in one year usually foreshadows a decrease in the following year, which can have a very negative impact on cash flow from business operations.
Q: What if the borrower is a single asset entity owning only the income producing property? Then they are analyzed as essentially one and the same, correct? Also, the principals of that SAE would be your guarantors, correct?
A: They are not one and the same. Our loan would be to the SAE and not the income producing property. The SAE may have additional amounts of debt, and it may have loans outstanding to partners or it may have made significant distributions to partners, which compelled the SAE to borrow to do so. Remember, the property is not the obligor – it does not service the debt. The property owner – SAE – does so.
Q: What about contributions or loans made to the corporation by the owner? Should they also be included in the cash flow?
A: Loans or contributions to the corporation from the owners are a different phenomenon from loans or distributions to the owners from the corporation. Loans and contributions from the owners are usually emergency financing and must be classified as new debt or new equity while loans from the corporation to the owner and distributions from the corporation to owner are operating expenses. Therefore, the two sets of cash flows have very different purposes and need to be classified differently.
Q: Can you please explain the concept of NOI contribution shown on Slide 24 as well as the implications from a negative NOI contribution?
A: To get to business "cash flow" as we've defined it, we need to adjust stabilized NOI of $285,527 by interest expense on the new term debt ($169,017) and depreciation expense on the adjusted market value ($118,750). These two adjustments give us the negative net income of $2,240 that we see on Slide 24, which is the starting point for computing business “cash flow”.
However, to get to business cash flow, we then add back depreciation expense, which contributes to overall projected 2008 business "cash flow" for Fresno Properties of $588,514 on Slide 25.
The key point is that the acquisition provides some help to the overall projected business “cash flow” of Fresno Properties but not as much as we would hope.
If NOI, based on either stabilized assumptions in the appraisal report or on current rent roles, were negative, it would mean that the property in question drains cash from the owner as well as drains cash from the group of related parties that play a role in estimating global cash flow.
Q: If we are relying on the cash flow from these other companies, wouldn't they have to guaranty the loan as well?
A: In theory, yes, we'd like a guarantee from the other companies. But keep in mind that how they perform and the cash they have available all depends on Fritz Schumacher who controls them and makes all the decisions about who gets paid and who does not.
Q: Can you provide further explanation of "Due To" as you cover the different companies.
A: “Due To” means the amount a company owes another party. There may or may not be formal repayment terms. Further, the “Due To” amount could be a current obligation or a long-term obligation. A “Due To” amount within a closely controlled group of companies is likely very informal with no documentation. However, for arms length companies or parties, there would likely be clear documentation that spells out interest rates and repayment terms.
Q: Assuming the NOI of $285,527 is correct and the DS on the property is $228,441 giving you the 1.25 x DSCR and the borrower is a SAE owned 100% by Fritz Schumacher, then this loan would be okay to complete. Correct?
A: Not necessarily, because we need to examine the financial statements of the SAE. However, even if we found a financially healthy company, there is still the issue of pressure on the SAE from Sequoia Properties, which may use up all the SAE cash flow – the critical point we want to stress in our approach to understanding and assessing global cash flow.
Q: Can you set stipulations in the loan documents that they can't move money from the SAE to other related companies?
A: You can indeed write a covenant that prohibits loans to companies or prohibit loans to owners. There can be real value in loan covenants, but they must be monitored and enforced to be effective.
Q: What caused Schumacher to withdraw that much money in one year from the companies?
A: We wish we knew. That is a critical question. We know the money did not end up as liquid assets. We would no doubt want to speak with Schumacher regarding the reasons for the large distributions and loans to him in an attempt to understand if those cash outflows would likely repeat in 2008 and beyond.
Q: Why is the net personal cash flow after debt service being used as part of the global cash flow as opposed to the net personal cash flow before debt service?
A: We're using personal cash flow after personal debt service, which is the amount available to support company debt. The key issue is personal cash flow after personal debt service, which is the amount available to support outside debt.
Q: Given some of the accruals, would you expect to see a difference between UCA and traditional cash flow as we looked at it?
A: We would need to review the sources and uses of cash on the entire balance sheet (not just the accruals) in order to determine the overall impact of the balance sheet on cash flow for the year. At a minimum, we would expect to see differences between UCA cash flow amounts and traditional “cash flow”, unless the balance sheets for all the companies showed little, if any, change from period to year – which rarely occurs.
With respect to the Schumacher group of companies, they actually performed a bit better on a UCA basis in 2007 but they did so in large part because they ran up their accruals – especially true for Sequoia Properties. Such an increase in accruals in one year usually foreshadows a decrease in the following year, which can have a very negative impact on cash flow from business operations.