Q: Is subject property income and debt service included in global DSC ratio?

A: I believe that your question came in while we were reviewing the 2007 Global “Cash Flow” and Debt Service table (Slide #45) which shows the historical information, pre-acquisition.  Therefore the Debt Service Coverage does not include either the additional cash flow or debt service associated with the proposed acquisition.

The projected cash flow and debt service associated with the proposed acquisition is included in the projected 2008 Global “Cash Flow” and Debt Service table (Slide #49).

Q: There appears to be a material difference in how I have always calculated global cash flow and how it was presented in the training.  In the training, the cash flow derived from the individual/guarantor in the global cash flow is presented as “available personal cash flow” which is AFTER personal debt service.   I have always held the opinion that global cash flow should incorporate all cash flow from the Borrower and guarantors prior to debt service and then capture all business and personal debt service on a combined basis.    Netting the personal debt service out of personal cash flow distorts global cash flow in most instances.  
 
A: The rationale behind using guarantor cash flow after all personal obligations have been met is that the guarantor must take care of his or her personal debt service, regardless of what the company may or may not do.  The concept of global cash flow, as it is customarily defined, is to combine "free" or available guarantor cash flow with business cash flow (prior to debt service) to determine if there is sufficient combined cash flow to service company debt.  Under this conceptual approach, the focus is on company debt service, not on a combination of debt service for both the company and the guarantor.

The computation will change if we calculate debt service coverage in the manner that you use, but the critical point is that the DSC must still be at 1.00 or above to assure that the borrower met its debt service.  For example, in applying your approach, the global DSC on Slide 32 would be 3.68 versus the 4.43 that we computed.  Our approach provides a more robust DSC in this example, but the point is that both are well above 1.00, which they must be to signal that global cash flow was sufficient to cover the borrower’s interest-bearing debt service.  Further, if we use your approach to compute the DSC on Slide 45, we would get 1.22 versus 1.23, quite an insignificant difference in this instance.

The key point that we stress in the webcast is that we should use ready cash and not personal cash flow in computing a global DSC.  In our view, the best measure of global cash flow available to service a company’s interest-bearing debt is true business cash flow before debt service complemented by the amount of ready cash a guarantor can provide from his or her highly liquid personal assets.  

In effect, we take the position that it really doesn’t matter if we use guarantor cash flow before or after personal debt service in computing global cash flow because the focus on guarantor cash flow diverts attention from the real issue.  The real issue, in our opinion, is that highly liquid personal assets are the measure of guarantor cash support rather than guarantor cash flow. In a crisis, a guarantor must access cash to support company debt service, and his or her highly liquid personal assets are the best measures of the guarantor’s ability to provide cash support.

Q: When regulators request a Global Cash Flow analysis, what are they looking for?

A: In light of past conversations with regulators, I conclude several things about the their approach to global cash flow.

1. They are not looking for a consolidated or global debt service coverage ratio that incorporates all related parties, including owners and guarantors.
2. They are looking for an assessment of likely future cash flow and cash flow pressures between and among the related parties that can adversely impact an obligor's ability to properly service its interest bearing debt.
3. The concept applies to commercial as well as to commercial real estate transactions and deals.
4. Cash flow means real cash flow and not net income + depreciation or EBITDA as proxies for true cash flow.

Although the regulators have not made this point specifically, I suspect they will begin to look at replacing a guarantor's personal cash flow surplus with the dollar amount of highly liquid personal assets a guarantor can access within a very short period of time.  In other words, it's not a guarantor's personal cash flow that is so important but, rather, what he or she does with the personal cash flow.  If surplus personal cash flow goes into Treasury bills, then it will be available for supporting company debt service.  But if it goes into a speculative land purchase in Alaska, it's gone (perhaps for good) and the company is on its own in coming up with the cash to service its debt.

In any event, the focus is on the future and on likely future cash flow pressures from any related party that could impact a borrower's ability to service its debt.  That pressure could come from a related party that will have huge cash needs and, as a result, will drain away all available cash from the borrower, thereby impairing its ability to service its debt. The same could happen because a owner/guarantor needs a given level of cash to support a lifestyle and, therefore, can be counted on to pull dangerous quantities of cash from his or her companies.