April 25, 2013

Q: With respect to Slides 23 and 24, you should also consider any repayment of stockholder debt as another use of cash.

A: Yes, and it turns out to be a wash when defining Global Cash Flow, since it is cash out for the company but cash in for the guarantor in an equal amount. Therefore, the cash flows end up washing out, in effect, just as distributions end up washing out. But key question remains whether guarantor surplus cash flow is available in the form of ready cash to service company debt.

Q: Where are living expenses derived from? Is there a percentage of income you would use for living expenses?  Is there a rule of thumb for living expenses as a percent of income?

A: For Fritz Schumacher, we had to basically guess because he provided virtually no information about living expenses. This is the weakest area of a personal cash flow statement. There is no good standardized information that links income levels to living expenses. However, today's average savings rate is about 3% of disposable income, which suggests that all guarantor expenses (except for taxes) are 97% of disposable income.Disposable income, in turn, is generallydefined as total personal income minus all personal income taxes paid.

Q: Do you ever suggest verifying the guarantor's personal liquidity?

A: We should verify guarantor's ready cash (rather than living expenses) by requiring bank and brokerage statements. It is the ready cash that counts in a crisis, and we should indeed verify such amounts.  When we have concerns about a guarantor’s ability to sustain demonstrated ready cash, it’s certainly appropriate to conduct our verification more frequently.

Q: In reviewing cash flow for Fresno Properties, why are you not taking into consideration the loans to and from the other related entities as you did in the individual’s cash flow?

A: Loans to and from other related parties are quasi-financing events and are not part of operating cash flow available to service company debt. Our focus is on operating cash flow apart from outside or inside financing.

Recall, too, that we’re using a proxy for defining business cash flow rather than a fully defined UCA cash flow statement.

Q: I noticed that you netted the personal debt service obligations from the personal cash flow before calculating global debt service. Is that the preferred way? We typically add personal and other debt service together to calculate the global coverage.

A:  It is hard to say if there is a preferred approach.  We like to treat the guarantor as separate from the borrower. Therefore, we estimate a guarantor's personal cash flow surplus after personal debt service, which is likely how events unfold, and then add that surplus to business cash flow to get global cash flow available to service company debt. But remember that the whole concept of global cash flow is really flawed since it assumes that a guarantor's surplus is always available to service company debt.

Your question also brings out the importance of recognizing that lenders often exercise discretion in establishing loan policy and credit analysis practices.  

Q: Why did you include the entire loans to owners instead of the annual payments, i.e. interest only?

A: We include new loans to owners during the current period only and not the total amount of loans outstanding. The new loans – the difference between the prior year balance and the current year balance – represent the amount of cash outflow to owners in the period in question, which reduces a borrower's cash available to service debt.  Note also that any interest paid to owners is already included in the interest expense used in defining debt service for the period.  

Q: On Slide 47, where are you getting the CMLTD numbers?

A: In calculating principle debt service for the current period, always use CMLTD from the prior period.  

Q: In your examples you used the $1.7MM cash surplus, but in the last poll question you indicated we should look to liquid assets.

A: A guarantor’s ready cash (adjusted liquid assets) that can be delivered to the borrower in three to five business days in the event of a financial crisis is the most meaningful measure of guarantor support.  A guarantor’s cash flow surplus can be too easily consumed by multiple spending or investment opportunities and be unavailable to support a guaranteed borrower in distress.