Q: At our institution, the way we do our Global Cash Flow is to use Fritz Schumacher’s Cash after Personal Debt service of $1.77MM (on slide 27) and add that Business Cash Flow to get $3.13MM as it was on slide 33. However, it was recommended to use the “Ready cash total” from personal assets of $272.7M on slide 36 rather than personal cash flow of $1.77MM. We feel that this may be flawed because we view cash flow and cash on hand separately. Cash flow is typically recurring and the cash on hand could be gone at any point. Can you please explain more why we would use the “Ready cash total” from the PFS rather than cash flow?
For example, we are working on a deal that does not cover using the borrower and guarantors global cash flow. However, we have $15MM in verified liquid assets. If we were to use your logic and include the “Ready cash total,” this would cover over 50 times. Do you think this is the appropriate way to assess the cash flow coverage? If so, why?
A: Our recommendation that lenders use ready cash support to identify a guarantor’s contribution to global cash flow is intended to cause us to consider a guarantor’s likely financial status at the time of a potential borrower default. The scenario at that time becomes one of significant financial strain that will likely reduce or eliminate borrower cash flows to the guarantor. The consequence of the borrower’s deteriorating financial condition erodes, if not eliminates, guarantor cash flow and in effect makes liquid assets held by the guarantor the new primary source of repayment.
An important lender responsibility is to identify debt service capacity at all three levels: borrower, guarantor, and collateral liquidation. Our job is to then create a loan structure that mitigates risk at all three levels. Our Session Three focus is on guarantor assessment, and we recommend using guarantor cash flow and ready cash or other liquid assets as measures of a guarantor’s financial strength. Guarantor cash flow is often fleeting in that it can be invested in illiquid assets, consumed, used to support other guarantees, or given away. The impact is especially profound if that cash flow is heavily or totally dependent on the borrower because it can end abruptly and stress both borrower and guarantor ready cash support.
We fully agree that whether cash flow or ready cash assets drive our guarantor assessment, more is always better.
Course overview: Guarantor Analysis, Global Cash Flow, and the Second Way Out