Thursday, January 12, 2017

OCC: Semiannual Risk Perspective

The OCC has just recently released a new Risk Perspective report (covering the Fall of 2016).  You may find it here.

Tuesday, January 3, 2017

Days Receivables Outstanding

Another way to look at accounts receivable turnover is in days:

Days Receivables Outstanding=                       365             
                                                        accounts receivable turnover

This ratio expresses the average length of time in number of days between sales and the cash collection of receivables.  The average number of days that receivables are outstanding can seem like a more intuitive measure than turnover expressed in number of times per year.  In this case, a lower value (or fewer days) is favorable because it represents more rapid turnover.

Accounts Receivable Turnover

Accounts Receivable Turnover=     annual net revenue
                                                            accounts receivable

Accounts receivable turnover represents the average number of times per year that trade receivables "turn over" or are converted to cash.  Higher, more rapid turnover is favorable, since sales on credit are being converted to cash more quickly.  Lower, less rapid turnover is unfavorable since default becomes more likely as receivables remain uncollected, and since conversion to cash is necessary to service obligations or to earn interest.
A problem with this ratio is the fact that it compares accounts receivable at a single point in time to an entire year of sales.  If the accounts receivable balance is unusually high or low on the date of the financial statements due to seasonal variations or other factors, then this measurement may not provide an accurate picture.  Substituting average receivable balances over the year in the denominator, may help correct this.

Saturday, January 9, 2016

OCC Bulletin on Real Estate Lending

A few weeks ago, the OCC posted an Interagency Statement on Prudent Risk Management for Commercial Real Estate Lending.

The agencies seem to be noting increased concentrations and risk in commercial real estate lending activities.  This probably does not come as a surprise to most of you.  The bulletin includes a handy PDF document with explanations and additional references to regulatory guidance.

For your reference, the OCC also has a specific page for Commercial Real Estate, which includes additional links.

Adding back Rent in the Debt Service Coverage Ratio

Often, the building where a business operates is owned separately from the business, itself.  The company-owner will typically own the building individually or through an LLC and lease it to the business.
In such an instance, the rent paid to company-owners (either directly or via LLC or other organization) is typically added back to the numerator of the debt service coverage ratio, while the debt service on the property is included in the denominator.

The cash flows of the company are effectively paying the debt service on the property, regardless of the paper trail.  To perform a full and proper debt service coverage analysis, you include the debt service on the mortgage in the denominator and, correspondingly, add back related rent to the numerator.  (Remember, if you include either rent in the numerator or mortgage debt service in the denominator, then you must include the other as well.)

Sometimes it is only appropriate to add back a portion of the total rent:

Example 1: If the total rent is comprised of rents for various properties, you will only add back the rent portion for the properties also owned by the owner of the company, since only that portion is included as debt service.

Example 2: The owner may effectively be distributing income to himself from the company through excessive rent.  If the rent paid by the company is significantly more than the debt service for the given property, then it may be appropriate to add back only the amount of rent necessary for debt service for the property.

Example 3: If a portion of the rent includes cash expenses such as taxes or insurance, then the amounts of each of these expenses should not be added back.  Do not add back rent unless you obtain a financial statement or lease or verify that the rent added back does not include such expenses.

Note also that you should add back rent paid to owners and consider the corresponding debt service even if the loan is from a different bank.  You also add back rent when the company had been renting but is now buying a facility.


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