Debt service coverage ratio: Difference between revisions

Revision as of 15:14, 22 December 2017

Revision as of 15:18, 22 December 2017

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deterioration of the pool". They further go on to state that this

downgrade resulted from the fact that eight specific loans in the

pool hashave a debt service coverage (DSC) below 1.0x, or below one

times.

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entire pool of 135 loans? The Standard and Poors press release

provides this number, indicating that the weighted average DSC

for the entire pool is 1.76x, or 1.76 times. Again, this is just

a snapshot now. The key question that DSC can help you answer,

is this better or worse, from when all the loans in the pool were

first made? The S&P press release provides this also, explaining

that the original weighted average DSC for the entire pool of 135

loans werewas 1.66x, or 1.66 times.

In this way, the DSC (debt service coverage) ratio provides a way to assess the financial quality, and the associated risk level, of this pool of loans, and shows the surprising result that despite some loans experiencing DSC below 1, the overall DSC of the entire pool has improved, from 1.66 times to 1.76 times. This is pretty much what

a good loan portfolio should look like, with DSC improving over

time, as the loans are paid down, and a small percentage, in this

case 6%, experiencing DSC ratios below one timetimes, suggesting that

for these loans, there may be trouble ahead.

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===Pre-Tax Provision Method===

Income taxes present a special problem to DSCR calculation and interpretation. While, in concept, DSCR is the ratio of cash flow available for debt service to required debt service, in practice – because interest is a tax-deductible expense and principal is not – there is no one figure that represents an amount of cash generated from operations that areis both ''fully available'' for debt service and ''the only cash available'' for debt service.

While [[Earnings before interest, taxes, depreciation and amortization | Earnings Before Interest, Taxes, Depreciation and Amortization]] (EBITDA) is an appropriate measure of a company's ability to make interest-only payments (assuming that expected change in working capital is zero), EBIDA (without the "T") is a more appropriate indicator of a company's ability to make required principal payments. Ignoring these distinctions can lead to DSCR values that overstate or understate a company's debt service capacity. The Pre-Tax Provision Method provides a single ratio that expresses overall debt service capacity reliably given these challenges.

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For example, if post-tax outlays consist of CPLTD of $100M and noncash expenses are $50M, then the borrower can apply $50M of cash inflow

from operations directly against $50M of post-tax outlays without paying taxes on that $50M inflow, but the company must set aside $77M

(assuming a 35% income tax rate) to meet the remaining $50M of post-tax outlays. This company’s pretax provision for post-tax outlays = $50M + $77M = $127M. <ref>[http://ebiz.rmahq.org/eBusPPRO/OnlineStore/ProductDetail/tabid/55/Productid/56403794/Default.aspx Andrukonis, David (May, 2013). "Pitfalls in ConventionalEarnings-Based DSCR Measures — and a Recommended Alternative". The RMA Journal.]</ref>

==See also==