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bt service coverage ratio

From Wikipedia, the free encyclopedia
The debt service coverage ratio (DSCR), also known as "debt coverage ratio," (DCR) is the ratio of cash available for debt servicing to interest, principal and lease payments. It is a popular benchmark used in the measurement of an entity's (person or corporation) ability to produce enough cash to cover its debt (including lease) payments. The higher this ratio is, the easier it is to obtain a loan. The phrase is also used in commercial banking and may be expressed as a minimum ratio that is acceptable to a lender; it may be a loan condition or covenant. Breaching a DSCR covenant can, in some circumstances, be an act of default.


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1 Uses 2 Calculation
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2.1 Example 2.2 Pre-Tax Provision Method

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3 See also 4 References

Uses [edit]
In corporate finance, DSCR refers to the amount of cash flow available to meet annual interest and principal payments on debt, including sinking fund payments.[1] In personal finance, DSCR refers to a ratio used by bank loan officers in determining debt servicing ability. In commercial real estate finance, DSCR is the primary measure to determine if a property will be able to sustain its debt based on cash flow. In the late 1990s and early 2000s banks typically required a DSCR of at least 1.2,[citation needed] but more aggressive banks would accept lower ratios, a risky practice that contributed to the Financial crisis of 2007–2010. A DSCR over 1 means that (in theory, as calculated to bank standards and assumptions) the entity generates sufficient cash flow to pay its debt obligations. A DSCR below 1.0 indicates that there is not enough cash flow to cover loan payments.

Calculation [edit]
In general, it is calculated by: DSCR = (Annual Net Income + Amortization/Depreciation + Interest Expense + other noncash and discretionary items (such as non-contractual management bonuses)) / (Principal Repayment + Interest payments + Lease payments [1]) To calculate an entity’s debt coverage ratio, you first need to determine the entity’s net operating income. To do this you must take the entity’s total income and deduct any vacancy amounts and all operating expenses. Then take the net operating income and divide it by the property’s annual debt service, which is the total amount o f all interest and principal paid on all of the property’s loans throughout the year. If a property has a debt coverage ratio of less than one, the income that property generates is not enough to cover the mortgage payments and the property’s operating expenses. A property with a debt coverage ratio of .8 only generates enough income to pay for 80 percent of the yearly debt

a financial analyst or informed investor will seek information on what the rate of deterioration of the DSC has been. and the associated risk level. say .35 times (net operating income or NOI / annual debt service) to ensure cash flow sufficient to cover loan payments is available on an ongoing basis. For example. as of June 10. And there is still more. A DSCR of less than 1 would mean a negative cash flow.66 times.1 million. Jones would know the property generates 20 percent more than is required to pay the annual mortgage payment. The debt coverage ratio for this property would be 1.66x. It indicates that of the eight loans which are "underwater". is this better or worse. The Debt Service Ratio is also typically used to evaluate the quality of a portfolio of mortgages. the overall DSC of the .000 and an annual debt service of $30.95.1. indicating that the weighted average DSC for the entire pool is 1. stating that the downgrades "reflect the credit deterioration of the pool". For example. The S&P press release tells us this. the obvious question is: what is the total DSC of the entire pool of 135 loans? The Standard and Poors press release provides this number. explaining that the original weighted average DSC for the entire pool of 135 loans was 1. a property with a debt coverage ratio of 1. of 135 loans. A DSCR of less than 1. if a property has a debt coverage ratio of more than 1. Standard & Poors reported that the total pool consisted. reported that it lowered its credit rating on several classes of pooled commercial mortgage pass-through certificates originally issued by Bank of America. 2008.76 times. but some allow it if the borrower has strong outside income. or 1. of this pool of loans. the DSC (debt service coverage) ratio provides a way to assess the financial quality. since no one would make a loan like this initially. and an average decline in DSC of 38% since the loans were issued. or debt service coverage. this is just a snapshot now.052 billion. They indicate that there were. a popular US rating agency. Generally. they have an average balance of $10. provides a useful indicator of financial strength. lenders frown on a negative cash flow. For example. and shows the surprising result that despite some loans experiencing DSC below 1. Again. but also how much it has changed from when the loan was last evaluated. Now. Example [edit] Let’s say Mr.15 . They further go on to state that this downgrade resulted from the fact that eight specific loans in the pool have a debt service coverage (DSC) below 1. the property does generate enough revenue to cover annual debt payments. and only eight of them are underwater.payments.0x.000. The Debt Service Ratio. with a DSC of less than 1. with an aggregate trust balance of $2. from when all the loans in the pool were first made? The S&P press release provides this also. in the context of personal finance. would mean that there is only enough net operating income to cover 95% of annual debt payments. [1][2] Typically. or below one times.2 and Mr. most commercial banks require the ratio of 1. You want to know not just what the DSC is at a particular point in time. this would mean that the borrower would have to delve into his or her personal funds every month to keep the project afloat.76x. However. The key question that DSC can help you answer. Standard & Poors. This means that the net funds coming in from rental of the commercial properties are not covering the mortgage costs. In this way. eight loans with a DSC of lower than 1. The rating agency stated in a press release that it had lowered the credit ratings of four certificates in the Bank of America Commercial Mortgage Inc. as of that date. or 1. Jones is looking at an investment property with a net operating income of $36. Since there are a total of 135 loans in the pool. 2005-1 series.0x. 2008. on June 19.5 generates enough income to pay all of the annual debt expenses. all of the operating expenses and actually generates fifty percent more income than is required to pay these bills.

The Pre-Tax Provision Method offers a solution to calculate DSCR accurately given these challenges: Using the Pre-Tax Provision Method. where Pre-tax Provision for Post-tax Outlays is simply the amount of pretax cash that must be set aside to meet required post-tax outlays. from 1. with DSC improving over time.66 times to 1. CPLTD + Unfinanced CAPEX + Dividends. This company’s pretax provision for post-tax outlays = $50M + $77M = $127M. the pretax cash that the borrower must set aside for post-tax outlays would simply be $100M. in this case 4%. whereas another component of debt service (principal) impacts only the balance sheet and can be viewed as serviceable by EBIDA. And of course. and a small percentage. if post-tax outlays consist of CPLTD of $100M and noncash expenses are $50M. as the loans are paid down. suggesting that for these loans.income tax rate) For example.entire pool has improved. Earnings-Based DSCR = EBITDA / (Interest + Pre-tax Provision for Post-Tax Outlays). then the company can apply $100M of cash inflow from operations to post-tax outlays without paying taxes on that $100M cash inflow.76 times. [3] . and its noncash expenses are $100M. then Pretax provision for post-tax outlays = Post-tax outlays For example. This is pretty much what a good loan portfolio should look like. but the company must set aside $77M (assuming a 35% income tax rate) to meet the remaining $50M of post-tax outlays. because one component of debt service (interest) is a taxdeductible expense and can be viewed as serviceable by EBITDA. If post-tax outlays > noncash expenses. 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. if a company’s post-tax outlays consist of CPLTD of $90M and $10M in unfinanced CAPEX. In this case. then Pretax provision for post-tax outlays = Noncash expenses + (post-tax outlays noncash expenses) / (1. just because the DSCR is less than 1 for some loans. Pre-Tax Provision Method [edit] Income taxes present a special problem to DSCR calculation.e. i. this does not necessarily mean they will default. there may be trouble ahead. The provision can be calculated as follows: If noncash expenses (depreciation + depletion + amortization) > post-tax outlays. experiencing DSC ratios below one times.