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Radhan's Methodology: CSC – 4 Unsustainable Capital Structure


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Unsustainable Capital Structure

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Radhan's Methodology: CSC – 4 Unsustainable Capital Structure

  1. 1. Methodology:CSC–4 UnsustainableCapitalStructure
  2. 2. volatility Cash Flow Producing Units Cash Flow From Operation Size Timing Cash Flow From Financing Cash Flow From Investments Macro Conditions Industry Corporate Solvency Zone Covenants Solvency is a Dynamic Zone • A corporation is made of cash flow producing units • The cash flow can be produced from operations, financing or capital transactions (investments) • The ability to produce cash, in each of the above routes is dependent on the corporation itself, the industry it operates in and the macro conditions • Therefore, both the size and timing of debt service is volatile • This creates a constantly changing solvency zone in which several routes may be available to forecast the debt service
  3. 3. Financial Ratios Covenants Detection Only The Inherent Limitations of Financial Covenants Solvency Zone Covenants • Financial covenants are an important tool in detecting when the corporation is closer to the boundaries of the Solvency Zone • However misuse of this tool may limit its contribution to loan management and even adversely impact the ability to detect default and ensure recovery • The volatility of the Solvency Zone may decrease the effectiveness of the loan covenants. The corporation and loan officer must, from time to time, pending on the volatility of the Zone, redefine the covenants for internal uses. The financing party can use the MAC clause to enforce discussions on the breach of the non documented covenants • Once the documented covenants are breached using the same covenants and merely adjusting their level is usually ineffective: the covenants are consequential in nature and even though they are effective to detect when Solvency Zone limits may be crossed, they are not effectual in determining the current risk factors
  4. 4. The Uses of Trackers and Markers in Covenant Breach Situations Financial covenant breached Stable Capital Structure Complex Causation Collapsed Capital Structure (CSC 5) Waiver/ Enhancements Trackers and Markers Definition Analysis Trackers are parameters based on the specific corporation at the specific point in time that are on the critical path of the Corporation financial goals (e.g sales, expanses, specific contracts etc.). Markers are the target goals measured in Trackers’ units which attainment will qualify to recognize the capital structure as stable Monitoring Period Simple Causation failure Success