Unsustainable Capital Structure

1. Methodology:CSC–4
UnsustainableCapitalStructure

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. 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. 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