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Underwriting Guidelines

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					Underwriting Guidelines for the

Community Development Block Grant Program

CDBG Underwriting Guidelines
Established by Statute:

42 USC 5305 (e)
and

Regulation:

24 CFR 570.209

CDBG Underwriting Guidelines

(a) Are project costs reasonable?
(b) Are all project financing sources committed? (c) Are CDBG funds being substituted for non-federal sources? (d) Is the project financially feasible? (e) Is the return on the owner’s equity unreasonably high? (f) Will CDBG funds be disbursed on a pro rata basis with other finances provided to the project?

CDBG Underwriting Guidelines
(a) Are project costs reasonable?
Ensure that providing either too much or too little CDBG assistance for the proposed project is avoided
Accomplished by financial analysis of source and uses and revenue and expense projections.

CDBG Underwriting Guidelines
(b) Are all project financing sources committed?
Ensure: -sufficient sources of funds have been identified to finance the project -participating parties funds have affirmed intention to make funds available -participating parties have financial capacity to provide funds

CDBG Underwriting Guidelines
(c) Are CDBG funds being substituted for non-federal sources?
Ensure the most efficient use of CDBG funds Accomplished by financial analysis revenue and expense projections; debt service requirements and return on equity investments.

CDBG Underwriting Guidelines
(d) Is the project financially feasible?
Ensure the public benefit of CDBG assistance will materialize by financing a viable project. Accomplished by – -examining assumptions about project’s market share, sales levels, growth potential. - examining financial projections to determine the breakeven point and debt service capacity. - evaluating the experience of the company’s management to achieve the projections.

CDBG Underwriting Guidelines
(e) Is the return on the owner’s equity unreasonably high?
Ensure- that the CDBG assisted activity should not provide more than a reasonable return on investment to the owner given the industry rates of return, local conditions and the risk of the project. - that the ED program is able to maximize the use of CDBG funds for its economic development objectives.

CDBG Underwriting Guidelines
(f) Will CDBG funds be disbursed on a pro rata basis with other finances provided to the project?
Ensure that CDBG funds are not placed at significantly greater risk than non-CDBG funds

CDBG Underwriting Guidelines

Are project costs reasonable?
Are all project financing sources committed? Are CDBG funds being substituted for non-federal sources? Is the project financially feasible? Is the return on the owner’s equity unreasonably high? Will CDBG funds be disbursed on a pro rata basis with other finances provided to the project?

CDBG Underwriting Guidelines

Application to financial underwriting

Underwriting Guidelines applied to financial analysis Working Capital Loans

Fixed Asset Loans

Underwriting Guidelines applied to financial analysis Working Capital

Fixed Assets

Working Capital

Fixed Assets

Net Working Capital = Current Assets Minus $5,220

Current Liabilities
Equals

$2,110
$3,110

Working Capital Fixed Assets

Net Working Capital = Current Assets Minus $5,220

Current Liabilities
Equals

$2,110
$3,110

Working Capital For Loan Purposes

Accounts Receivable Inventory Minus

Accounts Payable

Working Capital Loan Underwriting
Calculate the Working Capital Cycle

Calculate the Borrowing Base

Working Capital Loan Underwriting
Calculate the Working Capital Cycle Determine Days Receivables Determine Days Inventories Determine Days Payables

Determine DAYS RECEIVABLES

Divide Accounts Receivable $1,320 by Annual Sales $16,000 = .0825 or 8.25%

Multiply .0825 X 365 days =

30 days

Determine DAYS RECEIVABLES

equals

Divide Accounts Receivable $1,320 by Annual Sales $16,000 = .0825 or 8.25%

Multiply .0825 X 365 days =

30 days

Determine DAYS INVENTORY

Divide INVENTORY $1,430 by COST of GOODS SOLD $8,760 = .165 or 16.50%

Multiply .165 X 365 days =

60 days

equals

Determine DAYS INVENTORY

Divide INVENTORY $1,430 by COST of GOODS SOLD $8,760 = .165 or 16.50%

Multiply .165 X 365 days =

60 days

equals

Determine DAYS INVENTORY

equals equals

Divide INVENTORY $1,430 by COST of GOODS SOLD $8,760 = .165 or 16.50%

Multiply .165 X 365 days =

60 days

Determine DAYS PAYABLES

Divide ACCOUNTS PAYABLES $600 by COST of GOODS SOLD $8,760 = .069 or 6.90%

Multiply .069 X 365 days =

25 days

Determine DAYS PAYABLES

equals

Divide ACCOUNTS PAYABLES $600 by COST of GOODS SOLD $8,760 = .069 or 6.90%

Multiply .069 X 365 days =

25 days

Determine WC Cycle

Add Days RECEIVABLES [30] plus Days INVENTORIES [60] subtract Days PAYABLES [25] =

65 days

Determine WC Cycle

equals

Add Days RECEIVABLES [30] plus Days INVENTORIES [60] subtract Days PAYABLES [25] =

65 days

Use WC Cycle to Determine Needs for Additional Growth

Use WC Cycle to Determine Needs for Additional Growth

Add Days RECEIVABLES [30] plus Days INVENTORIES [60] subtract Days PAYABLES [25] =

65 days

Use WC Cycle to Determine Needs for Additional Growth

At the same WC cycle the new WC requirement is $2,361; an increase of $211

Use WC Cycle to Determine Needs for Additional Growth

At the same WC cycle the new WC requirement is $2,361; an increase of $211

Working Capital Loan Underwriting
Calculate the Borrowing Base

Calculate the WC Borrowing Base

Add ACCOUNTS RECEIVABLE [$1,320] plus INVENTORIES [$1,430] subtract ACCOUNTS PAYABLE [$600] = $2,150

Typically lenders do not make loans at 100% value

Determine WC Borrowing Base

Loan to value ratios for AR and Inventory

Multiply ACCOUNTS RECEIVABLES [$1,320] X 80%; multiply INVENTORIES [$1,430] X 50% = $1,775

Determine WC Borrowing Base

Assets Loan value =

$1,775

Minus supplier credit [$600] = $1,175

Determine WC Borrowing Base

Assets Loan value =

$1,775

Minus supplier credit [$600] = $1,175

Determine WC Borrowing Base

Assets Loan value =

$1,775

Minus supplier credit [$600] = $1,175 which represents
the Borrowing Base or collateral for a Working Capital loan

Determine WC Borrowing Base

CDBG Underwriting Guidelines

(a) Are project costs reasonable?
Ensure that providing either too much or too little CDBG assistance for the proposed project is avoided Accomplished by financial analysis of source and uses and revenue and expense projections.

Assets Loan value =

$1,775

Minus supplier credit [$600] = $1,175 which represents
the Borrowing Base or collateral for a Working Capital loan

Determine WC Borrowing Base

CDBG Underwriting Guidelines

Are all project financing sources committed?
Ensure participating parties have financial capacity to provide funds

Total Net WC $2,150 minus external financing $1,175 = $975 equity financing needed

Other Considerations for WC Loans

When sales remain even throughout the year, so do WC requirements

Other Considerations for WC Loans

But when fluctuations in Sales occur so will changes in WC requirements

Other Considerations for WC Loans

Sales fluctuations will change WC requirements

Other Considerations for WC Loans
CDBG Underwriting Guidelines

Are all project financing sources committed?
Sufficient sources of funds been identified to finance the project

Sales fluctuations will change WC requirements

Other Considerations for WC Loans

Other Considerations for WC Loans

Changes in WC cycle can adversely effect the borrowing base

Other Considerations for WC Loans

Net WC is $3,490 for base year

Other Considerations for WC Loans

For the following year:
Net WC is $4,645; a 33% increase but Sales only increased 6%

Other Considerations for WC Loans

The WC cycle has increased

The key financial ratio; Current Ratio has improved from 3:1 to 5:1; But the efficiency ratios; Sales/Working Capital has decreased from 7:1 to 5:1; Sales/Total Assets will also decrease

Underwriting Guidelines applied to financial analysis Working Capital

Fixed Assets

Fixed Asset Loan Underwriting

Loan to Value Ratio and Cash flow to Debt Service requirements

Fixed Asset Loan Underwriting

Loan to Value Ratio General Rules 1. Do not finance 100% of the asset 2. Do not term the loan longer than the asset’s useful life

Fixed Asset Loan Underwriting

Loan to Value Ratio [LVR]

1. Do not finance 100% of the asset Establish a Maximum LVR [75%]

Fixed Asset Loan Underwriting
Maximum 75% of Value

Asset Cost $8,000 X 75% [LVR] = $ 6,000 maximum loan

Fixed Asset Loan Underwriting
Maximum 75% of Value

Asset Cost $8,000 - $ 6,000 = $2,000 the difference to be provided by the company

Fixed Asset Loan Underwriting
CDBG Underwriting Guidelines

Are all project financing sources committed? Will CDBG funds be disbursed on a pro rata share with other finances provided to the project?

Asset Cost $8,000 - $ 6,000 = $2,000 the difference to be provided by the company

Fixed Asset Loan Underwriting
Asset Useful Life vs. Loan Amortization period

After two years the asset’s book value is $6,000 and the loan balance is $3,800

Asset useful life 8 years: $8,000 = $ 1,000 per year expensed $6,000 loan amortized for 5 years

Fixed Asset Loan Underwriting
Asset Useful Life vs. Loan Amortization period

After five years the asset’s book value is $3,000 and the loan balance is $0

Asset useful life 8 years: $8,000 = $ 1,000 per year expensed $6,000 loan amortized for 5 years

Fixed Asset Loan Underwriting
Asset Useful Life vs. Loan Amortization period

If the loan amortization is longer than the asset’s useful life, then the company’s net worth will decline

Asset useful life 8 years: $8,000 = $ 1,000 per year expensed
$6,000 loan amortized for 9 years

Fixed Asset Loan Underwriting
Asset Useful Life vs. Loan Amortization period

CDBG Underwriting Guidelines

Are CDBG funds being substituted for non-federal sources? Is the return on the owner’s equity unreasonable high?

Fixed Asset Loan Underwriting

Cash flow to Debt Service requirements

1. Establish a CF/DS ratio 2. Determine DS capacity

Fixed Asset Loan Underwriting
Establish a CF/DS ratio: Determine DS capacity 1.5 : 1 For every dollar of debt service, the project must have a dollar and half of cash flow

Fixed Asset Loan Underwriting
Establish a CF/DS ratio: Determine DS capacity Subtract Operating Expenses from Gross Profit = Operating Cash Flow or Earnings Before Interest Taxes and Depreciation and Amortization EBITDA 1.5 : 1

Fixed Asset Loan Underwriting
Establish a CF/DS ratio: Determine DS capacity 1.5 : 1

Operating Cash / EBITDA = $1,590

Fixed Asset Loan Underwriting
Establish a CF/DS ratio: Determine DS capacity 1.5 : 1

Operating Cash / EBITDA = $1,590

Divide by CF/DS ratio 1.5 =
$1,060 DS capacity

Fixed Asset Loan Underwriting
$1,060 DS capacity Determine Debt Service Constant Divide by proposed loan $6,000 = .1766 Which is the Debt Service Constant [DSK]

Fixed Asset Loan Underwriting
Price the Loan $1,060 DS capacity Divide by proposed loan $6,000 = .1766

Find best match for .1766 on the Debt Service Constant table

Fixed Asset Loan Underwriting
Price the Loan $1,060 DS capacity Divide by proposed loan of $6,000 = .1766 for an asset with 8 year service life

DSK too high

Term too long

Fixed Asset Loan Underwriting
Price the Loan $1,060 DS capacity Divide by proposed loan $6,000 = .1766

Find closest match to .1766 on the Debt Service Constant table

Fixed Asset Loan Underwriting
Price the Loan

$1,060 DS capacity
Loan $6,000 @ 5.5% for 7 years = annual payment: $1,056

Loan Term less than asset useful life

Fixed Asset Loan Underwriting
Price the Loan

$1,060 DS capacity
Loan $6,000 @ 5.5% for 7 years = annual payment: $1,056

CDBG Underwriting Guidelines

(d) Is the project financially feasible?
Ensure the public benefit of CDBG assistance will materialize by financing a viable project.
Accomplished by –

Loan examining financial projections to determine the breakeven - Term less than asset point and debt service capacity. useful life

Grant and Loan Combinations
Borrower has an CF/EBITDA of at the established CF/DS of DS capability is $740 $1,110;

1.5:1

Grant and Loan Combinations
Borrower has an CF/EBITDA of at the established CF/DS of DS capability is $740 = .123 $1,110;

1.5:1

DSK = $740 divided by loan $6,0000

for an asset with a eight year useful life

Grant and Loan Combinations

DSK = $740/$6,0000 = .123 for an asset with an eight year useful life

DSKs are two high within the asset’s useful life; terms are too long for borrower’s repayment ability

Grant and Loan Combinations
DSK = $740/$6,0000 = .123 for an asset with an eight year useful life

Lender’s terms are 4% ; at one year less than useful life; DSK is .167

Grant and Loan Combinations

Divide CF $740 by .167 [4% @7 yrs] =

$4,442

Grant and Loan Combinations
Asset Cost $6,000

Equals

Borrowing Capacity
Difference is

of

$4,442
$1,558

Grant

Grant and Loan Combinations
Asset Cost $6,000

Equals

Borrowing Capacity
Difference is Grant

of

$4,442
$1,558

CDBG Underwriting Guidelines

Are project costs reasonable? Is the project financially feasible? Is the return on the owner’s equity unreasonably high?

Other Considerations for Long Term financing
Owner’s Rate of Return

Other Considerations for Long Term financing
Owner’s Rate of Return

Profit divided by Owner’s Equity =

Other Considerations for Long Term financing
Owner’s Rate of Return

Profit divided by Owner’s Equity = Return on Equity (Investment)

Other Considerations for Long Term financing
Owner’s Rate of Return

No Debt

Return on Equity (Investment)

Other Considerations for Long Term financing
Owner’s Rate of Return

Addition of Debt and Reduction of Equity Increases the ROE

Other Considerations for Long Term financing
Owner’s Rate of Return

This financing structure [5% 7 Yrs] meets Cash flow to debt service ratio

And Loan to Value ratio

Other Considerations for Long Term financing
Owner’s Rate of Return

Increasing the debt increases the owner’s ROE But also increases the risk indicators Lower CF:DS Higher LVR Lower D/Eq

Other Considerations for Long Term financing
Owner’s Rate of Return

CDBG Underwriting Guidelines

Are CDBG funds being substituted for non-federal sources? Is the return on the owner’s equity unreasonably high?

What is the Breakeven Sales point for Situation A? For Situation B?

A $ ?___ $

B ?___

Determining Project Feasibility
Calculating Sales Breakeven Point

Calculating Project Sources and Uses

Determining the Breakeven Sales point

Calculate the variable cost as a percentage of Sales

Determining the Breakeven Sales point

Calculate the variable cost as a percentage of Sales

Determining the Breakeven Sales point

Subtract the total variable cost from 1
= the Contribution Margin

Determining the Breakeven Sales point

Divide the Fixed Costs by the CM

equals

The Breakeven Sales Point

Determining the Breakeven Sales point

Recalculate variable costs as a percentage of sales

Determining the Breakeven Sales point

Subtract fixed costs; the Profit /(Loss) should equal $0

Determining the Breakeven Sales point

Situation B – Operating at a Loss; Same Sales, Same fixed Costs, higher variable costs and lower CM

4,000 / 16% =

Determining the Breakeven Sales point

(d) Is the project financially feasible?
Ensure the public benefit of CDBG assistance will materialize by financing a viable project.
Accomplished by –
- examining financial projections to determine the breakeven point.

Higher Breakeven Sales Point

Use the Breakeven Sales point to calculate project Sources and Uses

Use the Breakeven Sales point to calculate project Sources and Uses

Additional Sales and COGS means additional WC requirements

Determining Project Sources and Uses

WC requirements

Determining Project Sources and Uses

An increase in productive capacity may require additional fixed assets

Determining Project Sources and Uses

Calculate Additional Financing required

Determining Project Sources and Uses

Calculate Additional Financing required

Determining Project Sources and Uses

After total Project USES have been determined…

Determining Project Sources and Uses

Identify SOURCES to finance project costs

Determining Project Sources and Uses

CDBG Underwriting Guidelines

Are project costs reasonable? Are all project financing sources committed? Is the project financially feasible? Is the return on the owner’s equity unreasonably high? Will CDBG funds be disbursed on a pro rata share with other finances provided to the project?

Underwriting Guidelines for the THE END

Community Development Block Grant Program


				
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