Jaime Cépeda has proposed a credit operation for the acquisition of fixed assets. His client is a legal company dedicated to the service of transportation of heavy cargo, who is requesting a loan for the purchase of a tugboat.
The credit operation has been returned by the Risk Unit of the Financial Institution where it works, despite the client having the ability to pay to cover the installments of the proposed loan, measured through the Net Cash Flow tool. The argument put forward by Risks is that the client has a higher degree of leverage than allowed. Therefore, the only way to approve the loan is through an equity increase, which allows reducing the aforementioned ratio, to the maximum allowed.
The problem is that the partners of the legal company do not have cash to increase the assets of the business, but only a property free of lien from one of them, who is willing to leave it as a mortgage guarantee for the requested loan.
However, for the Risk Unit, the only possible option is to reduce the equity debt ratio. Therefore, the only alternative is to enter the property into the assets of the company, as a contribution from partners and then, if it is feasible, mortgage it in favor of the Financial Institution.
Option, in my humble opinion, questionable and despicable, because the inclusion of the home of one of the partners in the assets of the company would violate one of the Generally Accepted Accounting Principles, such as the Entity Principle, which clearly indicates that “financial information refers to the specifically defined business entity, separate and distinct from the individuals related to it”. On the other hand, its incorporation into the Balance Sheet would imply a tax contingency, since the property's own expenses (water, electricity, telephones, land, etc.) would be accounted for as business, with the possible subsequent negative effects.
On the other hand, it is commented that the company has the ability to pay to cover the loan for fixed assets; which should be a determining factor in the evaluation, rather than the debt ratio.
In any case, if the debt ratios exceed the maximum allowed by the Credit Institution (for example: 75% of Total Assets or 3 times the assets of the company) and the company, despite this, has the capacity of payment, measured through the Net Cash Flow: why not compensate the weakness of the patrimonial indebtedness with mortgages of the client, without having to request patrimonial increases? .
On the other hand: what does the Financial Institution look for with the determination of a maximum limit of patrimonial indebtedness or indebtedness of the assets? : Protect your claims! Measure the partners' commitment to the company! So: What better way to protect your debts than with mortgages in your favor!
In this regard, it is about breaking paradigms, such as the present one, which limits the approval of a credit application to a maximum debt ratio, despite having the ability to pay. In any case, said fears could be covered with additional guarantees and not with the requirement of equity increases that distort the nature of the companies, by inducing them to violate accounting principles, such as the one mentioned above.
