DSCR 1.18 and the Six-Month Waiver
An SME borrower has a USD 3.0 million term loan at 8.5%, amortising over seven years with annual instalments of USD 450,000; USD 2.95 million is outstanding. Latest accounts show EBITDA of USD 1,050,000, tax of USD 50,000, maintenance capex of USD 100,000 and an increase in working capital of USD 70,000. The covenant requires DSCR of at least 1.25x, tested annually. The bank defines cash flow available for debt service as EBITDA less tax, capex and working-capital increase, over interest plus scheduled principal. The borrower requests a waiver because a large customer delayed payment. Security is a factory valued at USD 3.6 million, with a 30% forced-sale haircut. The relationship manager wants a six-month waiver to "avoid an NPL hit".
1. Calculate the DSCR and state the covenant position.
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CFADS: 1,050,000 − 50,000 − 100,000 − 70,000 = USD 830,000
Debt service: interest ≈ 2.95m × 8.5% ≈ USD 251,000; scheduled principal USD 450,000; total ≈ USD 701,000
DSCR = 830,000 / 701,000 ≈ 1.18x
Against a covenant of 1.25x, this is a breach. The headroom required would be 701,000 × 1.25 = USD 876,000 of CFADS; the shortfall is about USD 46,000.
Sensitivity matters more than the point estimate. A 10% fall in EBITDA (to USD 945,000) reduces CFADS to about USD 725,000 and DSCR to 1.03x - essentially no cushion. The "large customer delayed payment" explanation must be verified: is it a timing issue or a permanent loss of the customer? A six-month waiver that assumes reversal is a bet on the customer's solvency.
2. Evaluate the waiver request against restructuring, and set out the conditions you would attach.
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A six-month waiver is the weakest option if the underlying cash flow has not recovered, because it simply defers the covenant test without changing the economics.
Restructuring test: rescheduling to nine years reduces the annual instalment to about USD 333,000, so debt service falls to roughly USD 584,000 and DSCR rises to about 1.42x. That is a real fix, not a deferral.
But a concession granted because of financial difficulty is forbearance. It will trigger a significant increase in credit risk and move the loan to Stage 2 with lifetime ECL. The RM's motive - "avoid an NPL hit" - is precisely the wrong basis for the decision.
Conditions I would attach to any waiver:
- Verified evidence of the delayed receivable (contract, correspondence, expected date).
- Equity injection or shareholder support, with a fixed deadline.
- Additional collateral or a guarantee.
- No dividends or related-party payments while the waiver is in force.
- Monthly management accounts and borrowing-base reporting.
- A hard trigger: if the receivable is not collected by the deadline, the file moves automatically to restructuring assessment.
3. What classification and accounting consequences follow, and how does the collateral affect the decision?
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Classification: forbearance plus a covenant breach and DSCR of 1.18x is at least Stage 2. If the borrower cannot meet the revised terms, or the concession was granted because it could not pay, the exposure is credit-impaired and moves to Stage 3. The bank must not let the RM's wish to avoid an NPL drive the classification - the classification drives the RM's numbers, not the reverse.
Accounting: Stage 2 means lifetime ECL and a materially higher provision than the current 12-month charge; Stage 3 means interest revenue on the net carrying amount and likely interest suspense.
Collateral: factory USD 3.6 million less a 30% forced-sale haircut = USD 2.52 million. Against USD 2.95 million outstanding, LTV ≈ 117%, so the loan is under-secured. Further adjust for selling costs and the time to enforce, both of which reduce recoverable value.
That LTV changes the decision. The bank's downside is a real loss, not a paper one, so a waiver should be granted only with additional security or a credible recovery plan. If neither is available, restructuring into a sustainable schedule with proper provisioning is better than a cosmetic six-month deferral.