Page 38: of Marine News Magazine (November 2014)

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EVALUATING THE PROPOSAL

Most loan proposals can be evaluated simply by compar- ing advance, interest rate, term, points or fees paid by the obligor. Others may have included requirements that specify when and how much it would cost to pay off or terminate the loan. Still others may require that certain covenants for debt and interest service coverage or liquidity ratios be met and maintained. Prohibitions on secondary mortgages, assign- ment of equity or limitations of distributions to shareholders are other possible covenants. Violations or breaches of these covenants may result in a default and the lender “calling” or accelerating payment of all future payments or increasing the pricing of the loan. No covenants are the best covenants.

Comparisons of leases or Bareboat Charters are not quite as simple, although the basics are the same. There is inherent risk incorporated to most operating leases which generally occur at the termination of the lease. Leases are available in a number of different “fl avors.” Some carry more risk and some carry less ... most risk lies in the value of the vessel at the end of the lease. In a fair market value termination, the vessel can be purchased at the then cur- rent fair market value (FMV) as determined by an inde- pendent surveyor. Further, the option to re-lease the vessel for additional periods may be based in part on payment history of the lessee and the then current index. What may be available to the lessee to mitigate some of the FMV risk in a operating lease or bareboat charter is the EBO. Given that if the lessor’s profi t (Internal Rate of Return or IRR) on the vessel’s lease remains the same, then the greater the amount of the EBO, the lower the amount of the rent . . . and vice versa. The EBO must meet the Internal Revenue

Service’s “compulsion test.” The purchase price of the col- lateral cannot be less than the present value of the remain- ing rents plus a FMV worth not less than 20% of assumed value. The lender’s rate of return of the lease and the EBO are generally the same. It is this value of this IRR which, in addition to the rent and amount of the EBO that is used for comparison between one proposal and another.

As the actual calculation of the internal rate of return at the EBO is arcane at best, contact your CPA or fi nancial analyst for their professional expertise in performing such calculations and shrink the mountain of proposals to the one that suits your business best. And, remember, it isn’t always just about the rate.

FINANCECOLUMN

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