SBA + Pari Passu Loan DSCR Test: Seeking Insights

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by a searcher
in New York, NY, USA

1yr ago

SBA + Pari Passu Loan DSCR Test: Seeking Insights

For those who have closed an SBA deal with a pari passu conventional loan, I could use your advice.

I just received the subordination agreement that the seller needs to sign, and it includes a DSCR (Debt Service Coverage Ratio) test. If the DSCR falls below a certain level, the bank has the right to suspend payments on the seller note. However, our lender has informed us that the DSCR is defined as (EBITDA - Distributions) / Debt Service. Essentially, any distributions to investors are subtracted from EBITDA in the numerator.

This is proving to be a tough pill to swallow because one of our key commitments to investors is a timely return of their capital. This construct makes it very challenging to distribute funds to our investors while remaining compliant with the DSCR covenant.

On top of that, I believe the bank is already well-protected through the SBA credit agreement, which prohibits distributions that could have an adverse impact on the business.

For context, this is the first time the bank is doing an SBA deal with a conventional loan, so I want to make sure this approach isn’t out of market or overly restrictive.

Have others encountered this DSCR definition or clause? If so, how did you manage it with your bank and seller? Any insights would be greatly appreciated!

1 Like

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reply by a lender 1yr ago
from California State University, Sacramento in Seattle, WA, USA

Several things to discuss here. Easier for us to discuss. Having a DSC metric for seller note payments is allowed by the SBA and something we do too. The calc is a diferent matter. Your investor distro needs to be written as discretionary cuz If they’re guaranteed than that’s debt . Nuances to discuss. Email me. redacted

reply by an intermediary 1yr ago
from The University of Chicago in Chicago, IL, USA

Commercial loans typically limit distributions to equity holders until the debt is fully paid off or paid down to a certain level. With SBA loans, I was surprised distributions are allowed. So, I called SBA. Their answer was they leave distribution restrictions up to each lender. I am guessing that has to with PG from SBA perspective. However, if there is a preferred return, or a return of the capital, to those who are also considered part of the equity stack to meet SBA %, then sooner or later SBA is going wake up and limit distributions, or some lenders are going to limit that from day one. SBA deals are highly-levered-transactions (HLT) to begin with. We all know HLTs have created problems in the past with asset bubbles (e.g. CRA enforcement forcing banks to lower equity requirements for housing resulted in the asset bubble that popped inredactedAllowing distributions to equity holders, in my mind, make SBA deals ultra-high HLT. Sooner or later the asset bubble will pop. If you can get by, go with it.