COMMERCIAL LOAN RATIOS

When a commercial loan committee underwrites a potential loan package, their primary criterion includes using three different ratios in evaluating the loan.

Debt Service Coverage Ratio (ability to repay)
A key component in the underwriting process is the ability to repay the debt.  Most lenders evaluate a borrowers ability to repay their loan by using a debt service coverage ratio (DSCR).  DSCR is defined as the amount of cash flow available to meet annual interest and principal payments on the proposed debt.  A DSCR of less than 1.0 means that there is insufficient cash flow generated by the property to cover the requires debt service.

The formula for DSCR is:
Earnings before interest, depreciation, and amortization (Net Operating Income)
                                      Total debt service

Net Operating Income $100,000
Annual Debt Service (Mortgage Payments) $80,000

$100,000 = 1.25 DSCR
$ 80,000

Capitalization Ratio = Net Operating Income
                                                    Value

The value of a property based on the anticipated benefits in the form of income

(1). The formula for calculating Net Operating Income is as follows:

Gross income (all figures are on an annual basis)

Scheduled rent          $xxxx
Other income            $xxxx

Total gross income          $xxxx
Vacancy and collection loss             -xxx

Effective gross income          $xxxx

Operating expenses
Fixed                                   $xx
Variable                               $xx
Replacement allowance      $xx

Total operating expenses                     -$xxxx

NET OPERATING INCOME           $XXXX

(2.) Mortgage Debt Service is the annual amount of all periodic payments for interest and retirement of the mortgage loan(s).

Loan-To-Value Ratio

The Loan-To-Value (LTV) Ratio is defined as follows:

LTV = Total loan balances (1st mtg + 2nd mtg)
        Fair market value (determined by appraisal)

For Example:

75% LTV = $750,000 (mtge)
                      $1,000,000

Debt to Income Ratio

Debt Ratio = Monthly Debt Obligations
                     Monthly Gross Income

The Debt to Income Ratio compares the amount of bills that the borrower must pay each month to the amount of gross monthly income he earns. This computation is used in residential lending, not much emphasis is placed on this ratio in the commercial lending realm. The emphasis will be placed on the income property's ability to "carry" itself by the income it generates.