A board paper, annotated.

What the firm’s work looks like on the page. A fictional company asks its board whether to accept a lender’s revised terms. The notes alongside explain why each part is there.

Fictional company, people and figures, for illustration only. Prepared, as all the firm’s work is, under the client’s name; the firm’s name does not appear on the paper itself. The financial results come from the stress test.

Board paper · Item 4 · June · Confidential

Calder Point Hotels Limited: refurbishment financing

From the managing director, for decision

1Decision requested

The board is asked to authorise management to negotiate on the basis of the lender’s revised term sheet, subject to the three conditions in section 7, and not to sign any instrument until those conditions are met and counsel has reviewed it.

2Background

The company proposes to refurbish its 120-room hotel, closing for twelve months. The lender’s first term sheet of 3 March Draft offered US$18.0m at 7.5%. Its revised term sheet of 2 May Proposed offers US$16.5m at 6.75% over 15 years, with a 12-month moratorium during which interest is added to the loan, and a covenant that earnings cover debt service at least 1.20 times.

Neither term sheet binds the company. The revised sheet replaces nothing; it is the lender’s current proposal.

3The facts relied on

StatementStatusSource
Refurbishment cost of US$19.2mReportedContractor’s estimate, 14 April; not a fixed price
Sponsor equity of US$3.0mCommittedShareholder letter, 20 April; not yet received
Planning consentExecutedPermit issued 11 February
Lender’s credit approvalReportedStated by the lender’s officer on a call; not in writing
Occupancy of 55%, 62%, then 68%ModelledManagement’s plan, against 61% before closure

4Sources and uses

Uses: refurbishment US$19.2m. Sources: loan US$16.5m and sponsor equity US$3.0m, a total of US$19.5m. The margin for cost overruns is US$0.3m, under 2% of cost. Interest added to the loan during the moratorium, about US$1.15m, is not drawn in cash; repayments begin on a balance of US$17.65m.

5Options

  1. Accept the revised terms as offered. The base case breaches the covenant in the first year of trading.
  2. Seek a 24-month moratorium. Removes payments in the first year of trading, but adds US$1.2m of interest to the loan and lowers cover in every later year.
  3. Accept the terms with conditions. Covenant testing from the second year of trading, a reserve funded by the sponsor, and a fixed-price contract.
  4. Do not proceed this year. The hotel continues to trade unrefurbished; its position against newer competitors is likely to weaken.

6The downside

On the lender’s terms, earnings cover debt service 0.91 times in the first year of trading, 1.22 the next and 1.49 thereafter. If the hotel opens six months late and occupancy runs ten points below plan, cover is 0.18, 0.81 and 1.07 in those years and settles at 1.19: the loan is paid, but the covenant is never met. The sponsor would have to find US$2.6m to cover the shortfalls, against US$0.8m in the base case.

A 24-month moratorium does not cure this. In the same downside, cover settles at 1.06, because the interest added to the loan raises every later payment.

7Recommendation

Option 3. Negotiate on the revised terms, provided that:

  • the lender agrees in writing that the covenant is first tested in the second year of trading;
  • the sponsor funds a debt-service reserve of US$2.6m, in cleared funds, before the first drawdown;
  • the refurbishment is let on a fixed-price contract with a completion date and damages for delay.

If the sponsor cannot fund the reserve, management recommends option 4.

8What would change this recommendation

  • A fixed price materially above US$19.2m, which would exhaust the contingency.
  • Written credit approval on different terms from the term sheet.
  • Forward bookings that support, or contradict, the occupancy assumed.

The labels used

Executed Proposed Draft Reported Modelled describe evidence; Committed describes the state money has reached. Each is defined in the glossary.

Papers a board can decide on.

The firm prepares board papers, proposals and memoranda in the client’s name, with the evidence labelled and the downside in plain view.