DSCR and Loan Covenant Question - 6 unit multifamily
Hello, I am buying a 6 unit property. I recently received an LOI from a bank for a commercial loan which states that I have to have a global cash flow ratio of 1.25x and a subject property or borrowing entity cash flow ratio of 1.15x.

I am not worried about the global cash flow ratio as we make more than enough W2 income. However, I have a few questions about the 1.15x ratio:

**1) What happens if I fall below this ratio? Will the bank recall the entire loan? Does this impact my credit score?**

**2) Do they even check the ratio if I can make the monthly payments? Our global cash flow will be close 3-4x of the debt service.**

**3) How do they track and verify expenses? And income? Can I just increase the borrowing entity cash flow by paying expenses directly or signing a lease with myself?**

**4) Does CapEx affect the 1.15x? For context, I think upon stabilization and rent increases my property ratio will be 1.2x. However, in year 1, it may be lower as we have to turn the units.**

I have done several residential multifamily loans, but this is my first commercial multifamily loan so really appreciate your help. If anything else I should know about the risks I am taking, that'd be great.
[{"id": "i3gn9t3", "text": "CA Mortgage Broker here. \n\n1) Varies by lender. Usually lenders put verbiage in the loan docs that have a needs list that are acceptable in case of lower than desired ratios. \n\n2) Again, depends. But usually based on your relationship with the lender they will ask for quarterly or semi-annual statements to verify liquidity and debt service. \n\n3) It gets tricky here but depends how deep they want to dig into this. Usually if you\u2019re current on your payments and nothing substantial stands out it will be a non-issue with most lenders.  YMMV. \n\n4) It does, but as long as the lender is aware of it they can account for it via various strategies including higher interest rate or construction holdback during the duration of rehab until units are back up-to market rents.", "replies": [{"id": "i3hi6bi", "text": "East coast borrower and concur across the board, especially about the relationship aspect. It\u2019s actually pretty wild the way some lenders start forgetting to ask for quarterlies, which then becomes twice yearly, then yearly, then not until it\u2019s time to refi.\n\nETA so long as the payment is made", "replies": [], "depth": 2}], "depth": 1}, {"id": "i3hurjs", "text": "I've only gotten 1 commerical loan (5 unit) from a bank, and my impression was that ratios were just for underwriting and they don't check them afterwards at all. I talked to several lenders for that property and it was same story with  all of them. Its now been 18 months since loan closing and I haven't had any requests from the lender for anyhing. Ymmv. I could imagine on larger properties they actually might request updated financials, but I can't imagine any bank bothering to do so on a 6 unit.", "replies": [], "depth": 1}, {"id": "i3jeuyx", "text": "Commercial lender here.\n\n1) It is extremely unlikely the bank will default on your loan based on a single out of compliance DSCR covenant. All the covenant does is give them a reason to bring you back to the table to discuss what needs to be done, if anything, if you do fall out of compliance and they can create a paper trail for the regulators to show they are maintaining credit quality. If global cash flow is sufficient they will likely note it and move on. \n\n2) If your loan is over a certain threshold they will likely complete an annual review and require you to provide annual financial statements, tax returns, rent rolls, etc. They will then spread the financials and complete an updated cash flow analysis to check covenant compliance. See 1), even if out of compliance it's not an automatic anything.. they will ask questions and figure it out without a default. Highly unlikely they will even ask any questions if you are paying, loan is in good standing, proper ltv, strong global. You may just get a question so they have it on file that the covenant being out of compliance was noted and they reached out.. it's all about papering the file for the regulators. If it continues to be out of compliance year after year you may start to have a problem. \n\nAlso they will reunderwrite when it comes up for renewal if it's a balloon. All of the above applies there as well.. 9 times out of 10 it will get renewed unless something has materially changed.\n\n3) Tax returns, financial statements, rent rolls. Honestly not worth the headache trying to fluff the numbers. Just send them what you got and take the questions if there are any. You already guarantee, no need to sign a lease to yourself that would be redundant. \n\n4) Depends on their definition of DSCR if it includes capex or not. I would look at the promisory note and check the covenant wording. Usually if it's included it is specially spelled out. Typically, DSCR is not inclusive of capex.. that would be a separate ratio known as Fixed Charge Coverage and is typically more of a 1.05:1.00 ratio. I would be surprised if they include capex in their calculation. If anything, when they underwrote they included an estimate \"Reserve for Capital Replacement\" of around $0.15 to $0.50/ square foot taken out of an underwritten NOI to account for ongoing capex. \n\nThe bank knows you need to stabilize. They aren't going to penalize you or shoot themselves in the foot for taking you out of compliance with that knowledge. \n\nOverall, TLDR, not that big of a deal at all. Very standard. They bank will not call the loan in if out of compliance.. the worst is you'll get an email or a phone call from your lender with some questions. If it continues year over year you may see that the loan is downgraded and the bank will try and push you out the door before they ever consider foreclosure.", "replies": [], "depth": 1}, {"id": "i3lam3x", "text": "Thank you everyone for your comments. Super appreciated and extremely helpful!", "replies": [], "depth": 1}]