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CASE 1.1 MIDI CAPITAL CANADA, COMMERCIAL

TRANSPORTATION FINANCING DIVISION

It was early morning on April 15 2016, when Steve Brant, assistant account manager for the Commercial Transportation Financing Division of Midi Capital Canada in Toronto, Ontario, Canada, finished reading the morning copy of The Financial Post and began reviewing a loan request for $270,000 submitted by an existing client Simon Carriers Ltd. Simon Carriers, a trucking company, requested the $270,000 loan to purchase two new 2016 Freightliner transport trucks, four new 53-foot trailers and four new mobile satellite systems that would be used to track the location of the transport trucks. Brant had to make a decision on the loan request and forward a report to the senior account manager for approval that afternoon.

MIDI CAPITAL

Midi Capital comprised of 27 diversified businesses, including operations in North America, Latin America, Europe and the Asia-Pacific region, its head office was located in Stanford Connecticut. Midi Diversified, Midi Capitals parent company was a publicly traded corporation with net earnings of over US$15 billion. Midi Capital was a major competitor in every industry it competed in, achieving record net earnings of US$3.6 billion in 2015. It expected each of its divisions to generate a 20% after tax-profit, and if a division fell below the goal of 20 per cent, they would have to justify why profit targets had not been met.

COMMERCIAL TRANSPORTATION FINANCING

Commercial Transportation Financing (CTF) was one of Midi Capitals 27 divisions. The majority of CTFs business was loaning money to medium and large-sized transportation and construction companies. Loans from $30,000 to $1 million were provided to purchase assets such as transport trucks, trailers, paving equipment and heavy machinery.

CTF was under tremendous pressure to generate profits. The selling strategy at CTF was Find, Win, Keep Find new business, Win new business and Keep new and existing clients. As of April 1, 2016, less than one percent of CTFs portfolio of over 2,000 accounts had been lost to bad debt. Account managers for the Southern Ontario Region were expected to generate $14 million in new loans each year, without exposing Midi Capital to unreasonable levels of risk.

Several requirements had to be met before CTF would approve a loan. First, CTF did not deal with any company that had been in business for less than three years. Second, the company applying for the loan had to generate enough cash flow to cover the monthly interest payments on the new loan. Third, the companys debt to equity ratio could be greater than 4:1 when including the new loan. Fourth, CTF would not finance more than 90 per cent of the value of the value of any asset, thereby requiring the company to have enough cash to pay for at least 10 per cent of the assets it wanted to purchase. Lastly, CTF considered the character of the business owners, general economic conditions, and any company assets that could be pledged as collateral as additional factors in the loan request.

THE TRANSPORTATION INDUSTRY IN SOUTHERN ONTARIO

The trucking industry had been very profitable from 1985 to 1988 until a major recession in 1989. During the recession, there was less manufacturing, resulting in fewer goods being shipped by trucking companies. Many trucking companies went bankrupt and those that survived the recession had to lower prices to stay competitive. The industry recovered during a manufacturing boom in the mid 1990s and the amount of freight shipped between Windsor and Toronto was at its highest level ever; however the transportation industry in Southern Ontario was very competitive with thousands of trucking companies competing for business. By the mid 2000s the transportation industry had experienced strong growth, but prices and profits remained low with trucking companies typically generating after tax net incomes of less than 8 per cent of revenues.

With prices low, trucking companies relied on higher volumes of business to generate profits. One way to increase sales volume was to purchase more trucks and trailers and hire additional drivers. For every truck and trailer, a trucking company would typically generate $150,000 to $200,000 in annual sales. However the high cost of purchasing new trucks and equipment required large loans to finance the purchase new assets. Because so many trucking companies borrowed money to expand, it was important to maximize the amount of time a truck was on the road to generating sales, to cover not only operating expenses but also to cover the loan payments.

NEW LEGISLATION

It was mandatory that all vehicles (trucks and trailers) used by the trucking companies meet the safety standards set by the Ministry of Transportation of Ontario (MTO). These standards were enforced on major highways at weight scale stations where all trucks were required to stop for inspections. Effective February 02, 1998 new legislation gave the MTO the right to impound any vehicle (truck or trailer) deemed to have a major defect.[1]

If a critical defect was found during an inspection, the MTO impounded the vehicle for 15 days and the vehicle could not be operated until the equipment had been repaired to meet safety standards. If the same or additional critical defects were found during any subsequent inspection, the MTO impounded the vehicle for 30 days. In addition to impounding the vehicles the MTO also charged fines ranging from $2,000 to $20,000 for equipment that did not pass inspection. Despite the risk of impoundment, thousands of trucks have failed safety inspections annually and the MTO has impounded thousands of trucks from the inception of the program until October, 2015.

SIMON CARRIERS LTD.

Background

William Simon and his wife Mary founded Simon Carriers Ltd. (SCL) in Waterloo Ontario, in the late 1980s. The company began as a one-truck operation hauling freight for a larger trucking company that contracted work to independent truck drivers. William was the driver and mechanic while Mary managed the accounting records. The Simons survived the economic recession of the early 1990s and continued to operate their business as a one-truck operation until late 2013 when they began searching for exclusive hauling contracts.

In March of 2014 SCL signed an exclusive two year contract with a small auto parts manufacturer that supplied the Ford Motor Co. assembly plant in Oakville, Ontario. Ford required its suppliers to make deliveries according to just-in-time inventory schedules, which meant that SCL, would haul multiple trailer loads several days a week.

To accommodate the new contract SCL borrowed $336,000 from Nippissing Credit on April 01, 2014 to finance the purchase of three new transport trucks and three new trailers. The company also hired three new drivers to drive the new trucks. As of December 31, 2014, SCL still owed $189,000 on the loan from Nippissing Credit. SCL paid $7,000 on this loan each month.

The trucking volume generated by the contract continued to increase. In October 2014, SCL sought financing to purchase two new trailers. A loan for $38,400 was arranged through Midi Capital on October 01, 2014, the current balance still owing on the Midi Capital loan was $36,000. CSL paid $800 on this loan each month. The trucking companys financial statements, ratios and sources and uses of cash are shown in Exhibits 1 through 4.

THE NEW CONTRACT

In March 2016, the auto parts manufacturer signed a new supplier contract effective May 01, 2016, with Ford. The new contract reflected a 60 per cent increase in trucking volume. SCLs two-year contract with the auto parts manufacturer expired on March 31, 2016, and had not been renewed. In an effort to reduce its own costs, and because the trucking volume would increase by 60 per cent, the auto parts manufacturer was allowing several trucking companies (including SCL) to bid for the new trucking contract. If SCL hoped to win the new trucking contract, it would need to expand its fleet to accommodate the higher trucking volume and to outbid competing trucking companies.

PROJECTED REQUIREMENTS FOR THE NEW CONTRACT

To expand its fleet, SCL required approximately $300,000. Since SCL was required to pay at least 10 per cent of the cost in cash ($30,000), it requested a $270,000 loan to purchase two new 2016 freightliner transport trucks, four new 53 foot trailers and four new mobile satellite systems. In projecting its income statements for 2016, SCL estimated revenues to be 30 per cent to 60 per cent higher than 2015. Salaries and wages were expected to increase by $60,000 to hire two new drivers and general and administration expenses were expected to increase by $13,000 due to the larger fleet. Additionally, bank charges and interest on the new loan would be $17,300. Depreciation on the new assets would be $30.000. Legal and accounting fees and rent and utilities were expected to remain unchanged from 2015 amounts. The operating expenses for 2016 were expected to remain at the same proportion of sales as they had been in 2015. No other purchases of new assets were expected for 2015. The companys income tax rate was approximately 45 per cent.

In projecting its balance sheets, SCL estimated the value of the new loans to be $270,000 less the monthly payments made between May 2016 and December, 2016[2]. SCL anticipated no changes to the age of receivables or the age of the payables. The company also had a line of credit of up to $50,000 that it had never used. It planned to use $30,000 from this line of credit to make the cash payment required by Midi Capital (10 per cent of the new assets). The Simons had used $50,000 in personal assets to secure the bank line of credit. None of the assets on SCLs current balance sheet were pledged as collateral. The main question for Brant was whether SCL would show a cash surplus on its projected balance sheet. A cash surplus would indicate that SCL would be capable of making the required loan payments, whereas a deficit would indicate that SCL would be incapable of paying back the loan.

Since profits remained low across the industry, the Simons believed that continued growth would ensure their profitability. If SCL lost this contract, the Simons knew it would be difficult to find enough work to keep their fleet working at 100 per cent capacity William and Mary had worked hard to grow their business and had never been late with a loan payment, despite having trailers impounded on two occasions. Mary commented:| We have been through good times and bad and weve expanded before. I feel that this is the right thing to do. We cant afford to stay small.

BRANTS DECISION

The new loan would bring the total of SCLs with Midi Capital to $306,000. Brants report would have to be reviewed by his senior manager since the total loan amount exceeded his account managers credit limit of $200,000. Brant had been with the company for eight months and it was important he made a well thought-out that followed CTFs minimum lending requirements. His report was due in a few hours.

[1] Examples of critical defects included loose or broken lug nuts, cracked wheels, cracked brake rotors, broken steering components, broken suspension components and tires with less than 25 per cent of the tread remaining across any part of the tire.

[2] The monthly principle payment on the new loan would be $5,625