The last several years have been filled with news about banks clamping down on their borrowers. While it is easy to understand that this means increased scrutiny as borrowers go through the initial loan approval process, it may not be so obvious that many banks have become very strict in the arrangement and enforcement of loan covenants. Breaching a loan covenant can have a devastating effect on any business.
The Master Loan Agreement typically contains detailed covenants that, if not fulfilled, could constitute a breach in the Agreement. If the bank determines there was a breach in the covenants, and therefore an “Event of Default” has occurred, the bank has the right to “accelerate” the repayment of the indebtedness and require repayment immediately. Their ability to enforce this right and the resulting impact could devastate a business.
Understanding your own specific Master Loan Agreement is important to knowing the special loan conditions, covenants, and requirements that your bank is watching for as you provide them with the information they periodically request.
While each bank has different lending criteria there are some covenants that appear frequently included in the Master Loan Agreement. Examples of these include:
- Requirement to provide monthly internal financial statements and/or CPA prepared financial statements that have been compiled, reviewed or audited (often this requirement has a time limit such as “by the 20th of the following month or within 120 days of year-end)
- The bank can require that capital expenditures over a certain dollar amount be approved by the bank prior to purchase.
- Owner draws or officer salaries are subject to limitations or bank approval.
- Requirement to maintain certain insurance policies to insure the collateral.
- The bank can reserve the right to grant or deny approval prior to selling any part of the business, disposing of substantial equipment, obtain credit or loans from other lenders or become a guarantor.
Managing your relationship with your bank is critical to helping you in future negotiations with the bank. Reading and understanding the loan covenants will allow you to create a proactive system to monitor progress on all financial loan covenants and better prepare you for renegotiation of the covenants when the loan needs to be renewed or refinanced. Creating an overview listing of the loan covenants that your or your accounting staff can regularly monitor will help you stay on top of any potential breeches of loan covenants.
In today’s tight credit environment it is critical that your business stay on top of all covenant issues. If you ever find yourself in the unfortunate position of being in breech of your loan covenants, or knowing that you are soon going to trigger a breech, it is important that you come up with a plan to discuss this with you bank as soon as possible. Your CPA can help you come up with a proactive plan that you can present to the bank to avoid the unnecessarily surprised and alarmed banker. Given enough warning, most banks can absorb many potential breeches of covenants. If the breech does occur, your bank will have had ample opportunity to evaluate the impact of the breech, and hopefully come up with a plan to help your business navigate past the breech.
Pursuant to IRS Circular 230, the Internal Revenue Service requires us to inform you that any tax advice included herein is not intended or written to be used, and it cannot be used by any taxpayer for the purpose of avoiding penalties that may be imposed by the IRS on the taxpayer. That said, please do not hesitate to contact us if you have any further questions regarding this matter.