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June 5, 2009

Loan Covenants Tighten Up…how about yours?

Matt G. Lamoreaux in a Journal of Accountancy Article says ‘Loan Covenants Tighten Up‘. Here are his suggestions for what a business should take a look at before talking to their lender. He was joined in the conversation by Sam Thacker of consulting firm Business Finance Solutions.

  • Negotiate and monitor ratios
    • Know what ratios your bank cares about
    • Compare yours to RMA or other industry standards
    • Monitor them closely
  • Prepare to be audited
    • [Linda’s note: Especially if you want the banker to consider an improving 2009 financial statement with a poor performance on the 2008 tax return.]
  • Watch out for positive cashflow covenant
    • Especially if your operating cycle is longer than 90 days
  • Get ready for new rate structures
    • Libor instead of Prime?
  • Be prepared for more stringent guarantees
    • Some banks are requiring owner guarantees of 5% owners, down from 20% owners
  • Know what is typical
    • [Linda’s note: It is hard to negotiate when you do not know what other lenders would require.]

Now is a good time to have a good relationship with your lender, if the lender is in good shape.

  • In what ways are loan covenants tightening up at your lending institution?
  • How flexible are you if the borrower misses a covenant?

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Linda Keith, CPA


Linda Keith CPA is an expert in credit risk readiness and credit analysis. She trains banks and credit unions throughout the United States, both in-house and in open-enrollment sessions, on Tax Return and Financial Statement Analysis.
She is in the trenches with lenders, analysts and underwriters helping them say "yes" to good loans.
Creator of the Tax Return Analysis Virtual Classroom at www.LendersOnlineTraining.com, she speaks at banking associations on risk management, lending and director finance topics.

  • Having spent 15 years in the banking industry making commercial loans, I can say that I have never seen as tough a period as the last two years. It goes without saying that any prospective borrower should read every one of the loan docs (BEFORE SIGNING) and understand potential covenants that may be placed on them. There are a number of ways to negotiate the actual ratio or the number of months out of compliance before the loan is in technical default. Most importantly when faced with a new loan that has covenants turn to your trusted advisor (CPA, Attorney, Financial adviser) to help you better understand them.

  • Great point, Sam. I am thinking a lot of businesses are just happy to be finding credit at all, right now. Reality is that in some ways, a very strong business is in a better position to negotiate than ever.

    The bankers are looking for good loans to make. Why not push a bit on negotiating less stringent covenants if you are a strong borrower?

    It does not hurt to ask. I bought a used kayak this weekend and luckily, talked to my cousin Glennis on the way. It was listed on Craigslist and she said, “Offer $50 less. Just do it.” That was a 10% savings, I asked, and got it.

    Business borrowers that are in good shape should stay very conservative in what they promise. And if a lender can stretch, they should. It is very frustrating to have a loan rated because the borrower missed a covenant when they borrower is still very solid.

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