As credit tightens and the cost of finance increases, many business owners are finding it more difficult to meet loan repayment schedules.
They may come into contact for the first time with a department in their bank that is responsible for ensuring the credit worthiness of the bank's lending portfolio. This department is often known as the "bad bank", and its job is to keep borrowers on the straight and narrow.
Meetings with the "bad bank" are set to become more common as lenders review their lending criteria and credit policies, which arguably have become lax in recent years.
Most business owners are aware of the difficulties they can get into by overdrawing or missing scheduled repayments, and take steps to avoid such monetary defaults. However, there are also more subtle, non-monetary defaults that can take business owners by surprise.
Lenders often attach financial and reporting covenants to loans in order to monitor ongoing credit worthiness. For example, they may require that EBITDA be greater than the interest payable by a certain multiple (known as 'interest cover'); that the business maintain Net Tangible Assets greater than a set amount (NTA backing); or that audited or management accounts are regularly lodged with the bank.
In good times, a breach of these types of covenants is often waived in the absence of a monetary default, but in tougher times they are likely to attract lender action. These actions could include:
- Increasing the pricing of facilities
- Charging review or extension fees
- Increasing the frequency of reporting required
- Requiring additional security or making bulk loan reductions
- Cancelling facility limits
- Demanding repayment of facilities
- Imposing timeframes to refinance
- Appointing receivers.
It may not always be possible to avoid breaching a covenant but there are a few key steps that can be taken to lessen the surprise:
- Incorporate financial covenants into budgets and management reporting
- Regularly review lending requirements and shop around for availability and pricing
- Review lending facilities following any significant change in business circumstances
- Be conservative in negotiation of facilities - under-promise and over-deliver where possible.
One of the best ways a business can make sure it stays within its borrowing limits is to take control of its finances with cash flow forecasting and budgeting systems.
With a slowing economy and high interest rates, trading conditions are becoming more difficult for business owners and they will need new approaches to keep their business healthy.
Andrew Needham is a director with accountants and business and financial advisers, HLB Mann Judd Sydney.