Dollar Bank - Business Center - Covenants

Loan Covenants

Loan agreements between banks and their business borrowing customers generally contain covenants which require that the borrower do certain things ("affirmative convenants") and not do others ("negative covenants") during the term of the loan agreement.

Maintain adequate insurance.
• Furnish financial statements quarterly and annually.
• Do not merge with or acquire another company.
• Do not allow other liens on company assets.

• Maintain a current ratio of not less than 1.5 to 1.
• Maintain tangible net worth in excess of $500,000.
• Maintain a ratio of total liabilities to tangible net worth of no greater than 3 to 1.

Covenant requirements by be extensive depending upon the amount and term of the loan and the credit standing of the borrower.

Most banks will monitor compliance with the loan covenants on a quarterly basis with the receipt of quarterly and annual financial statements. Sometimes the bank will require a periodic certification by a corporate officer or independent accountant that no covenant violation has occurred (Compliance Certificate).

• Waive the provisions of the violated covenant for a certain period of time. This waiver period generally lasts for up to one year at which time the covenant would be in full force and effect again; or Amend the covenant so that the borrower will not be in continuing violation.
• Demand a cure of the violation within a certain period of time. The cure period is specified in the loan agreement between the borrower and the bank, and generally runs from 10 to 30 days. Sometimes, however, no cure period is permitted with respect to certain covenants.
• If the violation has not been cured by compliance, waiver or amendment, or if no cure period is permitted, the bank may declare that an event of default has occurred and demand payment of the loan.

Bank loan covenants should not interfere with a company's normal operations if drafted properly. It is incumbent upon the bank and its borrower to come to mutually agreeable covenant that each can live with for the length of the loan agreement.

• Be certain that financial covenants, those that test for specific ratios or absolute numbers, are not so restrictive as to hinder your normal operations.
• Prepare forecasts (best and worst cases) to determine if compliance can be assured. Allow for seasonal fluctuations that may cause temporary violations (e.g. leverage may be higher during certain times of the year because of high inventories and consequent higher payables or line of credit borrowings).
• Review your covenants when financial statements are prepared to determine if any violations may have occurred.
• When contemplating major actions, such as a large capital expenditure or an acquisition, make sure that no covenants will be violated because of those actions.
• Keep your banker advised as to covenant violations, potential or actual, and try to work out remedies. This cooperative attitude tells your banker that you are as concerned about the violations as they are.