Why Businesses Are Taking a Closer Look at Lender Restrictions
In response to a pandemic that is disrupting business and life, companies across all industries are changing the way they operate. One area where businesses operate differently is the way they view and use finance.
In the mining industry, equipment financing has always been a part of normal business operations. Large conveyors, heavy machinery, crushing equipment and countless other items are usually acquired through finance or lease contracts. But in 2021, companies are taking a closer look at their finance and leasing agreements.
In a world where all may change on a topical headline, companies choose to keep their own cash as liquid as possible. One place where they can greatly affect future cash flow is in the fine print of finance and leasing contracts.
In short, there are several common covenants in loan or rental agreements that most lenders use to limit their risk. While these covenants effectively limit the risk of the lender, they can significantly limit the flexibility of the borrower.
Considerations to be made
Here are three common lending restrictions that aggregate producers should pay close attention to, as most lenders will seek to include them even on a small loan or rental of equipment.
1. General privileges. A general lien is exactly what it sounds like: A lender will put a lien on all the assets of a borrowing company. In other words, every building, every vehicle, every piece of equipment – all of this will be subject to a lien. Even the assets that a company fully owns, and future assets as well.
To give a quick example, suppose a producer finances a new machine through a bank. The bank places a global lien on all of the company’s assets. A year later, the company wants to sell a dump truck that it has owned for a decade. But, due to the general lien, they cannot sell it – not even privately – without the permission of the bank, which may or may not be granted. This applies to all other tangible assets of the business.
2. Minimum balances. Banks will insist that corporate borrowers keep a minimum balance with them. This minimum balance is usually 80 percent of the loan. This ties up a significant portion of the company’s liquidity and calls into question how much the bank really loaned (because 80 percent of the loan must be kept in the bank).
In the past, this restriction often went unnoticed by a corporate borrower, as it typically borrowed money from a bank it owned. already have accounts with. But the fact remains that this is a significant restriction and will limit a company’s options, as it won’t be able to change banks or dip too deeply into cash reserves in the event of a situation. emergency.
3. Annual loan requalification. Almost all banks will include fine print on any loan that allows them to review a borrower’s creditworthiness each year. And if a borrower does not meet the accepted threshold, the bank has the right to immediately recall the entire loan.
This can seriously hurt a business, as a bad year (or even a bad quarter) can lead to an unexpected call for a large loan years before maturity. And like I just said, because 80 percent of this loan is already banked and cannot be moved, this clause is fairly easy to apply.
Even if the company’s finances remain solid, this clause remains quite restrictive. For example, if a business wants to sell or merge, a new buyer may not be attracted to this restriction. Anybody wants a loan called in advance.
The bottom line
Businesses have always relied on financing to maintain their cash reserves. But the pandemic has made companies look a lot harder to stay as financially flexible as possible. This means not tie up assets and funds in loan covenants.
Many lenders have been slow to respond to these changing business dynamics. Commitments such as general liens have been part of bank lending for decades, and the bank is often one of the last institutions to respond to societal changes (i.e., how long has it taken banks to realize that we wanted them to open after 3 p.m.)?
Yet by paying more attention to these covenants and asking banks about them – as well as looking for non-bank lenders who don’t use these covenants – commercial borrowers are set to change the industry. credit. Maintaining financial flexibility for future emergencies is too important to be limited by the fine print.
Chris Fletcher is Vice President of National Accounts for Capital of the ridge, equipment financier for small and medium-sized enterprises.