This article appeared in the April 2020 issue of MiMfg Magazine. Read the full issue and find past issues online.
As businesses assess their financial future amid this current crisis, they should consider taking advantage of local, state and federal aid programs. However, it’s critical to take a close look at existing lending relationships and agreements first.
While the federal government is requesting banks be creative in order to help their clients during this unprecedented time, businesses should consider their existing contractual agreements and covenants. Many loan agreements have restrictions against taking on additional debt or encumbering collateral without the existing lender’s authorization.
Here’s what you need to know about your existing lending relationships and agreements — and how to best position your business to maximize the available assistance programs.
Working with your business advisor can make a big difference. Banks often simply respond better to a trusted independent third-party. It’s smart to turn to a trusted business adviser who has experience working with lenders in these circumstances — this person understands the language lenders speak, the information they need for their regulatory requirements and the reality of the proposed potential solutions.
Understanding different loan violations can be key. For a company with an asset-based revolving loan, these sorts of volatile financial circumstances can create either an out-of-formula violation or an over-formula violation.
- Out-of-formula violation: This kind of violation occurs when the existing loan balance, which was within the formulaic agreement previously, suddenly no longer is within the bounds of that formula because of some change in the collateral base. For example, most loans require accounts receivable be less than 90 days past due in order to be eligible to be included in the calculation of potential availability. Looking forward, it is likely that a business’ customers may be slow to pay. This could lead to becoming in-eligible and as a result, even though the company does not increase the amount that is has borrowed, it is now out-of-formula.
- Over-formula violation: This type of violation occurs when the company writes checks and attempts to advance more money than the availability formula allows. This can happen in these circumstances as companies are pressured to write checks and do so hoping deposits will come in to cover them before the checks clear. Many companies attempt to play the float and can be caught over-formula when sudden disruptions in the economy take place.
Banks may offer remedies. If you’ve considered your financing and lending covenants, or calculations of eligible collateral to support, and have determined that they currently are in violation, or expect to be in violation of the future, there are several potential remedies to consider.
Keep in mind that such help may be delayed given the high number of companies expected to find themselves in this situation. Remedies include the following:
- Waivers of covenants: Banks can simply waive the requirements for certain covenants. For example, lenders typically have the authority to waive the requirement of submitting reviewed financial statements within 90 days. In these cases, when a lender is contacted proactively, the greater the chances that requirements are waived and defaults are avoided.
- Over-formula agreements: Lenders also can approve temporary formula violation allowances, which typically are called over-formula agreements. This allows a company to borrow a certain amount of money over what is supported by the collateral for a temporary period. The company then can get through a temporary liquidity problem.
Additional help is available. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) provides stimulus funding and emergency assistance to both individuals and businesses that have been impacted by the virus. Learn more about how your business can benefit from this Act and listen to informative audiocasts on the CARES Act and other business continuity and preparedness topics at rehmann.com/covid-19.
Rehmann is an MMA Premium Associate Member and has been an MMA member company since July 2006. Visit online: rehmann.com.