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Why businesses are looking closer at lender-imposed restrictions

By |  January 1, 2021
Chris Fletcher

Fletcher

In response to a business- and life-altering pandemic, companies across every industry are changing how they operate. One area where companies are operating differently is how they look at and use financing.

In the mining industry, financing equipment has always been part of normal business operations. Large conveyors, heavy machinery, crushing equipment and countless other items are typically acquired via financing or lease agreements. But in 2021, companies are taking a much closer look at their financing and leasing deals.

In a world where everything can change on a news headline, companies are opting to keep their own cash as liquid as possible. One place they can greatly affect future cash liquidity is within the fine print of financing and leasing contracts.

In short, there are several common covenants in loan or lease agreements that most lenders utilize to limit their risk. While these covenants indeed limit lender risk, they can severely limit borrower flexibility.

Considerations to make

Money and calculator_StockImage: An aggregate business is now allowed to fully write off the entire cost of new purchases, utilizing 100 percent bonus depreciation. Photo: iStock.com/Wara1982

In a world where everything can change on a news headline, companies are opting to keep their own cash as liquid as possible. Photo: iStock.com/Wara1982

Here are three common lending restrictions aggregate producers should pay close attention to, as most lenders will seek to include them on even a small equipment loan or lease.

1. Blanket liens. A blanket lien is exactly what it sounds like: a lender will put a lien on all a borrowing company’s assets. In other words, every building, every vehicle, every piece of equipment – it will all be subject to a lien. Even assets a company owns outright, and future assets, as well.

To give a quick example, let’s assume a producer finances a new piece of machinery through a bank. The bank puts a blanket lien on all of the company’s assets. A year later, the company wishes to sell a dump truck they’ve owned outright for a decade. But, because of the blanket lien, they cannot sell it – not even privately – without the bank’s permission, which may or may not be granted. This is applicable to every other tangible company asset.

2. Minimum balances. Banks will insist that borrowing businesses keep a minimum balance with them. This minimum balance is usually 80 percent of the loan. This ties up a significant amount of the company’s cash, and calls into question how much the bank really loaned them (because 80 percent of the loan has to be kept in the bank).

In the past, this restriction was often unnoticed by a borrowing company, because they typically borrow money from a bank they already have accounts with. But the fact remains that it is a significant restriction and will limit a company’s options, as they will not be able to switch banks or dip too deeply into cash reserves for an emergency.

3. Annual loan requalification. Almost all banks will include fine-print language on any loan that allows them to review a borrower’s creditworthiness annually. And if a borrower falls short of the accepted threshold, the bank has the right to call in the entire loan immediately.

This can severely hurt a company, as a poor year (or even a poor quarter) can lead to a large loan being unexpectedly called in years before the term dictates. And as just stated, because 80 percent of that loan is already in the bank and cannot be moved, this clause is quite easy to enforce.

Even if the company’s finances remain strong, this clause is still quite restricting. For example, if a company wishes to sell or merge, a new buyer may not be enamored being held to this restriction. Nobody wants a loan called in early.

The bottom line

Companies have always used financing to maintain their cash reserves. But the pandemic caused companies to look much harder at staying as financially flexible as possible. This means not tying up assets and funds in restrictive lending clauses.

Many lenders have been slow to respond to this changing business dynamic. Covenants like blanket liens have been a part of bank lending for decades, and the bank is often one of the last institutions to respond to societal change (i.e., how long did it take banks to realize we wanted them open past 3 p.m.)?

Still, by paying more attention to these covenants and asking banks about them – as well as seeking out non-bank lenders who do not utilize these covenants – business borrowers are poised to change the lending industry. 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 Crest Capital, an equipment financer for small and medium-sized companies.


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