I’ve been helping middle market clients for some time now (nearly 3 decades) and inevitably, there are some that have tripped bank covenants. My advice to clients is to be upfront and proactive.
Your Banker Doesn't Like Surprises
Bankers like clarity, certainty, and communication. They are trying to manage risk and mitigate risk at the same time. They want to know, “what is the worst-case scenario for their bank portfolio and what does that look like?" Like in many healthy relationships, honesty is the best policy. Your banker (just like you) doesn’t like surprises and will eventually find out everything, so you might as well take action earlier rather than later.
Before contacting your bank, be prepared. I suggest to my clients that they may want to calculate the covenant violation and determine, if possible, when they think they will be back in compliance. Projections may help in this regard and going out two years on a monthly basis will aid in these upcoming discussions. Another approach for a shorter time frame would be to prepare a 13-week cash flow projection. This is a popular report showing where your company is trending in the short run. Next, reach out to your bank and ask for a meeting. By doing this, you will be building trust, credibility, and respect from your banker (I should know, I was a former middle market commercial banker for 15 years).
Keep the Lines of Communication Open
In the meeting with the bank, ask your banker to either waive the covenant for a period of time, at least until you are back in compliance with the covenant. Or, if it is going to be a while (into the next fiscal year), ask your banker to reset the covenant so that the violation doesn’t continually show that you are out of compliance with your bank covenants on your year-end financial statements. Also, set up quarterly meetings with your banker, showing your banker that you have taken this violation seriously. At this time, you can show your banker what you are doing to rectify the situation by providing quarterly financial statements and commentary.
Have a Plan B
It also doesn’t hurt to have a ‘life-line’, meaning that you meet with a few new banks each year in case your current bank decides to have a ‘knee-jerk’ reaction to your covenant violation. Banks have very different credit cultures and some banks continually change their minds as their personnel changes. I also tell my clients that, oftentimes, your relationship with your banker is more important than it is about saving the last dollar on your credit facilities. The times when this is most relevant is when things get tough. Every banker will fall in love with your business when it is doing well, but relationships are tested when there is a downturn in either your business or in the economy.
If you’ve violated a covenant and are having difficulties with your bank, give us a call. We’re happy to help. Sometimes emotions run high and can get in the way of a healthy relationship where communication is supposed to be a two-way street, leading to a positive outcome to get your business back on track.