How the changing landscape of bank covenants could impact your manufacturing business

By Darin Styles, CPA

Over the past several months, we’ve noticed a trend that’s affected some of our manufacturing clients: Traditional lenders are becoming less flexible on bank covenants—i.e., the conditions included within a loan agreement. This is especially true for large banks, and it’s spelling trouble for manufacturers who struggle with inconsistent cash flow.

In fact, we’ve seen a number of our clients have their debt called or refused renewal because they fell out of compliance with one or more covenants. Interestingly enough, not one of them had missed a loan payment.

Whereas in the past banks may have been willing to work with borrowers who fail a certain compliance metric for a quarter or two, they seemingly are less able to do so.

If you’re financing with a very large bank, here are a few things to consider.

Understand your loan agreements and maintain transparency with your banker.

Now more than ever, it’s important to stay in compliance with your bank covenants. This starts with making sure you fully understand your loan agreements—and the metrics, dollar amounts, ratios, and conditions you must meet each quarter or year.

If you’re concerned about a potential compliance violation, let your banker know as soon as possible. Traditionally, transparency has gone a long way toward compelling lenders to work with borrowers, although this may no longer be the case.

Key steps to stay ahead of compliance issues

• Regularly review your loan agreements to stay informed of all covenant requirements.
• Monitor key financial indicators like cash flow and debt ratios to proactively detect potential violations.
• Maintain communication with your lender to keep them updated on your financial position and any anticipated challenges.

Know your options for alternative financing.

If you haven’t already, it may be prudent to explore other funding options. A couple to consider:

Asset-based lending

Asset-based lending (ABL) offers financing that’s secured by business assets, such as inventory, equipment, and receivables. While covenants still play a role in ABL, they tend to be more flexible than those required by traditional banks. These loans typically carry a higher interest rate than traditional bank loans, yet are usually lower than credit cards and payday loans.

That said, ABL may not be the right choice for manufacturers who don’t have the necessary collateral (typically inventory and equipment). In these situations, ABL financing is secured by the manufacturer’s receivables, which could incur a higher level of lender scrutiny.

Community banks

More often than not, a community bank will provide the same financial services as larger institutions—but with more flexibility. Because community banks don’t have a national corporate presence, they aren’t beholden to the same rigid rules and regulations when it comes to loan agreements.

Another benefit: Community bankers tend to focus on building personal relationships with business owners. This can be particularly valuable if you need customized loan terms or additional financial guidance.

Don’t be caught off guard.

No one wants to be surprised by a lender calling their debt. If you’re financing with a large national bank and haven’t recently reviewed your loan agreements, consider doing so as soon as possible. Knowing where you stand—and keeping your banker in the know as well—can help you stay in front of any compliance issues.

How to protect your business from an unexpected loan termination

• Assess your current financing terms and identify any potential risks.
• Explore alternative lending options now to avoid last-minute financial stress.
• Work proactively with your lender to address concerns before they escalate.

Given the recent trend, it may be wise to take a look at your alternative financing options so you can pivot quickly if needed. If you’d like a referral to an ABL or community bank lender, the Abdo team can help. We can assess your situation and connect you with someone in our network who may be a good fit.

Need help navigating bank covenants?

Manufacturers are facing stricter bank covenants and shifting loan conditions. Abdo can help you evaluate business loan rates, assess alternative lending options, and position your company for long-term financial stability.

For guidance on your financial strategy, contact us today.