How to Review & Negotiate Loan Covenants to Avoid Covenant Breaches?

Loan covenants are clauses in loan agreements that require the borrowers to do or not do certain things. Positive or affirmative covenants are the things that the borrowers must do during the loan term, such as paying taxes, maintaining collateral and insurance, providing audited statements, and others. Negative or restrictive covenants place limitations on the things borrowers can do, depending on their risk level. Here you will know how to review loan covenants and negotiate them to avoid breaches.

Covenant Analysis to Review Loan Covenants

Whether negative or positive, loan covenants are often associated with financial ratios and benchmarks. There are numerous ratios, metrics, and benchmarks that lenders may use to assess a borrower’s performance. Covenant analysis helps monitor these financial debt ratios and benchmarks to help lenders and borrowers address issues early on. This analysis also helps maintain a bonding capacity and ensure that the borrower stays compliant with the loan covenants. 

The ratios to be measured include numerous matters of liquidity, efficiency, leverage, and profitability. Research and analytic specialists may decide to analyse and test these monthly, quarterly, or yearly, depending on the loan agreement.

The Right Time to Negotiate Loan Covenants

The best thing a borrower can do is read the loan terms and conditions carefully before signing the agreement. If possible, send the agreement to a legal counsel for proper review. Ensure that everything, including the interest rate, loan maturity, and other terms look pretty good. If the loan terms and conditions seem to give unusual control to the lender over the borrower’s assets, it’s time to negotiate the loan covenants with the lender. 

Weigh the benefits of financing against the chance to lose control. What will happen if the borrower’s finances see a downturn? Will the lender prevent or impede a recovery based on the loan covenant breach? Every borrower must go through this covenant analysis process and negotiate if needed. The best time to negotiate loan covenants is before signing the agreement, not after a breach. Lenders also need to analyse the borrower’s performance so that they are not taken by surprise later.

How to Negotiate Loan Covenants?

Remember, breaching loan covenants can have devastating effects on your finances. Therefore, it is crucial to negotiate loan covenants to avoid a breach. 

  • Do Proper Research: Based on your research and analysis, identify any hidden expenses and negotiate them with the lender. The research will also help the borrowers to compare and find the right financial institution with favourable covenants. Set a target in mind before starting the conversation.

  • Speak Responsibly: Using loan-related terminology will demonstrate your confidence and give you an edge while negotiating. Such terms include financial covenants, loan tenure, upfront costs, balloon payment charges, loan-to-value ratio, etc. 

  • Focus on Prepayment Charges: Most lenders charge a fee if you repay your loan before the loan term ends. This is because they have to bear a loss due to reduced interest collection from you as a borrower. Negotiating prepayment charges will give you flexibility during times of dynamic interest rates. 

 

As long as you have a high credit score and valuable collateral, you can negotiate the loan covenants with the lenders, including the interest rate, processing fees, annual fee, commission, prepayment charges, etc. Since negotiating loan covenants needs research and relevant knowledge, a professional knowledge partner can give you an edge over others. Compare lenders, read the covenants carefully, and negotiate according to your repayment capacity.



Comments

You must be logged in to post a comment.

About Author
Recent Articles
May 9, 2022, 5:59 PM shulamite grace s
May 9, 2022, 5:41 PM Chauhan Bhavin
May 6, 2022, 5:53 PM Muhammad Guslahn