Unfair bank covenant ??

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#1
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We have a client who operates as a C Corp (fiscal year, formed over 100 years ago), has minimal corporate debt with a local bank (say $150k). They also have an LLC that owns the real estate for their operating company that has a pretty big mortgage. Let's say the properties are worth $3.5 million but the mortgage is $2.9 million.

The C Corp pays rents that cover the mortgage payment and the real estate taxes but there is very little cushion.

Bank requires us to have Debt Service Coverage of 1.15 to 1.0 at the C Corp level but we need to include the LLC debt in the equation. We are also allowed to include the LLC operating income into our equation. But since the LLC is basically a 1.0 to 1.0 coverage that hurts us with the bank covenant.

The bank also factors in unfinanced Cap ex into the equation that always hurts us.

Is there some better formula I can sell the bank on. I have asked to just exclude Cap ex but they say they need to factor it in. Shareholders take decent salaries and C Corp shows small profits or small losses. Should I be able to factor in Shareholder salaries into the equation
 

#2
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I've dealt with these a couple times, and the bank's numbers seem very normal to me... running the entities on a consolidated basis, EBDA minus cap ex and principal payments. You definitely cannot factor shareholder salaries in; part of the purpose of these ratios is to prevent the shareholders from taking salaries out and stiffing the bank in a bankruptcy.

Is the problem the debt service coverage ratio, or is the real problem the underlying profitability of the business, or a client that can't let money sit in their checking account?
 

#3
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"a client that can't let money sit in their checking account?"

You hit the nail on the head. Company should be very profitable but the owner loves to spend. The bank already has a clause on the shareholder's salary. Every local non profit goes to this company to hit them up for donations/advertising as they know he can not say no. And if there is $$$ in the check book, he is looking to get his next project under way.

In a way, I think the bank having a tight leash on him helps keep him in line but it is frustrating to keep missing the covenants.
 

#4
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BerkshireTemp wrote:"a client that can't let money sit in their checking account?"

You hit the nail on the head. Company should be very profitable but the owner loves to spend. The bank already has a clause on the shareholder's salary. Every local non profit goes to this company to hit them up for donations/advertising as they know he can not say no. And if there is $$$ in the check book, he is looking to get his next project under way.

In a way, I think the bank having a tight leash on him helps keep him in line but it is frustrating to keep missing the covenants.


If a bank writes a loan covenant but doesn't enforce it, does it actually exist?

The client has a huge risk if he continues to do things the way he always has. Sure, the bank isn't doing anything on the covenant right now, but they're probably overreacting to the good times as much as they will overreact to the bad times. It will not last forever and the client needs to be put in line (even if he doesn't want it).

You might have some risk as well, perhaps in a pointless lawsuit, but definitely on your relationship if the bank finally calls the loan and the client gets mad at everybody but himself.
 

#5
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Northern MI and Coastal SC
As missingdonut said, work to protect yourself. My largest client had to violate bank covenants due to a hurricane. We approached the bank and asked if they could do a temporary waiver, which they did, but I also made sure it was included in the minutes from the financial board meetings that they were in violation of the covenants, the bank had temporarily issued a waiver, and we needed to work toward coming into compliance. Eventually we did, but it was still a CYA effort since things so quickly turn litigious in this society.

I am not surprised by any of the covenants you mentioned. I have seen them among various companies, though I was not battling an owner or owners that wanted to spend every dollar they had available or take on more debt.
 


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