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Protect Your Trucking Business from Bank Loan Covenants

By 01.24.20September 23rd, 2020No Comments
protect trucking business fro bank loan covenants blog

It’s a good thing that truckers are a tough breed as these are certainly tough times we’re in. During the first half of 2019, approximately 640 trucking companies went bankrupt across North America. According to industry data from Broughton Capital LLC., that’s over three times the number of insolvencies from the same period last year. Until the market loosens, competition will remain high, margins low and difficulty maintaining reliable cash flow will continue, contributing to more bankruptcies. In this volatile environment, banks will use the restrictive nature of bank covenants to limit their exposure to risk, normally to the detriment of the clients they serve.  Any trucking business currently dealing with a bank or planning on doing so should investigate alternative funding sources, such as Factoring Line of Credit to better their financial stability.

Why Use an Alternative Source of Funding?

Banks are self-serving and will act quickly to cut loose any business that represents increasing risk. At the turn of this new decade, banks are extremely nervous by the state of the trucking industry and are monitoring trucking clients very closely. Any sign of your financial statements trending negatively is enough to trigger immediate action with the real possibility of losing your commercial loan. Medium and large trucking fleets need a reliable alternative financial solution to traditional banking in order to secure steady cash flow and position themselves for future growth.

Can a Bank Take Away Your Line of Credit?

Most definitely they can and will if you fail to meet the obligations of your loan agreement. Banks are typically risk averse and are constantly changing their playbook to protect their own interest. Customer loyalty means nothing to your banker if your trucking company’s financial statements are trending in the wrong direction. If the bank sees trouble looming ahead, trucking companies with long-term banking relationships are just as much at risk of losing their commercial loan as any other business. The real danger presents itself when your company trips a banking covenant.

What is a Bank Loan Covenant?

A financial covenant (bank loan covenant) is a set of conditions in a commercial loan that requires the borrower to fulfill certain conditions or which forbids certain actions. The purpose is to restrict the borrower from creating additional risk to the company and more importantly, to the bank. Every loan agreement made between a bank and a trucking company will carry some form of financial covenant to protect the bank’s interest. Loan covenants are generally associated with financial benchmarks of your business performance and are closely monitored by the bank to assure compliance. Loan covenants are tested regularly, and at any time, the bank has the right to demand access to your financials to conduct spot checks. Trucking companies are at risk of suddenly losing their financial backing if a loan covenant is broken and the bank feels their risk exposure has increased. At the beginning of this new decade, banks are feeling very uncomfortable with the state of trucking and are watching trucking companies very closely for this reason.

What are the Typical Loan Covenants Found in Trucking Business Loan Agreements?

Below are some examples of typical loan covenants most likely to be tripped by trucking companies causing the bank to demand loan repayment:

  • Total debt to tangible net worth ratio covenant: This ratio identifies the total value of a company’s assets that can be sold to offset short- and long-term liabilities (debt) should your company become insolvent. If this ratio is too high, indicating not enough assets are available to cover total debt owing, the bank will take action.
  • Debt Service Coverage Ratio: a measurement of the cash flow available to pay current debt obligations due within one year, including interest, principal, and lease payments. If net operating income is too low, the bank will take action.
  • Current Ratio:liquidity ratiothat measures a company’s ability to pay short-term obligations (debt and other payables due within one year). If current assets are not high enough to balance current liabilities, the bank will take action.

Note: numerous other covenants may also be included in your bank loan agreement. Tripping any one covenant is grounds for the bank to terminate the loan agreement and demand repayment of the loan in full.

How Bank Covenants are Calculated

Every loan agreement made between a bank and a trucking company will carry some form of financial covenant to protect the interests of the bank.

Graphic showing how Debt Service Ration, Debt To Net Worth Ration and Current Ration are calculated

Consequences of Debt Covenant Violation

One of the biggest problems with debt covenants is that they get a lot of attention prior to signing a loan agreement, then are quickly forgotten by the borrower the minute the contract is signed. Too often, truck company owners trip a covenant without realizing it happened. Banks on the other hand never forget about the covenants. If you trip a covenant while the bank feels the industry is too volatile for their liking, you will undoubtedly be faced with one of three actions; be sent to special loans, forced to sign a forbearance agreement or receive a notice of foreclosure.

What is Special Loans?

Being sent to special loans is as painful as having the IRS breathing down your neck. Your company is thoroughly audited, the bank increases reporting requirements, the cost of borrowing increases and your credit score goes into a deep dive. It is often the advanced step toward your loan being called in.

What is a Loan Forbearance Agreement?

This is a redefined contract that supersedes the original loan agreement and sets out new conditions providing the borrower more time to repay the loan. A forbearance agreement will force the borrower to give up certain rights or collateral in exchange for additional time. In this circumstance, the bank improves its position to the detriment of the borrower, who has now given up all claims or defense against previous or pending bank actions.

What is a Notice of Foreclosure?

This is the end of the line as far as your relationship with the bank. They have terminated your funding and have demanded repayment of the loan in full, often as quickly as 10 days from date of the notice.

How to Protect Your Company from Restrictive Bank Covenants

The best protection is not to enter into a loan agreement that has restrictive covenant obligations attached. A much better fiscal strategy is to partner, not with a bank but with a financial provider who’s focused on your success. An industry specific financial provider, such as eCapital, has full understanding of how your business works and dedicated services to meet your needs. Factoring Line of Credit is designed specifically for medium to large fleets in need of working capital with the flexibility to grow with your business. Whether you are currently looking for a loan, have an exist line of credit and want out, or have already tripped a covenant, call eCapital today to discover your options.

What to Do if the Bank Forecloses on Your Loan?

Time is of the essence! You will have only a few days to secure new funding and pay off the loan in its entirety, or face financial ruin. Contact eCapital immediately! We will assess your situation, propose a Factoring Line of Credit with flexible terms to match your needs and make the necessary arrangements to buy out your commercial loan.

What is Factoring Line of Credit?

Factoring Line of Credit is the ideal hybrid of a commercial line of credit wrapped in a freight factoring facility. Similar to a commercial line, it provides the ability to access funds as needed and to only pay fees on amounts drawn.

Although it performs much the same as a banking line of credit, it is in fact a factoring facility and is therefore not a loan. It is the selling of accounts receivable invoices to build a cash reserve from which you can draw from.

Factoring Line of Credit was first introduced in 2008 during the credit crisis to provide trucking companies a cost-effective alternative to bank financing. This unique factoring product is easy to qualify for, provides fast access to working capital and removes the danger of the bank losing confidence and suddenly pulling your source of funding.

These are certainly tough times we’re in, make sure your trucking company has the financial stability to ride through the storm. eCapital has the resources and services to get you started on the road to healthy cash flow. All you need is a viable business approach, credit worthy customers and a determination to succeed.

Are you ready to explore your options? Let’s talk! Give us a call at 800.705.1500.