Do You Need a Bank-Covenant Waiver? - On the Numbers
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SECTION: On the Numbers

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Do You Need a Bank-Covenant Waiver?

By Garry Bartecki

Article Date: 01-01-2010
Copyright(C) 2010 Associated Equipment Distributors. All Rights Reserved.

Don’t kiss 2009 goodbye just yet – there’s work to be done with the auditors, and the sooner you get it done, the better.

Hopefully you were able to take advantage of the tax benefits available to you in 2009. If you haven't, you still have time to review the 2009 results to see if there are opportunities there you may have missed.

Here are a few other ‘09-related matters to contend with:

  • Get your insurance policy audits completed ASAP because you probably have refunds coming. While you are doing this, check your sales and payroll estimates for 2010 insurance purposes and see if they need adjusting. No sense paying premiums you don't need to pay.
  • Your annual audit (or whatever level of reporting you do) needs to get finished up sooner rather than later. The annual audit will differ from past years because this year your industry has a bull's eye on it. From an audit and risk assessment standpoint, auditors put all dealers into the same risk pool, meaning they plan to do more work on these types of audits to reduce their risk going forward.
  • Bank issues need to get resolved before the auditors can complete their work. If you need a covenant violation waiver, it may take some time to get this negotiated and agreed to.
Getting this work done quickly gives you the opportunity and time to work through issues with the auditors and still meet your filing deadlines. It also allows you to file for tax refunds sooner.

Not much has changed on the tax and audit issues – auditors will spend more time on your AR, question the value of inventory, look very closely at your bank arrangements and contracts and will ask you how they are doing to determine if the company will still be in existence in December of 2010.

Bank covenant waivers need some discussion because in years past they were somewhat easy to get. But that landscape has changed, as you would expect, requiring more negotiation on your part. You need to understand what type of covenant violation you have and what you can do to correct it. Some can be fixed easily while others may not be fixable, thus requiring the lending institution to change the covenant language and parameters if they care to do so.

Bank covenants cover income statements issues, balance sheet issues and general issues. Income statement violations are thus period related and refer to expenses incurred in excess of a covenant stated amount, salaries or owner distributions in excess of covenant limitations, EBITDA requirements or other such stated limitations. Since income statement issues are period related, they can usually be remedied by asking for the waiver. As long as operating results have not been jeopardized because of these violations you will normally be able to work out the waiver with the bank. If spending inhibited your ability to pay the bank, they may ask the owner to contribute the excess expense back to the company. If you have an EBITDA issue, that is more serious because this calculation somewhat determines if the company can fund the bank's interest and principal payments.

Balance sheet covenant violations are much tougher to fix. They normally deal with balance sheet leverage ratios that can require material amounts of cash or other funding changes to put you back into compliance. And getting a waiver for the current year really does not mean much, since you are out of compliance on the first day of the new year unless a new workable agreement has been reached between the company and the bank. In these cases, you really need the waiver for the current year end and the following year to allow the auditor to avoid reclassifying your bank debt to 100 percent current status or issuing a “going concern” opinion, which questions your ability to stay in business for the following year.

In addition to the financial aspects of both the income statement and balance sheet covenant requirements, you also have your GAAP requirements and quarterly reporting schedule. With all the recent changes in GAAP there is a risk of reporting on a non-GAAP basis if you report on a quarterly basis. Consequently, it is important to ensure GAAP compliance for each quarter you report, or you may find yourself out of compliance because you only book the GAAP changes at year-end.

Banks now have more compliance issues to contend with, which means you do also. Help them and yourself out by getting your house in order and meeting your timing and covenant requirements. First order of business is to review the bank loan docs and covenant requirements. If you are out of compliance, ask for the waiver and negotiate to a conclusion before you have an issue with your auditor.

By the way, elections are coming up. Do your homework and vote for people who will listen to you.

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