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The Risk of Violating Debt Covenants

Healthcare practices have faced unexpected economic challenges thanks in part to COVID-19. This unstable financial environment has made it tough for many providers to meet their debt covenants. But the consequences could be more than defaulting on current loans; you could put future borrowing ability in jeopardy as well.

The bank’s authority over your loan doesn’t end with approval. Lenders often impose conditions that the borrower must meet throughout the life of the loan. These conditions, or debt covenants, can specify actions to be carried out or thresholds to maintain.

The point of debt covenants is to protect lenders from excessive financial loss. If a debt covenant is violated by the borrower, the lender is usually able to call the loan due before subsequent months of unpaid installments accumulate or the borrower defaults.

There are usually two types of debt covenants:

  • Affirmative covenants require the borrower to do something specific, such as supply the lender with regular financial statements, maintain proper books or have a certain level of insurance policy coverage in effect. These are meant to keep the borrower in good financial condition, thereby increasing the chances they’ll pay off the loan successfully.
  • Negative covenants make borrowers avoid activities that could negatively impact their credit rating or ability to make payments. For example, lenders commonly require a minimum debt ratio (your total debt compared to your total assets), a days-cash-on-hand ratio (having enough cash accessible to last a set number of days) or limits on distributions to owners.

If you don’t meet your debt covenants, lenders can take any number of actions. They might require you to bring in a financial advisor to monitor your affairs. They could call the loan due before you even miss a payment.  And of course, your credit or bond rating could be downgraded—making it more difficult for you to get a loan in the future.

Ideally, you’re paying attention to your finances and will know whether you’re in jeopardy of violating debt covenants. But there are other, more subtle indicators that you could be headed for trouble. For example, if you’ve got low patient volume, that means less money is coming into the practice.

You might also be experiencing staffing shortages, inoperable medical equipment, and supply chain disruptions. These keep you from having the personnel, equipment and materials needed to care for your patients. And in the case of staffing shortages, practices relying on personnel services companies to fill those gaps are facing even higher payroll costs.

So how can you avoid this trap of debt covenants? Stay on top of your finances. This starts with using a healthcare CPA who understands the business side of your practice. They’ll help you make sure your accounting practices are sound and your processes are efficient. They can also perform a revenue cycle enhancement study to make sure you’re not leaving uncollected money on the table.

Getting a loan is tough as it is; the last thing you want to do is make it more difficult. So make sure you’re aware of your debt covenants. And ask your CPA for help if you’re concerned about your ability to honor them.

 

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.