Cash Flow

The Basics of Lending and Loan Covenants

In business, trust is important, but insurance is essential. When your business needs to borrow, you want to know you can trust your lender and that you understand its expectations for when and how you will repay the loan.

Loan covenants act as that insurance. By agreeing to a loan covenant, both sides state their intentions: The borrower promises to stay financially sound for the term of the loan, and the lender outlines its expectations for the borrower’s debt and capital as the loan is paid back.

Before you take out a loan, here are a few things you should know about loan covenants so you can establish your business as a reliable lending partner.

Covenants can protect your business—so long as you understand them

“By and large, covenants are really designed to protect the earning assets of the borrower,” says Dev Strischek, senior vice president and senior credit policy officer at SunTrust Bank.

Generally speaking, Strischek says loan covenants either require a borrower to do something or prohibit the borrower from doing something. Also they come in two kinds: quantitative and qualitative. 

A quantitative loan covenant might require a borrower to maintain a certain debt-to-worth ratio, a measure of equity in the business compared to outstanding debt. Or it might stipulate that a borrower cannot exceed a certain debt-to-worth. It also might require the borrower to maintain a certain ratio of cash to total assets.

A qualitative loan covenant, on the other hand, might require the borrower to provide financial statements within 10 days of the close of each quarter. Or it may say that the borrower cannot incur additional debt from another lender without the prior consent of the bank.

“One way or another, they’re there to make sure that the borrower doesn’t sell off his equipment—as an example—that he needs in order to make his product or provide his services,” Strischek says. “They’re designed to keep the borrower out of trouble.”

Communication makes covenants more effective for you

Violating a loan covenant can result in the borrower being penalized or the bank calling the borrower’s loan into default.

It’s not always negligence on behalf of a business that results in a covenant being violated.  Sometimes a covenant may be tripped by unforeseen events, such as a flood that necessitates a large expenditure to get the business back to normal, a snowstorm that prevents product from being shipped or other unexpected costs that cause a shutdown or interruption in the company’s operations.

Another common pitfall occurs when a company grows quickly, causing its debt-to-worth ratio to be skewed since it may be buying lots of new product or incurring hefty salary or wage expenses. “Sometimes it’s just growing so fast that it sort of outstrips the covenant,” Strischek says. 

In those instances,and depending on the circumstances, lenders tend to be flexible. For example, in the event of a fast-growing business, a banker might be inclined to overlook a covenant violation in lieu of the prospect of having a “bigger, more profitable company to work with.”

That’s why it’s critical to keep in close contact with the bank if you think a covenant might be breached.

Strischek says banks tend to set quarterly rather than monthly covenants to give the borrower time to get his or her financial house in order. Also, he says, depending on the circumstances, banks tend to set covenants high enough so the borrower has some room to breathe.

In many ways, loan covenants allow both parties to have a clear understanding about the rules of the road related to borrowing. After all, it’s in the best interest of both the bank and your business that a loan repayment is consistent and easy.

As Strischek puts it, a loan covenant acts much like the rumble strips on the side of a highway, ensuring that the driver knows what’s considered in and out of bounds. “Covenants are like those strips—they wake you up before you get yourself into trouble.” 

This content does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.


Investment and Insurance Products:

Are Not FDIC or any other Government Agency Insured   Are Not Bank Guaranteed  May Lose Value 

© 2018 SunTrust Banks, Inc

equal housing logoSunTrust Bank is an Equal Housing Lender. Member FDIC

equal housing logoEqual Housing Lender. SunTrust Mortgage, Inc

SunTrust, SunTrust Mortgage, SunTrust PortfolioView, SunTrust Robinson Humphrey, SunTrust Premier Program, AMC Pinnacle, AMC Premier, Access 3, Signature Advantage Brokerage, Custom Choice Loan and SunTrust SummitView are federally registered service marks of SunTrust Banks, Inc. All other trademarks are the property of their respective owners.

Services provided by the following affiliates of SunTrust Banks, Inc.: Banking products and services are provided by SunTrust Bank, Member FDIC. Trust and investment management services are provided by SunTrust Bank, SunTrust Delaware Trust Company and SunTrust Banks Trust Company (Cayman) Limited. Securities, brokerage accounts and insurance (including annuities) are offered by SunTrust Investment Services, Inc., a SEC registered broker-dealer, member FINRA, SIPC, and a licensed insurance agency. Investment advisory services are offered by SunTrust Advisory Services, Inc., a SEC registered adviser. GFO Advisory Services, LLC is a SEC registered investment adviser that provides investment advisory services to a group of private investment funds and other non-investment advisory services to affiliates. Mortgage products and services are provided by SunTrust Mortgage, Inc.

SunTrust Mortgage, Inc. - NMLS #2915, 901 Semmes Avenue, Richmond, VA 23224, 1-800-634-7928. CA: licensed by the Department of Business Oversight under the California Residential Mortgage Lending Act, IL: Illinois Residential Mortgage Licensee #MB-989, Department of Financial and Professional Regulation, 100 W. Randolph, Suite 900, Chicago, IL 60601, 1-888-473-4858, MA: Mortgage Lender license #-ML-2915, NJ: Mortgage Banker License - New Jersey Department of Banking and Insurance, NY: Licensed Mortgage Banker—NYS Department of Financial Services, and RI: Rhode Island Licensed Lender.

"SunTrust Advisors" may be officers and/or associated persons of the following affiliates of SunTrust Banks, Inc.: SunTrust Bank, our commercial bank, which provides banking, trust and asset management services; SunTrust Investment Services, Inc., a registered broker-dealer, which is a member of FINRA and SIPC, and a licensed insurance agency, and which provides securities, annuities and life insurance products; SunTrust Advisory Services, Inc., a SEC registered investment adviser which provides Investment Advisory services.

SunTrust Private Wealth Management, International Wealth Management, Business Owner Specialty Group, Sports and Entertainment Group, and Legal and Medical Specialty Groups and GenSpring are marketing names used by SunTrust Bank, SunTrust Banks Trust Company (Cayman) Limited, SunTrust Delaware Trust Company, SunTrust Investment Services, Inc., and SunTrust Advisory Services, Inc.

SunTrust Bank and its affiliates do not accept fiduciary responsibility for all banking and investment account types offered. Please consult with your SunTrust representative to determine whether SunTrust and its affiliates have agreed to accept fiduciary responsibility for your account(s) and if you have completed the documentation necessary to establish a fiduciary relationship with SunTrust Bank or an affiliate. Additional information regarding account types and important disclosures may be found at

SunTrust Robinson Humphrey is the trade name for the corporate and investment banking services of SunTrust Banks, Inc. and its subsidiaries, including SunTrust Robinson Humphrey, Inc., member FINRA and SIPC.