Reading Your Facility Letter

A facility letter — a letter of offer, in some banks — is what arrives after the credit desk has said yes. It is not the term sheet you negotiated on; that was indicative, and bound nobody. This is the approval written out as an offer, and your signature turns it into a contract. Most letters are short because they lean on a separate booklet of general terms incorporated by reference: the letter holds what is particular to you, the booklet holds what applies to everyone, and the two together are the agreement. Read both. The clause that surprises a borrower at the worst moment is usually in the booklet.

The order below is the order most letters run in: what, for how long, at what price, against what, on what conditions, measured how, and what happens if the measurement fails. How Banks Approve Business Loans is the process the letter came out of.

Each facility is listed with a limit and a purpose. The limit is obvious; the purpose clause is the one borrowers skip, and the desk does not. It says what the money is for — working capital, the purchase of a named asset, a development — and using it for something else is a breach even if every payment is made. The desk cares because the purpose is how it matched the debt to the need: a line for a gap that closes, a term loan for something bought once. A working capital line drawn to buy a machine is the purpose clause failing quietly. Where several facilities sit under one limit, the letter will say how they share it — a sub-limit for guarantees inside a trade line, say — and that arithmetic is worth checking against what you actually intend to use.

Three different things can sit under this heading, and they behave very differently. A term is a date: the facility runs to it and is repaid or refinanced at it, on a schedule the letter sets out — level instalments, a residual balloon, interest-only for a period. An annual review is a promise to look again: the facility continues if the review is satisfactory, and the letter will usually say the bank may vary the terms at it. Repayable on demand is neither — the bank may call the facility at any time without a breach to point to, and almost every overdraft is written this way. Two facilities with the same product name can be committed at one bank and on demand at another. Find the words, not the label. A revolving line will also carry its clean-down here: the period each year in which the balance must return to zero, which is the bank's test that the line is doing what its purpose clause says.

The margin is where the desk's view of your risk is printed, and How Banks Price a Business Loan shows how it got there. Some letters carry a margin ratchet — the margin steps down as leverage falls, or up as it rises — which is worth reading twice, because it makes the covenant definitions in section 07 decide your interest bill as well as your compliance. Pricing and Fees compares the whole cost at the way you will actually use the money, which is the only comparison that means anything.

The letter lists what the bank will hold: a general security agreement over the company's assets, a mortgage over property, specific charges over named equipment, guarantees from the owners or from related companies. Two clauses here reach further than they look. All obligations means the security stands behind everything you owe the bank now or later, not only the facility in this letter. Cross-collateralisation means security given by one entity in a group stands behind another's borrowing. Neither is unusual, and neither is something to discover after signing. What Your Bank Holds as Security takes each instrument in turn, and Personal Guarantees is the one clause in the letter that reaches into your own life, and the one most worth negotiating a cap on before you sign.

Conditions precedent are what must happen before you can draw: signed security documents, a valuation the bank has instructed, evidence of insurance with the bank noted, a certificate from the directors, sometimes a capital injection or a subordination from a shareholder who has lent the company money. The list is the credit approval turned into a to-do list, and the drawdown waits on the last item — so read it against your own timetable, because a valuation that takes three weeks is three weeks you do not have the money. Conditions subsequent are the same idea with a deadline after drawdown: the bank has lent on the promise that something will be done within a set period. Diarise them. Missing one is a breach that no payment history repairs.

Three kinds sit here. Financial covenants are the tests — cover, leverage, sometimes a minimum equity or a maximum capital spend — and the letter prints both the level and the definition. Borrowers argue the level and sign the definition; the definition is where the covenant actually lives, because what counts as EBITDA, and what counts as debt service, decides where the line bites. Loan Covenants, Explained is the whole of that argument. Information undertakings are the covenants about telling rather than performing: management accounts within a set number of days of month end, a compliance certificate each quarter, annual accounts each year, at the level of assurance the letter names. The Monthly Pack is what those undertakings look like in practice. Negative undertakings are the things you agree not to do without consent: borrow elsewhere, give security to anyone else, pay distributions above a level, sell assets outside the ordinary course, change ownership. These are the clauses a growing business trips on by accident — a new equipment lease, a dividend, a shareholder loan — and each one is a call to the bank before, not after.

The default clause lists what lets the bank act: non-payment, a covenant breach, a false statement, insolvency, a default under another lender's facility — cross default — a change of control, and usually a material adverse change in your position as the bank judges it. What the bank may then do is in the booklet: stop further drawings, reprice, demand repayment, enforce the security. In practice a desk does almost none of that on a first breach; what actually happens is a conversation, a waiver, and a file that has changed lanes. But the clause gives the bank the right, and the right is what shapes the conversation. Some letters distinguish a review event from an event of default: a review event obliges the two of you to talk and lets the bank vary the terms — and in many letters, if you cannot agree, require repayment after a notice period; a default lets it act at once. For anything outside your control — a change in a customer, a regulatory shift — a review event is the better clause to be under, and it is negotiable.

Negotiate the definitions before the numbers; the headroom between the covenant level and your own forecast, so that an ordinary bad quarter is not a breach; a cap and a scope on any personal guarantee; a review event rather than a default for events outside your control; the fee on the undrawn part of a line you do not expect to draw; a cure period before a covenant breach becomes a default; and the information undertakings, so the days-after-month-end match what your accountant can actually deliver. Do not spend the meeting on the base rate, which the bank does not control, or on the security package as a whole, which the desk will not approve the facility without. And do it now: after signing, every change is an amendment the desk has to re-approve, and the answer to a request that could have been made at the term sheet is slower and less generous than it would have been then. Preparing an Application is the stage at which most of this is decided.