The Bank in Your Audit File

A business that borrows has a lender, and the lender holds half of what an audit needs to know about its debt: the balances, the limits, the dates, the security, the undertakings the business signed, and the letters that pass between the two when something goes wrong. An audit trainee meets the bank in the first week — a confirmation request to send, a facility letter to read, a covenant to check — and keeps meeting it for the rest of a career: in the classification of a loan, in the going-concern note, in the events after the balance date that decide whether the accounts can still be signed.

This page is the bank's side of each of those meetings, written by someone who has sat on it. It does not describe how to audit; it describes what the bank is holding, what it is willing to say and why, so that what comes back from it can be read for what it is. The same documents, read the lender's way, are worked in one-minute files on the Groundwork's assurance square.

A confirmation request arrives at the bank under the client's authority, and the bank answers it from its own records, not from the client's. That is the whole value of the exercise, and it is why the bank's answer covers more than the form asks: every account and its balance at the date; every facility with its limit, what is drawn and what is not; the security the bank holds and the charges registered behind it; guarantees the bank has given on the client's behalf — to a landlord, a supplier, a customs authority — which sit nowhere in the client's own books until they are called; guarantees the client has given to the bank for someone else's debt; and any right of set-off between accounts.

Differences between the two sides are normal and informative. A cheque in transit, a payment that cleared on the first of the month, a foreign currency facility stated in dollars on one side and the currency on the other — those reconcile. A guarantee the client did not mention, a facility in a subsidiary's name that is cross-guaranteed by the parent, a limit the client thinks is still there and the bank has cancelled — those are findings. The bank that answers only the balances it was asked about has confirmed nothing the client did not already know.

WORK IT · THE CONFIRMATION → · A BANK GUARANTEE, READ THE BANK'S WAY → · TERMS · Bank guarantee vs letter of credit

The facility letter is the contract, and an audit reads it for four things: the limit and what it is for; the expiry and repayment profile, which decide where the debt sits on the balance sheet; the covenants, with their definitions; and the events of default, which decide what the lender may do and when. The definitions matter more than they look. A leverage covenant is tested on EBITDA as the agreement defines it — often with add-backs capped, leases treated one way rather than another, and a frozen version of the accounting standards — so a business can be inside its covenant on its accounts and outside it on the bank's definition, or the reverse. The compliance certificate the client sends the bank each quarter is where that arithmetic lives, and it is in the bank's file.

Two clauses an audit should always find. A review clause, under which the bank can call the facility on review or on demand whatever the covenants say — in many frameworks the reason an overdraft is current however long it has been there. And the reporting undertakings: monthly or quarterly accounts, a budget before the year, the audited accounts within a set number of months. A business that is late on those has told the bank something before any number moved, and the bank's file will show it.

READING YOUR FACILITY LETTER → · LOAN COVENANTS EXPLAINED → · TERMS · Covenant headroom · Event of default · Hardcore overdraft

Around the middle of December the bank's phone rings with a particular request: a borrower is in breach of a covenant, or about to be, on a loan that is not due for years, and it would like a waiver letter — dated, please, before the thirty-first. The date is the point. A loan in breach gives the lender a right to demand repayment, and in many accounting frameworks a loan the lender could call is shown as due within a year unless the lender had already waived the breach at the balance date. Without the letter, long-term debt becomes current, working capital turns negative on paper, and the going-concern note has to say why. With it, nothing moves.

The bank reads the request as what it is: not a formality, but a request to change the shape of the accounts. So it reads the breach first — how large, why, whether the forecast cures it — and decides what the waiver is worth and on what conditions: a fee, a reset of the covenant, a tighter reporting undertaking, a step in the margin. What comes back is one of three documents, and they are not the same. A waiver gives up the right for a stated breach and period. An amendment resets the covenant itself. A reservation of rights letter does neither: it records that the bank knows, is not acting yet, and keeps every right it has — and it changes nothing about what the loan is on the balance sheet.

WORK IT · THE WAIVER → · WHEN THE BANK SAYS NO → · TERMS · Covenant waiver · Reservation of rights

When a business's accounts rest on a facility that expires inside the next year, the audit wants to know whether the facility will be there, and the question arrives at the bank as a request for a letter. What the bank can write is narrower than what is hoped for. A statement that it will renew is a lending decision; the committee that makes it has not met, and a relationship manager who promises it has promised something that is not theirs to give. What the bank can say, and usually will, is what is true: the facilities and their limits, the expiry dates, that the account is operating within its terms, that the annual review is on its normal timetable, and that no decision has been taken.

Read that letter for exactly what it contains. "No current intention to withdraw" is a statement about today. "The review is scheduled for March" tells you when the decision will exist. Neither is a commitment, and an auditor who treats them as one has moved the bank's decision into the audit file where it does not belong. What tells you more is the bank's behaviour: whether it asked for a weekly cash forecast, whether the account has moved to a different team, whether the last review came with new conditions. A bank that has started watching a borrower closely rarely says so in a letter; it says so in what it asks for.

WORK IT · THE LETTER → · AUDITED, REVIEWED OR COMPILED → · PROBLEM LOANS AND WORKOUT → · TERMS · Going concern · Watch list

What the bank holds as security is on a public register in most countries, and the audit reads it for the assets pledged, the charges that rank ahead of unsecured creditors, and the guarantees that bind one company in a group to another's debt. A general security agreement over all present and future assets is the usual form for a trading business; a specific charge over land or a vehicle sits beside it; a supplier's retention of title or a lessor's registered interest can rank ahead of the bank on the goods it covers. Cross-guarantees inside a group are the ones most often missed on the client's side: a subsidiary with no debt of its own can be liable for the whole group's, and its accounts should say so.

Personal guarantees from directors and shareholders are in the bank's file and rarely in the company's accounts, which is correct — they are the guarantor's liability — but they change what the bank is lending against, and they are the reason a business that looks unsecured on its own balance sheet is not unsecured to its lender.

WHAT YOUR BANK HOLDS AS SECURITY → · PERSONAL GUARANTEES → · TERMS · General security agreement · Negative pledge · Subordination

Between the balance date and the day the accounts are signed, the bank is often the first to know the thing that matters most: a facility not renewed, a breach discovered at the review, a demand made, a guarantee called. A lost facility goes straight to going concern; a breach discovered after year-end may say something about the balance sheet at year-end. The bank will not volunteer these to an auditor it has not been asked by, but it will answer a second confirmation at the signing date, and the question to ask it is simple: has anything changed since the first one.

WORK IT · THE LOST FACILITY →

Loans from shareholders, drawings against the business, and money moving between related companies are read on both sides of the file, for opposite reasons. The audit reads them for disclosure and for whether they are at arm's length. The bank reads them for what they do to the cash: a shareholder loan it has required to be subordinated is capital in all but name, and the bank will not let it be repaid ahead of its own debt; drawings that rise faster than the business — the 65% in two years that turned a family's succession into a question — are the first sign that the owners are consuming the business before the bank is told.

ISSUE 03 · THE DRAWINGS LINE → · THE ACCOUNTANT'S CHAIR → · TERMS · Related-party transactions

The audit reads a year that has ended. The bank reads the year that has not happened: whether the cash will cover the debt if the next twelve months are bad, what the monthly pack since the balance date says, whether the covenants hold on its own definitions. It reads cash before profit, because cash has no accounting policies, and it reads the footnotes as a set rather than one at a time, because that is where a year is assembled. That reading is the subject of the rest of this site, and the road from one side of the file to the other is the most-travelled road into commercial banking: From Audit to a Credit Desk. One file shows the two readings side by side — Issue 07, where an unqualified opinion and a lender's read of the same three notes reach different places — and it now has a chair for the partner who signed.

ISSUE 07 · QUALITY OF EARNINGS → · THE AUDIT PARTNER'S CHAIR → · TERMS · Quality of earnings