For borrowers with business/commercial loans over $1 million, you may be familiar with Annual Reviews.
For those borrowers with business/commercial loans under $1 million or only home and residential loans, you may not have come across this term because Annual Reviews and covenant monitoring generally no longer applies to borrowers with business loan exposures less than $1 million due to the Australian Securities & Investments Commission (ASIC) changing their definition of “unfair fair contract terms” in relation to small business loans in 2018.
However, it may be handy to know a little about Annual Reviews as your circumstances may change and you may find yourself subject to the same.
So, what is an Annual Review and what does an annual review exercise entail? We go into a brief explanation below.
What is an Annual Review?
In a nutshell, an Annual Review (‘AR’) is a yearly review of your commercial loan facilities and financial statements undertaken by your lender and lender’s representative (‘Banker’). Whilst this exercise can in some circumstances be signed off by your banker, generally speaking the lender’s credit department will need to sign-off on the AR to ensure you are meeting your mandated loan conditions and covenants. This process can sometimes be akin to applying for your loans all over again.
Depending on the outcome of the AR, your lender may decide to:
- Renew your facilities until the next AR is due i.e. in a year’s time;
- They may decide to closely monitor your business’ performance and loan conduct more regularly, by implementing monthly, quarterly or half-yearly monitoring.
- This can happen in circumstances where there has been a breach of your loan conditions and/or covenants;
- The lender may have detected a deteriorating trend within your business’ financial statements;
- In some extreme circumstances, the lender may decide that they would like their facilities paid back immediately or within a defined timeframe earlier than that which was initially agreed to.
- This can happen in circumstances where there has been a severe or recurrent breach of your loan conditions and/or covenants;
- The lender may have detected a recurring deteriorating trend within your business’ financial statements that does not appear to be manageable;
- The relationship between you and the lender may have broken down beyond repair.
What does an Annual Review Entail?
During an Annual Review, the lender will be analysing your financial statements, including (but not limited to) the following:
- Profit & Loss and Balance Sheet;
- Business Tax Returns;
- Integrated ATO Portals – this shows the lender whether you owe anything to the Australian Tax Office (ATO);
- Directors Individual Tax Returns and Notices of Assessment – this demonstrates to the lender that you have lodged your tax returns;
- Cash Flow Forecast;
- Aged Debtors / Creditors Listings – if you are a trading business, this shows the lender how much you owe your suppliers (and other creditors) and how much your customers owe you;
- Updated tenancy schedules and leases – if you are a property investor, this shows the lender if there have been any material changes, vacancies or rent reductions within your portfolio.
They will also be analysing your financial statements to measure the health of your business by calculating certain financial ratios such as (but not limited to) the following:
- Working capital ratios – which give the lender an idea as to the health of your cash flow;
- Interest Cover Ratio (ICR) – which tell the lender how much Interest your business can afford to pay versus the income it generates;
- Debt Service Cover Ratio (DSCR) – which gives the lender an idea as to how much in Principal & Interest repayments your business can manage versus the income it generates;
If your loans were offered subject to your financials meeting the above financial covenants to a certain level, the lender and their credit department will be looking to ensure that you have met these covenants. Not meeting these covenants may mean that you are in breach of your loan conditions which can result in a default.
Other conditions that may also be tested during an AR can be non-financial, such as (but not limited to the following):
- Periodical valuations of the security properties being used as collateral for your commercial facilities – if the valuations come in lower than the condition stipulates, you may be asked to remedy this situation by paying down some debt and/or providing an additional property as security;
- Minimum Weighted Average Lease Expiry (WALE) – this is generally a requirement for financed property portfolios and not trading businesses. The WALE (also known as Weighted Average Lease Term (WALT) depending on the lender) indicates the average expiry period of leases within a commercial property portfolio and gives an indication of current and future rental income;
- Maintaining certain insurances such as Key Person Insurance.
Breaches of your loan covenants are treated seriously, and whilst not all breaches result in a default notice being issued, they can result in more onerous monitoring which will mean that you have to submit financial information to, or comply with other requests for information from your lender more frequently resulting in more time spent on administration and potentially more money spent on accounting as generally your accountant will need to assist with the preparation of financial statements.
What can You Do to Prepare for an Annual Review?
Whilst the numbers are the numbers and there may not be much you can do once your financial statements are lodged, there are things you can do to prepare for an AR that may help you identify areas of concern and mitigate them before your lender picks them up. Here are some ways you can prepare for your AR:
- Sit down with your accountant and broker once your draft financial statements are ready and have your commercial loan letter of offer handy so that you can go through the financial covenants and other conditions together;
- Prepare a covering letter for your lender to accompany all the documents they have requested for the AR and flag any concerns you think they may raise and provide mitigants for each concern accompanied by evidence as to why this is not a major risk;
- Prepare a Cash Flow Forecast. Whilst this may not always be necessary, it may help to give your lender comfort as to how your business is likely to trade through the forecasted period and how it intends on meeting the mandated covenants.
Which Behaviours Lenders Like
- Honesty – this goes without saying, be honest about your business’ situation and your lender may be more inclined to assist you;
- Financial Veracity – financial statements without errors and cash flow forecasts that are based on robust assumptions will instil more confidence in your lender that you know how to run your business and that your information is reliable.
- Proactiveness and cooperativeness – this shows lenders that you are committed to meeting your financial obligations and are on the front foot when it comes to your obligations, be they financial and/or reporting;
- Timely delivery of the required information – often ARs need to be completed within a defined period of time and if your AR is not completed within this timeframe, this can create unnecessary pressure and attention for your file;
Which Behaviours Lenders Dislike
- Dishonesty, lack of integrity and respect;
- Inaccurate information;
- Tardiness in providing information;
- Being unhelpful, unresponsive or evasive.
We have firsthand experience in seeing the above behaviours making or braking a banking relationship and be the difference between the lender being more likely to assist a borrower in hardship (where the correct behaviours are exhibited), versus the lender calling in their debt and not willing to work through a tough situation due to lack of borrower cooperation.
Whilst sometimes onerous, an Annual Review can be beneficial for the borrower as it is providing information as to the general health of the business (albeit on an historic and sensitised level). Good bankers and brokers will also provide some insight into your business’ performance and where improvements can be made from a finance perspective.
How We Can Help You with this Process
- You give us authority to speak to your accountant directly and they send us the same information you would provide your lender;
- We coordinate a time to sit with you and your accountant to understand your business and its financial performance;
- We then package up all the information requested by your lender accompanied by a report that we prepare on your behalf analysing your business’ financials and performance according to your mandated loan covenants and conditions;
- We manage this whole process with your lender so as to alleviate you of the pressure associated with an Annual Review and/or more frequent monitoring requirements, so that you can concentrate on running your business.
The benefit in having us manage this process for you is that we do all the leg work for you. In most cases, we will identify areas of concern and bring them to your attention prior to the lender picking them up. This gives you a chance to explain the situation so that we can then present this to the lender in a way that may make them more comfortable than identifying potential risks without the benefit of commentary.
If you feel that you may benefit from this service, please contact us now to discuss your specific circumstances, as Annual Review requirements change from lender to lender and borrower to borrower. The above is just a brief explanation of what an Annual Review is and entails, but we hope it helps to provide some insight into this process.
Disclaimer: The information provided herein is for general information purposes only and does not constitute specific advice. It should not be relied upon for the purposes of entering into any legal or financial commitments. Specific advice should be obtained from a suitably qualified professional before adopting any investment/financial strategy.