While a host of automation products have dramatically improved the treasury toolkit in recent years, important gaps remain. At a time when a debt covenant violation could plunge a company into a possibly fatal liquidity crisis, the tools for monitoring covenant compliance and getting alerts in time to avoid catastrophes are still primitive. Help is on the way, but don't expect a slick, automated solution anytime soon. For now, most treasurers get by with the venerable spreadsheet. "We do all of our covenant compliance work, including sensitivity and scenario analysis, in Excel," reports Rick Moss, treasurer of highly leveraged HanesBrands Inc., Winston-Salem, N.C. "We take financial planning information from the budgeting/forecasting group and dump it into the spreadsheet file. After that, we do our own 'worst-case scenario' work to see how much cushion we have before we are likely to breach key covenants."
It works after a fashion. A treasurer or CFO should be able to look at an executive dashboard and see at a glance if covenant problems are looming, but that's rarely the case, reports consultant Craig Jeffery, managing director of Strategic Treasurer LLC, Atlanta. "Most companies still have a ways to go" to manage covenant compliance proactively, he says.
The problem is that no one system has all the relevant data, Jeffery says. "You have to extract the performance indicators from various systems. Some markers, like cash-flow metrics, may be readily available in a treasury workstation. Others, like fixed charge coverage, may be downloaded from an ERP [enterprise resource planning] system and reported through a treasury system. Still others, like minimum tangible net worth or inventory measures, may not be so easy to funnel into a report."
Getting the performance numbers isn't even the biggest problem, says James R. Simpson, managing partner of Corporate Finance Solutions LLC, Stamford, Conn. Covenants are embedded in loan agreements, dense legal documents that often run hundreds of pages. The covenants can be extracted and put into a clear checklist on a few pages, but that's not something computer software can do well. And it's not something that busy treasury staffs often can find time to do. And while it would seem that metrics like net income and EBITDA (earnings before interest, taxes, depreciation and amortization) are standard accounting terms, in fact the applicable definitions often are negotiated and vary from loan agreement to loan agreement.
So Simpson has fashioned a line of business in his consulting practice to help companies distill covenants and track compliance. "We write the Cliff's Notes to loan agreements," he says. "The guts of the process is rolling up your sleeves, reading through the loan documents, understanding them and extracting covenant compliance into a checklist that supports timely decisions." Simpson leaves clients with a paper checklist and a customized spreadsheet model. If clients throw their real or forecasted numbers up against their covenants, the model will show them actual or prospective violations.
He has a satisfied customer in Al Gever, CFO and treasurer of $200 million Smart Balance Corp., the Paramus, N.J., maker of buttery spreads and other food products for the health conscious. "I have a small support staff and our credit agreement runs more than 300 pages," he says. "I can't say the service spared us a covenant violation, but it allowed us to move forward with growth plans and make timely decisions confident that we wouldn't get tripped up by an inadvertent violation"
The test of whether a financial covenant has been violated usually comes from financial reporting at the end of reporting periods, but the most useful compliance information comes before those numbers become final and create a violation, Simpson says. That means getting trend numbers from financial, sales and operations systems before accounting close, when there is still time to avoid a violation or at least negotiate with the bank before the violation occurs. And don't overlook non-financial covenants, he cautions. "You could simply dispose of some excess equipment, like selling a couple of forklifts, and inadvertently violate a covenant and jeopardize a credit facility," he says.
What Simpson offers is far from a mass solution or even an economical one unless you compare the cost of the project to the cost of violating a covenant. Even banks don't have automated solutions for detecting covenant violations from the required reports but leave detection and enforcement up to the individual loan officers, Simpson explains.
While treasury workstations do not offer a plug-and-play application for covenant compliance, they can be useful, insists Andrew Woods, group vice president for global treasury solutions at SunGard/AvantGard. Debt modules are most useful for recording trades, interest-rate events and mark-to-market valuations for publicly traded bonds, but risk management modules can help monitor some bank debt covenants, he says.
"We concentrate on the financial covenants like minimum tangible net worth, borrowing ratios and minimum interest coverage because we have or can get the numbers. We don't pay attention to non-financial covenants such as asset disposal restrictions," Woods says.
But first the covenants themselves have to be set up in the system by treasury staff, which can be a manual, time-consuming process. Once the risk management module of a high-end system like SunGard's Quantum has the covenants and the numbers, it can issue dashboard alerts that, for example, warn the company that it is $10 million from breaching Covenant A or 2 percent from breaching Covenant B. It works, but first you have to build it, he explains.
Some bank relationship management packages also offer partial solutions. "We can help a company track covenants and set up a process for periodic signoff on the covenants, but the actual calculations usually are done on a spreadsheet," says Glen Solimine, CEO of Speranza Systems, which offers Speranza Command Center. "It's a nice idea to have all compliance metrics flow to one source of truth, but sometimes the view is just not worth the climb," he says.
But treasurers and CFOs are putting a higher premium on visibility these days, and not having to view a covenant crash can be worth a lot. For Simpson, the sales climb remains steep. "Most treasurers, CFOs and controllers think they know their loan agreements and are not enthusiastic about paying someone to do a lot of grunt work," he says. "But a covenant violation in this unforgiving market can be very expensive."