Article by Roger Schlueter
The Negative Pledge of Assets in Commercial Lending is a sometimes hard concept to understand. It is actually a very easy concept. The Negative Pledge is used in situations where the Borrower has Assets that are Unencumbered and that are Not Being Used as Collateral for that Particular Loan. The Bank is making a Loan on other Assets and wants these Assets to remain unencumbered – meaning the bank does not want the borrower to get a loan and use the assets as collateral for any loan.
So the Negative Pledge is saying that the Borrower will not Pledge this Asset to any Loan – the Asset will remain Unencumbered. The Bank usually uses this for a Customer that is in very good financial shape and that does not want to tie up all their assets on one or more loans.
Example:
Business has Total Assets of $3,100,000 in the following Assets: Cash $100,000, Accounts Receivable of $500,000, Inventory of $1,000,000, and Real Estate of $1,500,000. This Business has Total Liabilities of $700,000 made up of Accounts Payable of $200,000, and a Real Estate Loan of $500,000. Net Worth is approximately $2,400,000.
The Business wants to buy a new Plant and plans to borrow $1,000,000 to finance the new building/Manufacturing Plant that will appraise at $1,200,000. The Bank has No Problem making the loan but does not want the Business to Borrow any more money without consulting with the Bank first. The Bank may require a Negative Pledge on the Business Accounts Receivable and the Business Inventory. This will give the Bank the Comfort and Security the Bank needs to make the New Real Estate Loan with very little if anything down as a down payment on the New Loan.
There are many different ways to work this but the main thing to remember is that the Bank wants the business to have a relatively large amount of Equity in their business and not be able to borrow more from the Assets unless the Bank is consulted and agrees to the new debt. The Negative Pledge on the Accounts Receivable and the Inventory will assure that the Business cannot borrow against their Accounts Receivable and Inventory unless they get an O.K from the Bank First.
Please address and questions to roger@rogerschlueter.com and please visit my website at schlueterfinancial.com