What Happens at a Line of Credit's Annual Renewal Review

The call I dreaded making as an underwriter usually came about three weeks before a line of credit matured. The owner had used the line for a year without a single problem, never missed an interest payment, and assumed renewal was a formality. Then I had to tell them the bank was renewing at $90,000 instead of $150,000, or converting the balance into a term loan, or not renewing at all.

Almost every one of those conversations could have gone differently if the owner had known what the renewal review actually looks at. Most business lines of credit are not open-ended. They are one year agreements, and the renewal is a fresh underwriting decision made with a year of new data about you. Here is what that review covers, from the side of the desk I used to sit on.

Why a line that worked all year can still shrink

A revolving line has a maturity date, usually twelve months after it opens, sometimes twenty four. Check the promissory note; the date is in the first page or two. On that date the full balance is technically due. In practice the bank renews it, but renewal requires a credit officer to sign off again, and that officer is not looking at whether you paid interest on time. Paying interest is the minimum. They are asking whether they would approve this line today, as a new request, knowing what they now know.

What they now know is a full year of how you actually used the money. That history matters more than anything you said in the original application. If you are not sure how the draw and repayment mechanics fit together, I covered that in how a line of credit draw period works.

What the renewal review actually looks at

Updated financials

Expect a request for your most recent business tax return or year-end financial statements, plus interim statements for the current year to date. Many banks also want the owners' personal tax returns and a fresh personal financial statement from anyone who signed a guarantee. If your line agreement required CPA-reviewed statements and you sent internally prepared ones, that alone can stall a renewal.

Covenant compliance

Most lines above a modest size carry financial covenants. The two I saw most often were a minimum debt service coverage ratio, usually 1.25 times, meaning your cash flow covers all debt payments with 25 percent to spare, and a maximum ratio of total liabilities to tangible net worth, often somewhere around 3 to 1 or 4 to 1. The bank tests these on your year-end numbers. A breach does not automatically end the relationship, but it moves the conversation from renewal to negotiation.

The clean-up period

This is the one owners forget. Many working capital lines include a clean-up or rest provision that requires the balance to sit at zero for a set stretch each year, commonly 30 consecutive days. It is there because a line of credit is meant to fund short gaps, such as inventory before a busy season or receivables waiting to be collected. If your balance never touched zero all year, the bank reads that as permanent borrowing dressed up as a revolving line.

How you used the line

Beyond the formal clean-up test, the underwriter looks at the shape of your usage. A balance that rises before your busy season and falls after it looks healthy. A balance that climbs steadily and never comes back down looks like the business is using the line to cover losses or to buy long-term assets, which a one year facility is not built for. They will also look at your bank statements for overdrafts and returned items, the same signals I described in what a lender reads into your business bank statements.

Borrowing base, if you have one

Asset-based lines tie your limit to eligible receivables and inventory. At renewal, the bank may run a field exam and adjust the advance rates. Receivables more than 90 days past invoice usually fall out of the eligible pool, so an aging report full of slow payers can cut your available credit even if the stated limit stays the same.

High usage does not prove you need more

A lot of owners go into renewal thinking that heavy use strengthens their case for a bigger line. It often does the opposite.

Here is a real pattern, with the details changed. A landscaping company had a $120,000 line. Across the year, its average balance sat at about 88 percent of the limit, and the lowest it ever got was $71,400 in late February. The owner asked for an increase to $175,000. From his side, the logic was simple: the business was growing and the line was clearly useful. From the credit side, the line had never revolved. Seventy thousand dollars had been borrowed and never repaid, which meant it was functioning as a term loan with no amortization schedule.

The bank's answer was a term-out. It converted $70,000 of the balance into a four year term loan with monthly principal payments, and renewed the line at $60,000 with a 30 day clean-up requirement. The owner was frustrated at the time. A year later, with the term loan shrinking and the smaller line actually revolving, he got an increase without much discussion.

A line that goes up and comes back down tells the bank you can repay. A line that only goes up tells them you cannot.

The four outcomes, and what each one signals

When a renewal decision comes back, it is almost always one of these.

• Renewed as is. The bank is comfortable. Sometimes the rate or fees adjust with the market.
• Renewed with a lower limit or tighter terms. Something in the year gave the officer pause, often weaker margins or a covenant near its edge. You still have access, but the bank wants less exposure.
• Termed out. Part or all of the balance becomes a fixed term loan, as in the landscaping example. This is the bank telling you the borrowing was long-term and should be structured that way.
• Not renewed. The full balance becomes due at maturity, sometimes with a short extension to let you refinance elsewhere. This usually follows a covenant breach, a sharp loss, or a pattern of overdrafts.

Two of those four outcomes can be avoided with planning, and the third can at least be negotiated if you start early enough.

Starting the renewal 90 days out

When I was on the lending side, the renewals that went smoothly almost always started early. Ninety days before maturity, the owner sent year-end statements without being asked, flagged anything unusual in the numbers with a short written explanation, and asked whether there were any concerns. Sixty days out, they followed up. That gave the bank time to work through questions instead of rushing a decision in the last week, and rushed decisions in credit tend to be conservative ones.

If you know a covenant will be tight, say so before the bank finds it. A breach the owner explains in advance is a conversation. A breach discovered in a file review is a problem. The documents the bank will ask for are mostly the same set I listed in four documents every lender will ask for first, so getting them ready early costs you nothing extra.

This week

Pull out your line of credit agreement and find two things: the maturity date, and whether there is a clean-up or rest period clause. Then open your bank statements for the past twelve months and look for the lowest balance on the line. If the maturity is within four months and the balance never reached zero, start paying it down now, while you still have time to show the bank a line that actually revolves.