====== Loan Agreements ======
Loan Agreements are the formal, legally binding contracts that lay out the terms and conditions of a loan between a lender (like a bank) and a borrower (like a company you're researching). Think of it as the detailed rulebook for a [[debt]] relationship. This document specifies the total amount borrowed (the [[principal]]), the cost of borrowing (the [[interest rate]]), the repayment schedule (the [[amortization]] plan), and the final due date (the [[maturity date]]). For an investor, a loan agreement is far more than just administrative paperwork; it's a treasure map revealing a company's financial obligations, constraints, and the promises it has made to its creditors. A quick peek into these agreements can tell you more about a company's health and risks than a dozen flashy press releases.
===== Why Loan Agreements Matter to an Investor =====
As a [[value investor]], your job is to be a financial detective. Loan agreements, often buried deep within a company's financial filings (like the [[10-K]] or [[10-Q]]), are a crucial piece of evidence. They provide a direct, unfiltered look at the company's relationship with its lenders. This relationship dictates how much financial flexibility the company truly has. A business might look profitable on the surface, but if it's shackled by restrictive loan terms, its ability to invest in growth, pay dividends, or even survive a downturn could be severely hampered. The most important clauses to watch out for are the [[covenants]], which are specific rules the company must live by to avoid defaulting on its loan.
===== Key Clauses to Scrutinize =====
==== Covenants: The Golden Handcuffs ====
Covenants are promises made by the borrower to the lender, designed to protect the lender's money. They act as an early warning system. If a company breaks a covenant, the lender can often demand immediate repayment of the entire loan, which can trigger a financial crisis for the company.
  * **Financial Covenants:** These are performance-based rules. For example, a company might have to maintain a certain [[debt-to-equity ratio]] or ensure its earnings are at least three times its interest payments (a measure known as the [[interest coverage ratio]]). These metrics show the company can afford its debt.
  * **Negative Covenants:** These are restrictions on a company's actions. They prevent the borrower from doing things that might increase the lender's risk, such as:
    - Taking on significant additional debt.
    - Selling off major [[assets]] that generate cash flow.
    - Paying out large dividends to shareholders before servicing its debt.
//Value Investing Insight:// Covenants reveal the balance of power between the company and its lenders. Overly strict covenants can choke a company's ability to adapt and grow. On the other hand, a lack of strong covenants might suggest lenders aren't worried, or it could mean management has too much leeway to make risky decisions that benefit them at the expense of both creditors and shareholders.
==== Collateral: What's on the Line? ====
[[Collateral]] is a specific asset that a borrower pledges to a lender to secure a loan. If the borrower fails to repay, the lender can seize and sell the collateral to recoup their money.
  * A [[secured loan]] is backed by collateral, such as inventory, real estate, or equipment. These are less risky for lenders and usually have lower interest rates.
  * An [[unsecured loan]] is not backed by any specific asset. It's based solely on the borrower's creditworthiness. These are riskier for lenders and carry higher interest rates.
//Value Investing Insight:// As an equity holder, you are last in line to get paid if a company goes bankrupt. First come the secured lenders, who claim the collateral. By understanding what's pledged as collateral, you can assess what, if anything, would be left for shareholders in a worst-case scenario. If all the valuable assets are pledged, the risk for you, the shareholder, is significantly higher.
==== Interest Rates and Repayment Terms ====
The details of how a loan is paid back are critical. Is the interest rate fixed for the life of the loan, or is it a floating rate that changes with market rates (like the former [[LIBOR]] or its successor, [[SOFR]])? A company with a lot of floating-rate debt is vulnerable in a rising interest rate environment, as its interest expenses will increase, eating into profits. Also, look at the repayment schedule. Some loans require a massive "balloon payment" at maturity. This creates a significant [[refinancing risk]]—if the company can't find a new loan to pay off the old one when it comes due, it could face a liquidity crisis.
===== A Value Investor's Checklist =====
When you perform your [[due diligence]] on a company, don't skip the fine print on its [[liability]] section of the [[balance sheet]]. Use this checklist to guide your analysis of its loan agreements:
  * **Read the Filings:** Dive into the "Notes to Financial Statements" and "Management's Discussion and Analysis" (MD&A) sections of the annual report to find details about the company's debt.
  * **Hunt for Covenants:** What are the key financial and negative covenants? How much breathing room does the company have before it might breach one?
  * **Identify the Collateral:** Which of the company's assets are pledged to lenders? What's left over for equity investors?
  * **Analyze the Interest Rate:** Is the debt primarily fixed or floating-rate? How would a 1% or 2% rise in interest rates affect the company's earnings?
  * **Check the Maturity Dates:** Are there any large balloon payments coming up soon? Does the company have a plan to manage this refinancing risk?