An Introduction to Asset Based Lending (ABL)
Asset Based Lending is a financing method that uses the short term assets of a business as the basis of the loan facility. In this type of loan, availability is tied to the level of eligible collateral. By limiting availability, the lender expects to exercise better control over the credit and avoid situations where short-term credit misused to purchase long-term assets or siphoned away to the owners in the form of distributions.
The one determining factor that differentiates an ABL line of credit from a regular working capital line of credit is that in an ABL line availability is tied to the available collateral. While a regular “Open” line of credit is a firm commitment by the bank to lend a certain amount for a determined amount of time, the ABL line’s available amount will fluctuate with the level of accounts receivable and inventory. These trade assets are usually monitored on a monthly basis with borrowing base certificates provided by the borrower, and reviewed by bank staff. ABL facilities also usually include an “advance formula”, which limits the amount outstanding depending on asset class and unique characteristics.
Because the ABL facility limits availability based on the level of eligible assets owned by the borrower, it is common to consider them self-liquidating. This characteristic is evident when the borrower’s sales are in decline. As revenue drops, the amount of accounts receivable declines, and the inventory levels should decrease. Lower levels of eligible assets result in lower availability decreasing the exposure of the lender.
Eligibility and Common Advance Ratios Under ABL Formulas.
A well structured ABL line is used to primarily finance accounts receivable. Banks are usually concerned about lending mostly on inventory because of liquidity concerns, and the logistics involved in a possible liquidation. As a lender, the goal is to finance good quality receivables. The quality of receivables is determined by reviewing aging reports. By reviewing these reports, the analyst determines if the customers listed in the A/R aging pay on a timely basis, and if the customers’ financial strength is adequate.
Not all accounts receivable are the same. The faster that the customers pay the borrower, the better. The stronger financially that does customers are the better. The longer the relationship between the borrower and the customer, the better.
Under normal circumstances, eligible accounts receivable are limited to the following:
a) Domestic (due from businesses within the United States),
b) Not affiliated with the borrower,
c) Goods or services must have already been provided,
d) There is no other performance requirement on the part of the borrower,
e) Not older than 90 days or less from invoice date.
Would a lender be willing to advance on foreign accounts receivable? Lending on foreign receivables is discouraged because of the difficulty of collecting. Nevertheless, it is possible to structure the ABL loan to advance on foreign receivables as long as they are insured by an acceptable insurance company under terms and conditions acceptable to the lender. Eligibility will be determined by the terms of the insurance policy. If the policy allows for terms up to sixty days from invoice, then the terms of the asset based line are set to match the policy.
Inventory is another tricky asset. The most important factor to take into consideration with inventory is location. The lender should limit advances to inventory located in the borrower’s owned property or in leased premises as long as the lender can get a landlord waiver. No consigned or in transit inventory is usually allowed.
Advance rates are usually determined by the competitive environment. In my area, the common advance rates are:
Accounts receivable without insurance up to 85%, with insurance up to the amount of insurance coverage or 95%.
Inventory is usually advanced up to 65% with 50% being the most common. Usually the formula is structured so that there is a cap in the amount of availability based on inventory. The caps are structured either as a hard cap (Example: A line of credit of $2,000,000 might have a cap that no more than $1,000,000 will be advanced on inventory) or it could be structured as a reliance cap (Example: No more than 50% of the outstanding will be reliant in inventory). While they both accomplish the same goal, the reliance cap is more restrictive as it requires the borrower to have eligible accounts receivable to borrow on inventory.