ABLs: A Closer Look

An Asset Based Line of Credit, or ABL, is a working capital line of credit where the loan amount is governed by the appraised value of one or more assets (a borrowing base). Given this correlation between the loan amount and underlying collateral value, ABLs are considered less risky than cash flow or enterprise value loans, and therefore command lower interest rates.

An ABL borrowing base can be structured to monetize current assets, as well as a combination of the following assets:

• Cash & Marketable securities
• Accounts receivables
• Inventory
• Machinery and Equipment (M&E)
• Real Estate 
• Intellectual Property

Quick Breakdown

Capital Type: Asset Based Line of Credit, also known as ABL or ABL Revolver
Typical Use: Finance working capital needs
Funding Mechanism: Can be drawn within availability limits and repaid at will without any prepayment fees. Availability to be determined by applying pre-determined advance rates to various collateral components
Security: Senior secured first priority lien
Collateral: Typically, all assets of the company and pledge of equity. In certain circumstances, collateral can be limited to current assets (cash, accounts receivable and/or inventory)
Payment Priority: Usually first to be repaid from the proceeds of liquidation of its collateral. When paired with another debt facility with a first lien on the same collateral, the ABL facility will be repaid in equal proportion, or ratably, with other first lien debt

Who Should Consider an ABL Credit Facility? 

Borrowers that are asset-heavy and experience cash flow volatility make excellent candidates for ABLs. These include businesses with: 

1. A meaningful amount of working capital (A/R, inventory), e.g. manufacturing, distribution, retail, B2B services businesses, etc.
2. Manufacturing assets such as manufacturing plants, machinery & equipment, etc. 
3. Valuable real estate holdings (if working capital assets are being used to secure an ABL)
4. Valuable intellectual property (in limited circumstances). Businesses can add the appraised IP value to their ABL borrowing base to obtain additional liquidity

The more liquid the asset in the borrowing base, the lower the interest rate a borrower can expect. Fixed assets such as PP&E and IP are illiquid, meaning–with all else being equal–ABLs secured against these asset types will have higher interest rates when compared with ABLs secured against liquid assets such as accounts receivables. 

Advantages of ABLs

There are numerous advantages to both lenders and borrowers of ABLs. 

For Lenders: 

• Low Risk: ABLs are governed by the liquidation value of the underlying collateral, making them much less risky than other secured and unsecured loan types. 
• Strong Protection: With some exceptions, traditional ABLs maintain senior secured, first lien position on all assets, including assets that are not included in the borrowing base.  
• Greater Confidence: Borrowers with ABLs have their assets on the hook as collateral, plus they frequently report the value of the assets and their financial condition to lenders. While a bit restrictive for borrowers, lenders maintain greater confidence in the solvency of their loan.

For Borrowers: 

• Low Interest Rates: Given how low risk ABLs are, they typically come with a much lower interest rate than other forms of lending. 
• Covenant-Light: ABLs are usually straightforward, and contain very few covenants compared to other loan types. Frequently, ABL lenders forgo reporting of any covenants as long as the borrower maintains certain liquidity. Even when financial covenants are measured, they are limited to borrowing availability or liquidity and fixed charge coverage. 
• Competitive Market: ABLs are a well-established capital type, offered by almost all banks and many direct lenders. That means excess competition, which implies more efficient pricing and terms for capital seekers.

Drawbacks of ABLs

In addition to the aforementioned advantages, ABLs contain drawbacks for both lenders and borrowers. 

For Lenders: 

• Process-Intensive: Close monitoring and detailed analysis of collateral are a must for ABLs. This means specially trained employees and larger teams. 
• Competition: When it comes to ABLs, borrowers typically have a wider range of options than with other loan types. Also, considering how mainstream ABL facilities are, they are largely a commodity debt product with limited differentiation.  

For Borrowers:

• Detailed Reporting Requirements: Borrowers often have to provide monthly or even weekly status updates on their borrowing base. This involves a time commitment on the part of the borrower. 
• Not All Assets Make for Strong Collateral. For example, lenders might not be willing to lend against certain specialized assets, such as custom-designed inventory, or perishable goods with an expiration date. Other assets that might be difficult to monetize, such as certain IP types or accounts receivable.
• Asset Fluctuation Headaches: Some assets fluctuate in both value or quantity, which can cause availability issues. For example, if commodity inventory value fluctuates or accounts receivable moves over 60 days past due, this can become a problem for the borrower. 

Asset Based Lending Underwriting Process

Below are the underwriting process and maintenance requirements for ABLs:

Capital Providers: Banks and certain non-bank credit funds
Underwriting Thesis: Recovery through liquidation of collateral in a distressed situation
Underwriting Focus: Liquidity and value of collateral

Underwriting Process:

1. Evaluate nature and quality of collateral, assess seasonality of the business and relevant impact on value of collateral and liquidity. Analyze maintenance and discretionary capital expenditures to understand liquidity required to maintain business.
2. Conduct collateral exam to review and analyze accounts receivable performance, inventory records and record keeping systems. Establish dilution rates for accounts receivable and in turn, establish accounts receivable advance rate, which will govern the amount of capital that can be borrowed against accounts receivable.
3. Appraisal of inventory by a certified appraiser to establish Net Orderly Liquidation Value (“NOLV”), which will govern the amount of capital that can be borrowed against inventory. Appraisal of machinery and equipment and/or real estate to obtain NOLV if specific value is being ascribed to generate borrowing capacity.
4. Establish a mechanism to calculate the amount that can be drawn on ABL by incorporating advance rates in a formulaic structure known as the borrowing base.

Financial Covenants:   Most commonly, fixed charge coverage ratio. Less frequently, minimum liquidity or minimum excess availability requirement

Ongoing Reporting:    

1. Updated borrowing base to accompany each borrowing request, in addition to fully updated and recalculated borrowing base on a weekly or monthly basis along with supporting collateral details such as A/R and inventory aging
2. Company prepared unaudited monthly financials, audited annual financials, annual financial projections
3. Quarterly, bi-annual or annual collateral exams and appraisals – frequency to be determined based on the nature of collateral, seasonality of business and overall business conditions

Learn More

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