Many financial executives today are turning to asset-based loans because they are versatile and cost-competitive debt instruments that provide increased flexibility over other financing alternatives. However, some still view asset-based loans as "the last resort for commercial borrowers," or an expensive financing option that imposes an excessive reporting burden. The truth is, asset-based loans provide borrowers with enhanced operational flexibility through all phases of the business cycle. And with the ubiquity of computers, reporting for asset-based loans is more efficient and less labor intensive than ever before.
Asset-Based Vs. Cash Flow
Asset-based lenders have the benefit of liquid assets to protect their loan, thus these loans place less reliance on the borrower's operating performance, reflected by the number of covenant requirements attached to the loan. By contrast, cash flow loans typically come with stringent—sometimes highly restrictive—financial covenants, such as a leverage ratio maximum, fixed charge coverage, interest coverage and minimum EBITDA that can put significant stress on a company's ability to operate freely, especially during an economic downturn. Asset-based lenders are concerned with a company's asset coverage, liquidity and, to varying degrees, the borrower's ability to service their debt. The leverage ratio itself is not material.
Factors Driving Asset-Based Loan Market
Many factors have spurred the recent appeal of asset-based loans, but three things stand out.
The first factor is the widespread presence of aggressively structured cash flow loans completed in the late 1990's. During this period, when many companies were executing leveraged buyouts, acquisitions and roll-ups, banks were delivering highly leveraged cash flow loans, which were based on a multiple of the borrower's trailing earnings. The shortcoming of this lending strategy was that many of these loans depended on continued improvement in the cash flows of these companies, as well as a strong capital markets environment, to provide an exit for the borrowers and the lenders. Neither of these conditions held true, with the result being many of these companies are now struggling to meet covenants or to fulfill maturing debt obligations.
The second factor driving the demand for asset-based loans is the economic slowdown since 2007 and the effect it has had on companies—particularly those that operate in cyclical businesses. As these companies' earnings have suffered, they have turned to the inherent value of their assets—accounts receivable, inventory and fixed assets—to provide the operational flexibility and borrowing power their cash flows can no longer provide. Beyond mere necessity, however, these companies generally find asset-based loans offer additional benefits beyond increased liquidity. Today's asset-based loans are priced competitively with cash flow loans, and, as noted earlier, often come with fewer financial covenants.
The third factor driving companies to pursue asset-based loan structures is that the asset-based market remains steady and competitive in spite of large-scale bank consolidation that currently affect many other types of loan markets, especially the cash flow market. This consolidation, along with recent regulatory and shareholder pressures placed on lenders' portfolios, has caused many lenders to push under-performing loans out the door, an unfortunate trend made more commonplace in difficult economic times. The asset-based lending market is less volatile by nature since the borrowing power of a company's assets are characteristically more stable than its earnings. This makes for more competitive pricing and the large number of lenders in the market means there is a greater pool competing for the syndication of larger asset-based loans, such as the $2 billion credit facility provided to Kmart in 2002.
Defining Assets
Unlike a cash flow loan, the borrowing capacity for an asset-based loan is based on the amount, quality and liquidity of a company's accounts receivable, inventory and fixed assets. Generally, the current assets of accounts receivable and inventory serve as the borrowing base for a revolving credit facility that can be drawn down and repaid. This structure can accelerate a company's cash flow by allowing it to borrow against the future value of its current assets that are expected to become cash in the near term, in turn using the borrowed funds to finance working capital.
In addition, fixed assets (machinery, equipment, real estate) can be used to collateralize an asset-based loan. In contrast to its current assets, a company's fixed assets frequently serve as the borrowing base for a term loan credit facility, where the amount is fixed for a period of time, there is an agreed upon payment schedule, and amounts paid cannot be re-borrowed. There are also occasions where certain non-traditional assets (e.g., trade names and intellectual property) are eligible as collateral, but these assets are considered on a case-by-case basis. For the traditional form of assets, however, guidelines provide estimates for the value of assets as collateral in an asset-based loan. For example, eligible accounts receivable typically include receivables from completed sales, whereas items like older receivables (over 90 days from invoice) and foreign receivables are usually considered ineligible. Eligible inventory typically includes all finished goods and marketable raw materials, and usually excludes work-in-progress (WIP), slow moving or obsolete inventory, or inventory on consignment with customers.
Asset-based loan monitoring and reporting mirrors the strength of the borrowing company, and can be as infrequent as once per quarter. Present day monitoring has been facilitated greatly by new technology and applications like my.bofabusinesscapital.com. Borrowers can now monitor their accounts and access real-time information on-line, easing the administrative burden once associated with asset-based loans.
Beyond Asset-Based Loans
An "overadvance" or "senior stretch" loan features elements of both an asset-based and cash flow loan by offering availability beyond the lendable value of current and fixed assets as long as the company can demonstrate sufficient cash flows. In combination with funds lent on assets, the senior stretch product rewards companies with strong cash flows by providing a highly versatile structure that is generally priced lower than a pure cash flow loan.
As the banking industry re-evaluates its relationships with customers who are affected by the current dip in the economy, those financial institutions that offer asset-based loans are finding wide acceptance for their product. Time tested and versatile, asset-based loans are delivering strategic financing at competitive terms, allowing companies in all types of industries to achieve operational flexibility through the value of their assets.
|
