By Patrick Lilly; senior consultant, Young & Associates

Asset-Based Loans (ABL)

Asset-Based Loans (ABLs) are usually structured as revolving lines of credit that are secured by the borrower’s current assets. The amount of credit made available is determined by the quality and value of the collateral. Usually accounts receivable, inventory and sometimes equipment and real estate, depending on industry risk.

In this article, we will focus on General Building and Engineering Contractors, Trades Sub-Contractors, and construction-related services providers having current asset concentrations in accounts receivable. These types of businesses typically experience large swings in cash flow while awaiting progress payments or final payments on contracts, goods supplied, and services rendered. The ABL line of credit provides interim working capital to these companies. This helps to smooth out the peaks and valleys of payments received from their customers.

How it Works

Working with a pre-determined loan limit based on actual and projected needs, borrowers can access a percentage of the value of their pledged assets, depending on the current certified value of those pledged assets.

These loans require a close level of monitoring. The frequency is determined by the size of the loan and industry risk. This usually entails monthly or quarterly reporting requirements on the company’s financial status. This usually consists of a financial statement, accounts receivable, and accounts payable agings of even date, a certification from the company’s responsible financial officer and a borrowing base certificate (BBC), which sums up the amount of credit available based on the asset values.

Prudent Underwriting Guidelines

Loan Amount:

• Starting with the requested amount of loan, a thorough analysis of the projected cash flow needs of the borrower should be undertaken. An improper loan limit can spell problems for both the contractor and the financial institution. If too little of a limit is approved, the contractor can run short of necessary working capital. This can create a negative effect on performance. Too much of a limit approved invites spending on fixed assets due to the relative ease in access to the loan proceeds and a sizable unused commitment impairs the financial institution’s overall lending and earnings capacity.
• Accounts receivable aging reports are an absolute necessity for this type of financing. Carve-outs based on the age and/or nature of a receivable are predetermined as conditions of the eligibility of any particular account receivable. Typical carveouts are the exclusion of any AR over 90 days aged, the elimination of any intra-company or employee receivable and the elimination of receivables that are concentrated with one customer which total more than 15-20 percent of the total amount of receivables.

Reporting Requirements:

• The borrower is typically required to report on a monthly or quarterly basis. The nature of the reporting should consist of:
  • A current (less than 30 days aged) monthly or quarterly financial statement
  • Accounts receivable detailed aging of even date and balance as indicated on the financial statement.
  • Accounts payable detailed aging of even date and balance as indicated on the financial statement.
  • A BBC supplied on a form approved by the lender that mirrors the information on the agings, subtracts ineligible ARs and taxing authority payables, states the balance on the loan and the amount available to draw on the loan. This form should be completed, signed and dated by the authorized borrower representative.

Audit requirements:

• On larger and more complex borrowings, the lender needs to impose strict reporting requirements to protect the interests of the lender. This usually consists of:
  • Reviewed quality or better financial statements from the borrower due bank on an annual basis. (Usually no more than 90 days after the prior YE period)
  • Internally prepared and attested financial statement from the borrower on a monthly or quarterly basis. (Due lender no more than 30 days from the prior month or quarter ending period)
  • Depending upon the size, complexity and nature of the borrower, the lender may require a periodic field audit conducted by a qualified third party inspection firm as outlined in the Asset Based Loan Agreement. This audit reconciles the financial statement with the schedule of accounts receivable and payable, inventory activities and the most recent BBC. Such audits are integral to maintaining the integrity of the borrower relationship. They also protect the bank’s investment in the credit and its collateral position.

Other conditions:

• The lender should consider CAPEX usage restrictions on proceeds of the line.
• While ABL RLOCs rely on the cash conversion cycle for repayment, minimum pre and post distribution EBITDA DSCR covenants in combination with other standard C&I lending covenants such as minimum working capital or current ratio are prudent.
• The borrower’s key suppliers should be contacted for credit reference.
• Governmental contracting can result in extended terms. That may impair the bank’s ability to exercise assignment rights to receive direct payment in a collection action.

ABL financing can lead to a fuller relationship with a borrower. This can be beneficial to both the borrower and the lender. If managed and monitored properly, these types of loans can be valuable and profitable assets to the lender. It can then result in long term and expanding relationships.