Print Edition
August 2010 
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Asset-based Lending In The Current Market Place |
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Pauline Renaud, September 2009 |
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In the current financial environment, obtaining traditional bank funding on favourable terms remains a challenge for most businesses. Consequently, an increasing number of companies are looking at alternative options, such as asset-based lending (ABL), to secure financing. The renewed appetite for this form of lending is the result of several factors, including the lower-risk profile it presents for both lenders and borrowers, compared to other financing facilities. ABL however has its own issues, such as valuation and monitoring, which need to be managed early in order to limit potential risks. This is particularly important, as ABL is expected to become the mainstream and preferred source of lending for businesses going forward.
Driving forces behind ABL activity
Most lending activities have been affected by the current crisis, including asset-based lending. But unlike the majority of credit facilities, ABL provides several benefits to both lenders and borrowers, and is therefore faring better.
The increase in asset-based lending activity has been particularly noticeable over the last two years, due to the lack of cash flow financing during the crisis. In the meantime, new lenders have started appearing on the ABL market as the competition has thinned out. These different factors allow the ABL market to cover a wide range of companies and sectors. “Given the spectrum within the market, putting aside the exceptional times of last autumn and the beginning of this year, asset-based lending is generally always active to one degree or another. But the specific segments of the market that may be the most active shift depending on larger economic forces,” asserts David W. Morse, a partner at Otterbourg, Steindler, Houston & Rosen, P.C. “Obviously, there has been a significant drop off in the large, sponsor-driven acquisition financings, particularly those where the asset-based component was only a small part of a complex capital structure involving other bank and capital market debt products.”
But other parts of the market have witnessed vibrant activity, as confirmed by Paul Beveridge, a managing director of KBC Business Capital. “There is a generally lower level of demand for some applications of ABL. However, there is still a strong demand for refinancing and restructuring, as companies and advisers are turning to ABL as an available and committed source of finance – as opposed to on-demand overdraft financing,” he says. The refinancing of corporate debt with asset-based loans has indeed experienced an up-tick, particularly in the second quarter of this year, due to the large number of companies struggling under heavy debt burdens.
Several experts have also noted that asset-based lending has been busy in the area of ‘amend and extend’ for existing asset-based facilities, as part of a broader restructuring of a business’s capital structure. Some exit financings by companies seeking to emerge from bankruptcy protection, and debtor-in-possession (DIP) financings for companies in Chapter 11, have also become more common, given the large number of businesses collapsing. “In addition, fewer companies are making a profit, and are therefore remaining asset-based borrowers for much longer than in the past. Indeed, many borrowers used to be profitable enough to be considered ‘bankable’ and transitioned to conventional banking versus remaining asset-based lending borrowers. This is no longer the case,” points out Donald F. Clarke, president of Asset Based Lending Consultants, Inc.
Besides the current crisis, and the subsequent lack of financing, one of the main drivers encouraging the recourse to ABL has been its flexibility, availability and attractive pricing, compared to other types of funding. But the credit crunch has also made banks more wary of lending money, making them turn to ABL, which is considered to be a safer credit facility, says William S. Veatch, a partner at Morrison & Foerster LLP. “In the pre-recession era, there was a trend towards ‘covenant light’ credit agreements and loose collateral arrangements, giving the borrower complete control over its business. In the current recession, lenders are reverting back to fully-secured, asset-based loans where the lender has airtight protection vis-ŕ-vis the collateral, and a significant voice in the event that there are early warning signs of trouble in the borrower’s business. The recession has necessitated a return by lenders to stricter credit underwriting requirements,” he adds.
Seizing opportunities, avoiding pitfalls
Asset-based lending is particularly recommended in some sectors or for certain types of companies, such as capital intensive businesses with assets that can be leveraged to provide working capital. Companies with assets that specifically encourage ABL funding are concentrated in the manufacturing, retail and distribution sectors, but also in the services industry. Types of assets usually include stocks or inventory, plant and machinery, property, as well as brands and intellectual property, given the fact there is a greater certainty regarding their valuation in terms of recovery. But some experts insist most categories of assets can allow a business to find credit in the form of an asset-based loan, as every company has receivables.
But ABL is not only being used solely by struggling companies – it can also be a positive tool for taking advantage of opportunities in the market. “In addition, companies experiencing strong growth with limited capital investment look to asset-based lending to provide the working capital they need to fuel expansion,” adds Mr Clarke. Some businesses operating in specific sectors are pursuing this type of lending in particular, as part of a broader investment strategy. “The recession has created significant buying opportunities across all industries, for businesses to complete strategic acquisitions of their competitors at an attractive price,” explains Mr Veatch. “Asset-based loans can be an invaluable tool for completing such an acquisition financing. Opportunities exist in all industries, including the technology sector, where the assets consist largely of intangible intellectual property rights.”
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