Collateral options for ABL: What’s eligible, what’s not?

If your business has high inventory levels or is poised for rapid growth, but lacks cash flow, an asset-based loan (ABL) might be the perfect fit. Find out if an asset-based loan could work for your organization.

Does your organization have accounts receivable and inventory that can be leveraged to improve liquidity? The nature and quality of your working capital can make all the difference.

Companies that maintain high levels of quality working capital assets and produce modest cash flow are ideal candidates for an asset-based loan (ABL).

Find out if an ABL is right for you

Current asset collateral is key for leveraging an asset-based loan. Manufacturers, distributors and retailers are good candidates for ABLs as they invest significantly in working capital and, in some cases, produce relatively low free cash flow (FCF).

“An ABL can be perfect for a company of this profile, particularly if they are poised for rapid growth, acquisitions or considering a shareholder buyout,” says John Freeman, Head of Sales and Originations for U.S. Bank Asset Based Finance.

The traditional way to measure senior debt capacity is a function of cash flow, typically calculated as a three to four time multiple of EBITDA (earnings before interest, taxes, depreciation and amortization). A collateral-based lending provider uses a borrowing base predicated on working capital liquidation values, which typically range from 50-75% for inventory and 85-90% for accounts.

Many companies can generate higher debt capacity via a borrowing base rather than through traditional commercial loans. 

Eligible collateral has a hierarchy

“Lenders specializing in asset-based loans look for collateral which is liquid,” Freeman adds. When it comes to collateral assets, the stack-rank asset preference is typically as follows:

1. Receivables 
2. Inventory 
3. Equipment 
4. Real estate
    

“The quicker an asset can be converted to cash, the higher the ABL advance rate,” Freeman explains. “Primary collateral includes accounts receivable or inventory which are easily valued and monetized. These include commodities such as consumer goods, food, metals, forest products, energy products, etc. Generally, the faster the asset's turnover, the more attractive it is as collateral.”

Conversely, ineligible collateral assets are usually those with lower value or those that may be subject to material shifts in consumer trends. For example, a wholesaler of shingles is considered stable because the size, look, construction and volume of inventory isn’t likely to experience material year-to-year changes.

This stability isn’t the same for a wholesaler of apparel or certain technology-based products. Both examples are subject to potential obsolescence due to changes in demand trends and product mix. 

Read more: ABL Mythbusters: The truth about asset-based lending.

>> Learn more: Contact us to discuss how ABL can fuel your growth strategy.

Some collateral types are more challenging than others

For purposes of securing an ABL, lenders find the following types of collateral less desirable:

• Receivables that are past due or subject to high dilution levels 
• Foreign receivables without insurance 
• Inventory that is primarily slow-moving, specialized or consigned 
• Single purpose real estate or equipment that can be difficult to monetize

Large facilities, such as a steel mill or foundry, are challenging as collateral assets, while multipurpose buildings like warehouses near dense city centers are more attractive.

It’s prudent to prepare for a meeting with prospective lenders

Lenders often start the process of evaluating a borrower by dispatching field examiners to review their working capital assets. If applicable, third-party appraisers are also engaged to evaluate inventory, machinery and equipment, and real estate. After funding, the lender tracks adjustments in value through periodic field exams and inventory appraisals. As a borrower, at least monthly you will be asked to submit reports that reflect changes in the quantity and/or value of your pledged collateral assets.

Organizations eying an ABL facility should consider these questions when looking for potential collateralized lending partners:

• Do they want a relationship — or do they see it as just a transaction? It’s always best to work with a lender that wants a relationship with your company and seeks to build trust.
• Do they listen? It’s prudent to choose a lender that’s willing to understand your business, think creatively and tailor a solution to meet your specific needs.
• Do they have experience in your industry? A major determinant of a lender’s ability to add value to an asset-based structure is its understanding of your business. 
• How long have they been in the business? Ensuring that your lender has an extensive track record showing an ability to provide this type of financing throughout multiple stages of the economic cycle will serve your business in the long term.

In many cases ABL pricing is more competitive than traditional loans

Costs can vary by lender, but most borrowers can expect to pay loan costs such as a closing fee, a direct interest charge, and unused fees. Despite more aggressive leverage tolerance and higher advance rates, ABL pricing is competitive with traditional cash-flow structures due to the collateral lending product having historically low losses industry wide.

At U.S. Bank, we’re here to help you decide if an ABL is right for your organization. Contact your relationship manager or visit usbank.com to learn more.