Bank of America Merrill Lynch Article
April 2015
A Guide to
Asset-Based Lending
Businesses with increased liquidity and working capital needs may find an asset-based loan (ABL) to be an
attractive alternative to conventional bank financing.
More liquidity. Fewer restrictions.
Four scenarios
ABL can provide an attractive alternative to cash-flowbased bank financing by generating more liquidity in certain
circumstances, and encouraging more efficient working
capital management. It also subjects the borrower to fewer
and less restrictive financial and negative covenants. Assetbased lending does this by utilizing a company’s current and
noncurrent assets as building blocks for its debt structure,
focusing on liquidity and relying on collateral monitoring
for comfort.
This guide examines the various types and features of
this time-honored and evolving form of financing. But first,
we look briefly at the four challenges that ABL helps
businesses address: performance setbacks, growth initiatives,
expansion possibilities and capital-markets opportunities.
ABL can provide an attractive alternative
to cash-flow-based bank financing by
generating more liquidity in certain
circumstances, and encouraging more
efficient working capital management.
During the early 2000s, ABL experienced a paradigm shift.
Mid- and large-corporate borrowers saw the virtues of these
structures, turning ABL from a Main Street-focused product
to a Wall Street product. And because of its flexibility and
adaptability across the credit spectrum, and the ability to
pair it with a variety of junior capital products, the selection
of an asset-based structure became increasingly one of
choice rather than necessity.
Take the first challenge: Companies experiencing
performance-related issues — financial deterioration,
an industry downturn, operational issues — often require
funding while they work through them. ABL can provide
the necessary breathing room and liquidity to enable
management and its advisors to effect a turnaround.
Next, businesses seeking to maximize their growth
potential require funding for capital expenditures,
working capital and high organic growth. Here too,
ABL is a readily available avenue as it is more leverage
tolerant and can help fill working capital in-balances
created by fast growth.
Organizations seeking to expand beyond organic
growth initiatives often find they need to draw on
third-party resources to fuel mergers, acquisitions, buyouts,
entrance into new geographic arenas, and new product
commercialization. In connection with this, they also can
turn to the ABL market.
And finally, capital structure-related opportunities — debt maturities, stock repurchases and dividends — can frequently be met by use of asset-based loans.
ABL facilities have less restrictive negative covenants,
which enable companies to have the flexibility to undercut
these transactions.
1
2
Growth
• Capital expenditure needs
• Working capital needs
• High organic growth
Solutions
Restructuring/DIP
Traditional ABL
3
4
Expansion
• M&A
• LBO
• Geography/Product
the availability of working capital from
the borrower’s current asset base.
(e.g., 85% of the net orderly liquidation value) determined by
a third-party appraiser. When such assets convert to cash,
the advances are repaid.
Drivers of Asset-Based Lending
Performance
• Financial deterioration
• Industry downturn
• Operational issues
A revolving credit facility can optimize
Senior Stretch
Junior Capital
Capital Markets
• Debt maturities
• Stock repurchase
• Dividends
Traditional ABLs
What are the various types of asset-based loans available
to middle-market businesses to provide the senior debt
financing in these situations? Traditional products include
revolving lines of credit, or “revolvers,” and term loans. In
these structures, the lender takes a first-priority security
interest in the assets pledged as collateral for the loan.
Revolvers
An asset-based loan is commonly structured as a revolving
line of credit without a scheduled repayment, and on an
interest-only basis. A “revolver” allows a company to borrow,
repay and reborrow as needed over the life of the loan
facility or agreement. The lender advances funds based on a
percentage of the accounts receivable (normally 70% to 85%)
and inventory. A borrower’s inventory is typically based on the
lesser of either 0% to 70% of the lower of cost, or market,
depending on the category of inventory; or a percentage
A revolving credit facility can optimize the availability of
working capital from the borrower’s current asset base.
Ineligible collateral is excluded from the borrowing base.
Ineligible accounts receivable include past-due receivables,
intercompany receivables and other lower-quality receivables.
Ineligible inventory generally includes work in process,
packaging materials or inventory at a subcontractor.
However, depending on the industry, customer relationship
and length of the production cycle, work in process may be
considered eligible.
A key structuring consideration in ABL is the borrower’s
level of liquidity measured by the level of excess availability
under the revolver. Excess availability is the amount absent
in an event of default that the borrower is entitled to borrow,
and represents the excess of collateral availability over the
amount of the loan and letters of credit outstanding, as
well as any reserves established by the lender. The amount
the asset-based lender is willing to lend increases if the
amount of the assets securing the loan increases. In ABL
the borrowing base, not the facility size, generally drives
availability.
A sufficient level of openings projected and excess
availability will depend on the size of the business,
working capital fluctuations and management’s liquidity
cushion comfort.
A revolving line of credit typically has a term of two to five
years and represents a committed form of capital. Periodic
borrowing, reporting and collateral examinations are required,
with such frequency depending on the credit profile of the
borrower and its liquidity position. Certain borrowers may only
have a springing financial covenant (i.e., a covenant such as
fixed-charge coverage that it is subject to, if excess availability
under its revolver drops below a certain level), which is
referred to as “covenant lite.” Bank of America Business
Capital currently provides revolvers of $10 million or more.
In the next section, we will address term loans. However,
in certain circumstances, the advance against a borrower’s
fixed assets may be included in the revolver borrowing base
rather than as a separate term loan.
Term loans
Like a revolver, a term loan is dependent on the composition
and amount of available collateral and cash flow to support
debt service. In a term loan facility, lenders are more willing
to advance against machinery and equipment than real
estate. The entire amount typically is advanced at closing,
with repayment of principal and interest amortized over
a period ranging from 5 to 15 years depending on the
composition of the collateral or the unamortized balance
due at maturity of the credit facility.
In a term loan facility, lenders are more
willing to advance against machinery and
equipment than real estate.
Term loans are typically amounts based on a certain
percentage of the appraised net orderly liquidation value
(NOLV) of the machinery and equipment (M&E) and the
appraised fair market value (FMV) of the real estate. The
NOLV is a third-party assessment of what can be realized
over a period of typically up to six months against the
M&E, and reflects the age and condition of the M&E as
well as market conditions. For M&E, in some cases, a net
forced liquidation value (FLV) or auction value may be more
appropriate and/or the net proceeds may not exceed those
realized in an orderly liquidation, since benefit of a more
orderly sale may be outweighed by the higher expenses over
a longer liquidation period.
The real estate appraisal, obtained by the lender, must meet
the standards of the federal Financial Institutions Reform,
Recovery, and Enforcement Act. In contrast to M&E, which
has a much shorter realization time frame, real estate may
have a prospective holding period of several years. Lenders
generally avoid lending against vacant, discounted operations.
Typical advance rates against fixed assets comprising the
term loan are up to 85% of the NOLV of the M&E, and up
to 75% of the FMV of the real estate. For some fixed assets
such as a chemical plant or other operations that would likely
be sold in an intact sale, in the case of a failed non-operating
entity, a liquidation value-in-place concept may apply.
In these cases, the lender would typically apply a lower
advance rate against the appraised value (e.g., 50% to 60%).
Lenders typically define debt service coverage as earnings
before interest, taxes, depreciation and amortization
(EBITDA), less cash interest, cash taxes, unfinanced capital
expenditures (CAPEX) and distributions (dividends) divided by
scheduled principal payments on indebtedness. The standard
is to look at these items on a trailing 12-month or fourquarter basis. (Certain add-backs to arrive at an adjusted
EBITDA may be acceptable.)
Pricing and amortization
Unlike the cash flow market, where term loans based on
cash flow are priced the same as a revolver based on cash
flow, term loans most represent a mutual portion of the total
credit facility and are typically priced 25 to 50 basis points
above the revolver. This pricing differential reflects the less
liquid nature of these assets and the greater recovery risk
inherent in a longer realization period.
The amortization period of a term loan depends on the
asset composition and the credit quality. M&E is typically
amortized over five to seven years, while real estate may
be amortized over 10 to 20 years, with the amortized
principal due at the maturity of the credit facility (e.g., five
years). Asset-based loans using real estate as collateral
may have longer amortization periods than equipment loans
because of the generally shorter economic life expectancy
of equipment. Blended amortization schedules for the two
asset classes are usually established.
Asset-based loans using real estate as
collateral may have longer amortization
periods than equipment loans because
of the generally shorter economic life
expectancy of equipment.
At Bank of America Business Capital, asset-based term loans
are acceptable, provided they generally do not exceed 40%
of a borrower’s gross borrowing capability (i.e., the amount
eligible based on applying the advance rates to the borrower’s
current and non-current assets). In addition, the advance
against real estate should not exceed 15% of the gross
availability. If the borrower’s credit facility requires syndication,
in the asset-based lending market, there is generally an
aversion to structures where the advance against fixed
assets exceeds 30% of the gross availability.
An ABL facility with fixed assets — either advanced separately
as a term loan or included as a reducing advance in the
revolver (and with such reducing advance tantamount
to the amortization those fixed assets would have as a
term loan) — may be structured as covenant-lite. However,
to the extent that the fixed-asset advance is relied
on (i.e., not covered by abundant excess availability),
the borrower is typically subject to at least a fixed-charge
coverage covenant.
The value of intangibles
Certain companies may have intellectual property with
quantifiable value as collateral in an ABL structure.
Such intellectual property could include brand names in a
consumer products company, or products and their related
tooling, patterns and designs in an industrial company.
This value is often predicated on the cash flow generated
by the business, and is established based on a “relief from
royalties” concept (i.e., the value of the intellectual property
is equal to the discounted present value of the royalty
payments, which the company is excused from having to
pay by virtue of its ownership of the intellectual property).
Lenders prefer to see these valuations supported by values
commanded in distressed sales in the market.
Loan advances against intellectual property are typically
25%–50% of the appraised value, and the portion of the
overall loan secured by intangibles is often structured as a
separate tranche, or portion, of the loan. Premium pricing is
tantamount to cash flow market pricing on that portion of
the facility, with the loan amortized over a period of up to
three years.
Structured advances
Structured out-of-formula advances (structured advances)
may be available for acquisitions, recapitalizations and other
special situations. They may also be appropriate for short
seasonal periods. A structured advance is a hybrid financing
solution that falls between an asset-based loan and a
cash-flow-based loan for companies that have more marginal
free cash flows (e.g., due to high levels of unfinanced
capital expenditures), because the borrower operates in
a more cyclical industry or lacks all of the business value
characteristics that would qualify the borrower as a cash
flow lending candidate. Also known as an “over-advance
loan,” it is structured with both asset-based and cash-flowbased components, providing a higher level of leverage and
delivering more capital up front than do loans based solely
on typical ABL advances against collateral.
This type of loan is often used when a company has
demonstrated pro forma historical and projected ability to
service its debt, including amortization of the structured
advance. Common uses of a structured advance are in
connection with leveraged buyouts, acquisitions and
recapitalizations. While priced at a premium to a typical
ABL facility on a blended cost-of-capital basis, the pricing
is attractive compared to the cash flow lending market.
Typically structured advances are amortized over a period
not to exceed three years. There may be an excess cash flow
(ECF) sweep applied to the over advance (e.g., 50% of ECF).
Loan advances against intellectual property
are typically 25%–50% of the appraised
value, and the portion of the overall loan
secured by intangibles is often structured
as a separate tranche, or portion, of the loan.
FILO tranches
First-in last-out (FILO) tranches are used within a
revolving credit facility as another way of increasing the
overall amount of the loan. FILO tranches started in the
retail-finance segment of the market, but are now also
being utilized for distributors and wholesalers and,
even more recently, manufacturers.
Like a term loan, the FILO amount is advanced in full at
the closing (i.e., “first in”). Also, like a term loan, once repaid
through an amortization of the FILO tranche, the FILO loan
funds cannot be reborrowed. The FILO loan is part of the
senior credit facility and receives the benefit of a first lien
on the company’s assets.
The advance under the FILO is typically an additional
5% of the borrower’s eligible accounts receivable (A/R)
and 5% – 10% of the NOLV of eligible inventory (thereby
increasing the advance from 85% NOLV to 90% NOLV).
FILO advance may be at the higher end of the value in
cases where the overall credit facility is relatively large or
where the borrower’s credit profile is relatively strong. FILO
tranches are generally amortized up to three years, but there
may be a holiday prior to the start of amortization. FILO
tranches are typically priced at a premium of 150 basis
points or more above the revolver.
Critical factors in structuring such tranches include debt
service coverage, senior leverage and the level of excess
availability. Pro forma debt service coverage on a historical
and projected basis is more critical. And opening and projected
availability should be greater than the FILO advance.
Structuring considerations
In providing intellectual property advances, structured
advances and FILO tranches, lenders generally prefer to
work with larger borrowers, similar to preferences for larger
EBITDA companies held by cash flow lenders.
As the size of the term loan or fixed-asset advance increases
as a proportion of the gross availability or intellectual property
advances, structured advances or FILO tranches are included
in the facility, the level of senior debt/EBITDA and total debt/
EBITDA draws more scrutiny from lenders. And in these
situations, the financial covenant package can include both
a fixed charge and leverage covenant.
In a nutshell, middle-market companies with assets can use
them as collateral against which to borrow. And they have
numerous options when it comes to structuring an agreement.
The following chart illustrates some of those options.
The left-hand column lists debt categories based on priority
of the lender’s claim on assets. The center column shows
traditional product types grouped on the basis of their
degree of security for the lender. The right-hand column
identifies several alternative loan products.
Historically, structures available to middle-market companies
were more “plain vanilla,” dominated by senior debt in
combination with mezzanine financing. However, the market
has evolved considerably. And ABL structures are highly
flexible and adaptable in partnering with a wide variety of
institutional term loan and junior capital providers to achieve
an optimal financing structure.
Bank of America Business Capital – Financing Structures Available to Middle Market Companies
Priority of Claim
on Assets
First
Last
Secured
Typical Middle Market Capital Structure
Traditional Products/Structures
Senior Secured Debt Leverage
up to 3.5x +/- (Sr. Secured Debt/EBITDA)
ABL Revolver
Bifurcated Secured Term Loan*
Pro Rata (Cash Flow)
Institutional/Hybrid
Revolver and Term Loan Term Loans
Unitranche – Pro Rata
First Out/Last Out
Second Lien Term Loan
Coupon-Only Mezzanine Debt
Mezzanine Debt
Private High Yield Notes
Junior Debt/Traditional Subordinated
Debt Leverage up to 5.0x +/(Total Debt/EBITDA)
Equity (~35% to 50% of capital structure)
Convertible/Preferred Securities
*Bifurcated Secured Term Loans have first lien on fixed assets and are used in conjunction with an ABL Revolver
Alternative Products/Structures
Unsecured
• Borrower size, credit quality and industry sector greatly influence leverage and terms available within middle market
• Financing structures that pair ABL revolvers with term loans (i.e., traditional cash flow, bifurcated and unitranche) have become
increasingly popular due to relative flexibility and favorable pricing
• As Business Development Companies (BDCs) remain active and aggressive across all loan segments, borrowers have increasingly
tapped these non-traditional sources of debt capital by turning to alternative products and creative financing options
• With junior collateral providers focused on leverage both from a Debt/EBITDA stand point as well as a Loan/Enterprise
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