For companies that are concerned about their future performance, asset-based lending could be the answer.
It is always hard for companies to predict their future performance, but at times of economic uncertainty, that’s an even greater challenge. Asset-based loans appeal to all companies that want greater flexibility and a lower cost of capital, but they are also a good option for companies that are worried about the level of their future earnings.
“One of the drivers of asset-based lending at the moment is economic uncertainty,” says Michael Sheff, Head of Asset-Based Lending at BBVA Compass. “In uncertain times, an asset-based facility can be more attractive than a traditional bank line.”
Traditional loans use a company’s future cash flow as collateral, and loan agreements often include covenants that require a company’s earnings and debt to EBITDA ratios, among other financial metrics, to remain at a certain level if the company is to avoid default.
By contrast, asset-based loans have very few financial covenants and are less reliant on that company performing consistently well every quarter. That makes them a more predictable source of capital that maximizes a company’s liquidity. “Many companies are moving away from cash-flow based financing because they are uncertain about their future cash flow, earnings and so on,” says Sheff.
That particularly applies to companies operating in cyclical industries where earnings are hard to predict, those operating in industries that are particularly sensitive to movement of commodity prices or other market variances, and companies that are going through a financial turnaround or reorganization.
However, economic or company-specific uncertainty is just one of several reasons why asset-based lending is attractive. Asset-based loans, now available in most industries, including retail, manufacturing, distribution and business services, and secured by a variety of different assets, can be a good fit for any company that wants far greater flexibility and lower funding costs. By allowing a bank to get closer to its collateral, companies can achieve just that.
As well as enabling companies to avoid restrictive financial covenants, asset-based loans, which are typically structured as revolving credit facilities, also offer companies a lot more flexibility about how they use the proceeds.
That means they are suitable for covering general operating costs as well as non-operational needs, such as paying dividends to shareholders, refinancing debt or funding an acquisition. “We look at the quality of the assets, how we margin the assets and how we monitor the assets in great detail,” says Sheff. “These loans are fully secured and constantly monitored to insure the loan-to-value equation remains favorable, so we don’t need to apply lots of financial covenants or place undue restrictions on the use of the cash.”
A Lower Cost of Capital
Because these loans are secured by the value and performance of a company’s existing assets, rather than future cash flow, they have a lower risk of loss. “This means we can typically offer clients lower pricing than is possible with cash-flow based loans,” he says.
Many asset-based loans are based on the value of a company’s accounts receivables, the appraised value of its inventory, or the appraised value of fixed assets, such as real estate, machinery, or equipment. Some loans involve a combination of several different elements. One Tier 1 automotive client of the bank, for example, recently secured a loan based on its accounts receivables, its inventory and its machinery and equipment.
However, companies may have other types of assets that could be considered. If the assets can be valued, that value can be monitored, and if there’s an active and predictable secondary market to support the valuation, anything within reason is a possibility.
Asset-based loans are available throughout the industry to borrowers both large and small. For example, Sheff says that traditional asset-based loans offered by BBVA Compass start at $10 million, but are usually between $15 and $25 million. Its Asset-Based Group will lend more based on the value of the assets and also teams with other banks to offer larger, syndicated loan facilities. For example, the bank is agent on a $75 million syndicated, asset-based loan for a manufacturing client, backed by its accounts receivable, inventory and machinery and equipment.
The loan application process for an asset-backed loan often takes longer than for traditional loans, because the value of the assets must be assessed on site. Sheff says that from drawing up a detailed proposal to closing the loan usually takes around 45 days. In return for greater flexibility and lower funding costs, companies will also need to report on collateral for the duration of the loan and the bank will carry out field examinations to inspect the collateral from time to time. Asset-based loans are clearly not the best solution for everyone, but they could offer many of today’s companies more liquidity, flexibility, and a better cost of capital. It could be time to give them another look.
This article was originally published by BBVA Compass.