The corporate lending world can, in its simplest form, be divided into two different
approaches: the asset-based credit market and the cash flow-based credit market.
In ABL transactions, the lender’s interest is secured by the borrower’s assets, which then
forms the basis for determining how much credit the borrower can access. In contrast, the
cash flow method of determining credit capacity is principally based on an analysis of
the borrower’s enterprise value.
Asset-based lenders have generally found that, over time, the valuation of a borrower’s
assets is remarkably stable over a variety of business and economic cycles. This makes
calculating a borrower’s credit capacity based on asset values a highly predictable way
of providing capital to clients.
Cash flow-based loans, while also usually a secured form of financing, often use EBITDA
(or a company’s earnings before interest, taxes, depreciation and amortization) along with
a multiplier to determine credit capacity, rather than the value of the underlying collateral
assets. The level of EBITDA can change and the multiplier applied can change significantly during business and economic cycles. During an economic downturn, most companies will see their EBITDA decline, both on a relative and absolute basis. Often, the multiplier being used by lenders will shrink at the same time; this combination of declining EBITDA and a shrinking multiplier can result in a significant decline in available credit capacity at what could be the exact time a company most needs access to capital.
Frequent uses of ABLs
For higher quality, large-corporate borrowers, ABLs are often used simply for financing working capital. These companies will often access the public or private capital markets for long-term forms of financing for the majority of their overall capitalization. They will then use ABLs to fund seasonal changes in working capital, for shareholder value-creating actions such as share repurchase programs, dividends or distributions, and for opportunistic acquisitions.
For midsized companies, in addition to providing working capital financing, ABLs often incorporate
term loans, which are secured by longer-term assets such as machinery and real estate, to provide incremental credit capacity.
ABLs also tend to play a key role in the financing of companies facing cyclical or operating
performance headwinds that have caused their credit profile to deteriorate. They need
patient capital to attempt to execute on their business turnaround or restructuring
plans, or just to weather the current environment, including the possibility of bankruptcy
reorganization. Often, an ABL is “transitional” capital for these companies; for a time it
provides incremental liquidity and structural flexibility characteristics that help owners
and managers reposition the company. Once that is completed, these companies often
refinance again in the cash flow credit market.
There are also times when companies use an ABL as transitional capital only to later
realize that many of the characteristics of ABLs fit their business well. They may see that
both the discipline and freedom associated with these loans can enhance the way they
execute their plans. These companies often never go back to the cash flow loan market.
In fact, there are several Fortune 500 companies that have opted to used ABLs.
Manufacturers, wholesale distributors, retailers, and some forms of service companies
are prime candidates for ABLs. Solid ABL candidates will usually have tangible asset-rich
balance sheets, often with at least half of their total assets in working capital assets,
such as accounts receivable and inventory.
Like all lenders, asset-based loan providers look for companies with solid management
teams and a history of being able to effectively manage their businesses, even when
facing difficult circumstances. They also look for companies with excellent financial
accounting information systems that can provide reliable data about both operating and
Does company size matter in qualifying for an ABL?
No. Companies of all sizes can qualify for an ABL as long as their business is a good match
for the characteristics that asset-based lenders look for. For midsized companies, annual
revenues between $35 million and $250 million are typical of today’s borrowers. But ABLs
are also delivered just as easily to multibillion-dollar revenue companies.
What about credit ratings?
Since asset-based lending is always secured, its target market is non-investment grade
companies (companies with an actual or equivalent S&P rating of BB+ and below, or a
Moody’s rating of Ba1 and below). External credit ratings are not required to issue an ABL.
Which assets qualify as collateral under ABL structures?
Accounts receivable and inventory—assets that have a high degree of market liquidity
and can be easily valued and monitored—head the list of qualifying assets. Long-term
assets such as equipment and real estate are often used as additional collateral when
the ABL is structured as a term loan with a fixed amortization schedule.
Some proportion of even the most liquid of asset classes are typically ineligible in ABLs.
Examples include substantially past due accounts receivable, some types of work-inprocess
inventory or assets held for sale not in the ordinary course of business.
Project Finance can be characterised in a variety of ways and there is no universally adopted definition
but as a financing technique, the author’s definition is:
“the raising of finance on a Limited Recourse basis, for the purposes of developing a large capitalintensive
infrastructure project, where the borrower is a special purpose vehicle and repayment of the
financing by the borrower will be dependent on the internally generated cashflows of the project”
The terms ‘Project Finance’ and ‘Limited Recourse Finance’ are typically used interchangeably and
should be viewed as one in the same. Indeed, it is debatable the extent to which a financing where the
Lenders have significant collateral with (or other form of contractual remedy against) the project
shareholders of the borrower can be truly regarded as a project financing. The ‘limited’ recourse that
financiers have to a project’s shareholders in a true project financing is a major motivation for
corporates adopting this approach to infrastructure investment.
Project financing is largely an exercise in the equitable allocation of a project’s risks between the
various stakeholders of the project.
MBA Core Management Knowledge - One Year Revision Schedule