Understanding asset-based lending and its value
Asset-based lending (ABL) has evolved over the last several decades, and as a result, the value and usefulness is frequently misunderstood. Here to break down the complexities and explain the importance of this area of banking are Greg Carasik, executive director, UMB Capital Finance and Doug Motl, executive vice president, director of originations, UMB Capital Finance.
What is asset-based lending?
Many businesses have capital needs that go beyond what a traditional commercial bank credit structure can (or should) provide. Asset-based lending is a form of capital that is most often used by businesses that need or want to utilize a very high percentage of their maximum debt capacity. Because lending to these leveraged enterprises involves a lower margin for error, asset-based lenders take a more detailed approach to the determination of debt capacity. Core debt capacity is determined by a careful analysis of key business assets. Asset valuations are provided by knowledgeable, independent appraisers. Field diligence is also performed to evaluate books and records, ensuring accurate financial reporting and measuring the performance of current assets. Analysis of a borrower’s operating performance and capital asset needs will then determine the debt service capacity and the liquidity/borrowing availability required to fund ongoing operations. The strength and sustainability of the cash flow stream will determine any degree to which debt capacity may exceed core asset values.
The initial and ongoing diligence performed by an asset-based lender allows greater access to capital, but in return requires more frequent and detailed financial reporting. The incremental risks involved in financing a more leveraged enterprise also result in a higher cost of capital, in comparison to traditional commercial banking. ABL is, therefore, generally best suited to a business with robust information systems and a sound business strategy.
ABL borrowers generally fall into one of two primary categories:
The first category is a borrower whose funded debt needs are expanding to near capacity due to an aggressive growth strategy. These cases may be driven by organic growth, such as geographic expansion or the addition of a new product line. They may also be driven by the strategic acquisition of another operating business. Aggressive growth strategies create the need for greater leverage in relation to debt capacity, but they also present specific risks, such as execution risk and transition risk, which require more specialized underwriting. In some cases, debt capacity may include term debt in excess of the value of assets. In such cases, an ABL revolving credit facility remains at the core of the debt structure, as proper control of working capital is critical to the management of a leveraged enterprise. In order to successfully fund an aggressive growth strategy, asset-based lenders must often work efficiently alongside other forms of capital. Knowledge of capital markets and the framework of inter-creditor relationships is an important feature of ABL.
The second main category of ABL borrowers involves a business whose funded debt needs are somewhat stable, but whose debt capacity has contracted due to operating performance or economic circumstances. This category of borrower is often misunderstood in relation to its candidacy for asset-based lending. The presence of poor operating performance is not the distinguishing feature of an ABL borrower. A potential candidate for ABL is very often a business whose strategy for profitable growth has been interrupted by an unexpected event, such as the loss of a key customer, an operational problem/issue or a cyclical factor in the economy. What makes a business in this situation a viable candidate for ABL is a clear near-term strategy for a return to profitable growth and the debt capacity to properly execute this strategy. Debt capacity in these cases is generally tied closely to the value of assets, due to volatility in the trailing cash flow stream.
Where does ABL fit in within UMB’s overall suite of offerings?
ABL represents an extension of our traditional commercial banking product suite. UMB has made substantial investments in systems and key personnel in order to meet the needs of certain more leveraged businesses, operating near the edge of available debt capacity. Some businesses, especially those owned by private equity firms and other strategic investors, may have a consistent need for such leverage. Other businesses will have acute, shorter-term needs to operate near maximum debt capacity. As these needs subside and debt levels normalize, these businesses will often choose to return to a traditional commercial banking environment, which provides a lower cost of capital and less rigorous day-to-day reporting requirements. We encourage this transition along the spectrum of credit product offerings, as we respond to the varying needs of our commercial clients.
How is UMB unique from other ABL providers?
The feature that distinguishes us the most from our direct competitors is our ability to fund transactions throughout a broad performance profile. We have successfully closed recent transactions to finance aggressive growth strategies, as well as certain mid-stage turnaround strategies. From a size perspective, we have played key roles in transactions over $40MM, while remaining equally willing to focus on transactions with debt commitments under $15MM. Another key feature is our willingness to customize a credit structure to fit the needs of each borrower. These structures often include unique covenants built to fit a particular business or industry.
What is the future of ABL at UMB?
The ABL group has had great success over the last six years since it entered the UMB fold in 2015. The team contributes to the bank’s overall health by providing services that produce higher yields, a national footprint to sell banking services and the ability to provide financing throughout a customer’s life cycle. UMB has structured the ABL group to have the flexibility to compete on a broad profile of transactions based on price, structure, and size. Our internal credit approvers are extremely supportive of the ABL product and grant us the ability to compete and retain relationships throughout a broad financial performance spectrum.
As with any lending structure, ABL has its nuances, but provides significant value to clients and the bank alike. For more information on UMB’s ABL group, visit https://www.umb.com/business-banking/capital-finance/asset-based-lending.
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Greg Carasik and Douglas Motl