Asset-Based Lending Nationwide Industry Standard Practices and Procedures Important in Business Litigation
Renowned expert witness, experienced asset-based lender and former high-level banker and banking regulator Don Coker explains nationwide industry standard policies, practices and procedures for asset-based lending at institutional and private lending entities.
Asset-Based Lending Overview
Asset-based lending refers to lending that is secured by balance sheet assets other than real estate. An asset-based lender looks to balance sheet assets rather than cash flow in determining how much it will lend and under what terms. In essence, the asset-based lender and borrower are both looking to the asset-based financing to provide a source of funds that will be available even if cash flow funds are not available. In the worst case scenario and in the absence of cash flow from the business, the asset-based lender expects to be able to obtain full repayment of the asset-based loan from the sale of the balance sheet assets that secure its loan.
Lenders that offer asset-based loans include:
● Institutional lenders such as banks, although some institutional lenders do not possess the expertise necessary in order to offer, originate, and properly service these types of loans.
● Non-bank private lenders which can run the gamut from the GE Credits down to the local or regional variety of private lenders.
Keep in mind that regulated institutional lenders, such as banks, have guidelines that define what they can and cannot do in structuring asset-based loans; whereas unregulated asset-based lenders are not subject to those restrictions.
Potential collateral for an asset-based loan includes:
● Accounts receivable;
● Raw materials;
● Notes receivable;
● Intangible assets;
● Sometimes rolling stock or equipment;
● First or second mortgages on real estate assets (used sometimes, but infrequently).
A “borrower’s certificate” usually is required by the asset-based lender wherein the borrower certifies the level of the eligible accounts receivable, and is accompanied by an aging of the accounts receivable.
It is common for asset-based lenders to carry out periodic audits of the borrower’s collateral. Depending upon the nature of the business, the lender might audit all of the collateral or a representative sample. The frequency of audits can be anywhere from monthly to three or four times per year depending upon the lender’s level of comfort with the borrower.
Chattel collateral is secured by a UCC-1 filing and real estate collateral is secured by a standard mortgage or deed-of-trust depending on the laws of the state where the property is located.
Asset-Based Loan Structure
The usual purpose of asset-based lending is to provide working capital for the company. Some lenders, such as banks, make unsecured working capital loans to strong borrowers with whom they have an established relationship; but it has been my experience that non-bank lenders almost always require collateral.
Since the usual assets that secure an asset-based loan are accounts receivable, inventory, and raw materials, all of which flow through the company as raw materials flow in, are transformed into product, and then flow out resulting in accounts receivable, asset-based loans secured by these assets are structured as revolving lines of credit where the borrower pays monthly interest-only on the average outstanding balance, and pays the principal upon maturity. Often, these loans are set up on an annual basis, and renewed when the borrower demonstrates its ability to pay off the line upon maturity.
If hard assets, such as equipment, machinery or rolling stock, are used as collateral by an asset-based lender, typically it is set up on a separate term loan with repayment terms that are reflective of the asset’s anticipated useful life.
Similarly, if real estate is used as collateral by an asset-based lender, it often is set up on a separate term loan with principal and interest payments and an amortization of up to five years or so and possibly on a balloon basis.
Eligible Collateral and Borrowing Base
In order to determine how much a borrower can borrow on an asset-based loan, the lender closely examines the prospective collateral and determines what collateral is “eligible” to serve as collateral for the asset-based lender. Basically, the lender is trying to weed out any collateral that it deems questionable are unlikely to result in an inflow of funds to the company and in turn, to the lender. The aggregate of all of the eligible collateral is sometimes referred to as the borrower’s “borrowing base”.
Once the eligible collateral is established and criteria set up for acceptable collateral that will be received after the loan is closed, then the asset-based lender applies its current loan-to-value ratio for each of the types of collateral. For example, the lender may allow the borrower to borrow up to 85% loan-to-value ratio against eligible accounts receivable and up to 65% loan-to-value ratio against the value of eligible inventory. Asset-based lenders vary in their quality opinions regarding certain types of collateral and the loan terms that they will offer to a borrower.
Conditions of the Loan
A typical asset-based lender is less strict than is an institutional lender when it comes to restrictive covenants as a part of its financing structure offered to borrowers, and the main criteria relied upon are the definition of eligible collateral and the borrower’s debt coverage ratio, sometimes called the “fixed charge coverage ratio”. The asset-based lender wants to see that the borrower will be able to cover its debt service requirements as well as any other anticipated expenditures that will be required to keep the business moving forward.
Springing vs. Full Dominion Loans
"Dominion" is an asset-based lending term that defines how the proceeds of the payments that are received on the collateral accounts receivable are to be applied to repaying the debt owed to the asset-based lender.
If the loan is a “springing dominion” transaction, then typically so long as the level of the outstanding debt is lower than the borrower’s available credit under the asset-based lender’s loan facility or less than the borrowing base, then the payments may be sent to and collected in a lockbox and then swept to an account controlled by and accessible to the borrower.
In a “full dominion” asset-based loan, the payments that are paid into the lock-box account are applied to repaying the outstanding balance owed on the asset-based loan as the payments are received on a daily basis.
Asset-based loans, such as those described in this article, are different from most other types of loans in that the collateral is ever-changing as new raw materials flow in, products are produced, and then sold to buyers, resulting in accounts receivable. It is the changing nature of the collateral that results in a challenge for the asset-based lender.
© 2012 by Don Coker. Serving clients worldwide from his Atlanta metro area office.
ABOUT THE AUTHOR: Banking, Lending, and Asset-Based Lending Expert Witness Don Coker
Expert witness and consulting services. Over 500 cases for plaintiffs & defendants nationwide, 120 testimonies, 12 courthouse settlements, all areas of banking and finance. Listed in the databases of recommended expert witnesses of both DRI and AAJ.
Clients have included numerous individuals, 75 banks, and governmental clients such as the IRS, FDIC. Employment experience includes Citicorp, Ford Credit, and entities that are now JPMorgan Chase Bank, BofA, Regions Financial, and a two-year term as a high-level governmental banking regulator.
B.A. degree from the University of Alabama. Completed postgraduate and executive education work at Alabama, the University of Houston, SMU, Spring Hill College, and the Harvard Business School. Called on by clients in 31 countries for work involving 61 countries. Widely published, often called on by the media.
Don Coker serves clients worldwide from his Atlanta metro area office.
Copyright Don Coker
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.