For those with experience using or currently servicing asset-backed financing lines, what are some of the preconditions, covenants and cash controls your organization has agreed to with its ABL lenders?
Asset-backed Lending and Credit Insurance
Answers
The "preconditions" are that the lending institution believe that you can make payments and return principal (in any structure). If you are cash producing, what are your expected future cash flows and are they ample for making payments. If you are not profitable now, what are your plans for making the payments and how much do they believe them. If you are early stage (e.g. venture backed) the bank will spend time with your investors. If they get the feeling that your investors are behind you and will continue investing, that will go a long way. In that case, they are betting not on you alone, but on whether your investors will be there to cover your cash needs through good times and bad.
Covenants typically follow those elements that the lender thinks are important to your meeting your obligations to them. Thus, you can expect cash flow goals, cash/balance sheet strength ratios, etc.. One tihng to push back on, however, are covenants that would tie your hands as an operating entity. I have had success pushing back on covenants that I thought (and could successfully argue) would make it harder for the company to thrive. When you go into that negotiation you should have your full list of negotiating points and you should understand your deal continuum: what can I give up easily, what do I have to fight for, and what are those final elements in-between that I can bend on if push comes to shove.
I have seen some banks require that the collections on the assets (usually A/R) come through their bank.
Also, has anyone used credit insurance to help mitigate their exposure?
Credit Insurance is very unique, and as a unique product has some unique "gotchas" associate with the product. It can save the proverbial bacon, or fry it.
Make sure you both understand the product and go through the contract with a fine tooth comb. Most CI contracts won't pay if the client utters the words (this is very simplified) "dispute".
Caveat Emptor
I agree with the comment on credit insurance. If you don't understand how cumbersome it is to comply and how damaging it can be if you don't you've wated your money. I've approached credit insurance from a rsik
If you look at your premiums and deductibles and compare it to your historical losses, credit insurance could be a waste of money. Wayne's point about frying the bacon is good advice.
We use Credit Insurance primarily as a
My company has used credit insurance selectively for a couple of years. We were fortunate that the amount we wanted to finance could be secured using the receivables of our largest customer who has an excellent credit rating.
The reporting can be time consuming but after the first couple months we found it not that difficult to comply.
I agree with the other comments that you need to carefully read the policy to make sure you understand under what conditions the premium will pay out and what you can actually expect to net.
First it is important to have a strong relationship with your partners at the lending institution as issues will arise. Understand your cash to cash cycle throughout your entire business cycle. A typical lending format will be about 60% against inventory and 80% against AR. Two covenants that you may need to forecast will be Debt Ratio and FCCR. Debt ratio drives your interest rate and is usually calculated at Debt/EBITDA. Depending on your type of corporation, restrictions on Dividend Distributions are driven from the FCCR. Components of what is considered a Fixed Charge are important. Leasing also comes into play with negative covenants, which I imagine will become more important with the new leasing reporting from FASB. Asset Lending is a good tool to self-police your cash flow, but can restrict a business during times of growth with investment.
In a former life I oversaw an asset based loan agreement for my company. We selectively used credit insurance to credit enhance receivables that would otherwise not be included in our borrowing base. For example, foreign receivables, receivables over the concentration limit, or receivables not meeting some other criteria. We were always short of cash and this was a way to improve our liquidity (at an additial cost).
Credit insurance when use properly can actually increase business by providing additional head room on a low internal credit limit determination. Conversely, if a credit insurance company won't insure one of your customers, you might have a problem and should be reviewing your internal credit decision.
In other words, if your internal credit decisions are less than perfect, the knowledge you can gain from a credit insurance company can be very valuable.
As a former ABL lender, we used credit insurance primarily on accounts that had concentration risks either in their customer or industry bases. A diverse base should provide sufficient protection that insurance is not necessary. The ABL lender should have credit history within its own records on many of your customers and will use its own resources to do a thorough risk analysis. Scott's comment that knowledge gained from either an insurer or lender in relation to your own credit policies should be well heeded.
As for covenants/ preconditions, an ABL lender values the tangible assets securing the loan much more than typical soft controls of a commercial bank (ratios, goals, even profitability). The ABL lender will stress controls on the assets. We required lockbox control of the receivables which were pledged in the borrowing base, monthly reporting of a companys bank activity (mainly watching the deposit side), regular financial reports, reports of inventory activity and supporting documentation, proof of insurance of warehouses/inventory, and the ability to audit as necessary. Customers biggest push back was usually in the lock box of payments but that typically is a precondition of acceptance. One area where there is room for negotiation is the verbiage of language in notifying your customers to redirect to a lockbox. To secure the transaction, there is certain language required in the notification by the UCC. ABL lenders sometimes will provide initial flexibility in language to get lockbox control but will always reserve the right to notify your customers with harsher language should lockbox controls be violated.
Filed Under:
FP&A