ABL mythbusters: The truth about asset-based lending

ABL has changed, as well as how businesses can leverage an asset-based loan. Read four ABL myths to understand the potential benefits of this effective, often cheaper financing option.

Tags: Assets, Cash flow, Financing, Loans
Published: May 26, 2021

One of the most interesting developments in corporate finance is the increased appreciation of Asset-Based Lending (ABL) as an effective, often less expensive option for financing asset heavy businesses with low cash flow. These are not your father’s ABLs. They are well-collateralized, competitively priced vehicles to finance large, successful companies. Yet decades-old misconceptions still cloud the understanding of ABL and – worse yet – may still keep some companies from considering a loan instrument that could be their most effective option for financing.

Why do those misconceptions still exist? ABLs earned their reputation decades ago, when they were seen as creative financing for troubled companies that didn’t have the cash flow to support traditional loans. “They’d say, okay, now we have to just mortgage everything we have to try to get a loan to pay down our current debt and keep the company going,” explains Matt Downs, a senior vice president for specialty lending at U.S. Bank. “They didn’t want to go back to the country club and say they just got an ABL loan, because everyone would look at them like they were about to file bankruptcy.”

Back then, most ABL deals were viewed as survival loans for “mom and pop” businesses. But Downs says investment banks started using the ABL structure for larger deals about 25 or 30 years ago, which completely changed the perception of the industry.

“That created a whole syndicated loan market for ABL deals. You can make a very large loan to a steel company that’s backed by accounts receivable, inventory, equipment and maybe some of their real estate,” he explains. “You can sell-off loan participations to other like-minded asset-based lenders to spread the risk. It’s all about debt capacity. The question is how much debt can you support, and some very successful companies can support more debt with asset-based financing.”


How ABL has changed

Traditional loans are based on cash flow or multiples of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). But ABL uses a different formula. As the name would suggest, asset-based financing is based on the value of the company’s assets, which become the loan’s collateral. As a result, a successful widget distributor with large inventory but low margins might have a much higher debt capacity with ABL.

“If you're trying to finance on a cash flow basis as a multiple of your cash flow or multiple of EBITDA, you might not generate very much.” Downs says. “But if you did it as a percentage of your actual inventory, because you carry a ton of inventory in a big warehouse as a distributor, you’re going to be able to generate a much larger number with an asset-based loan.”

As a result, an increasing number of large, successful businesses have discovered the merits of asset-based financing.

“That’s where ABL has gone, especially on the large corporate side,” he says. “It’s just another method of financing a company that maybe could generate more debt capacity in a different way.”

Still, despite its increased popularity, some of the concerns about ABLs continue to persist. So, changing that perception may require some ABL myth busting.


“It’s just another method of financing a company that maybe could generate more debt capacity in a different way.”

Myth: ABL is only a loan of last resort

Reality: ABL is really just another capital markets product. It’s simply a different way of financing a company that is more focused on asset levels than cash flow.

“For an asset-heavy company that has thin margins and doesn't really have large EBITDA levels, an ABL might be a better fit than for a company that doesn’t have a lot in the way of assets, but has a lot of earnings,” Downs says. “It just really depends on the makeup of the company, but there is still some of that negative connotation out there for folks who just have never dealt with ABL. They had an initial impression and they never spent the time learning the actual facts.”


Myth: ABL is not very popular with equity sponsors

Reality: Actually, ABL is used quite often to help finance acquisitions for the same reasons that it has become popular for other financing. Although the people that buy companies tend to operate in multiples of EBITDA, savvy investors recognize the value of a well-constructed ABL.

“It's a simple analysis,” Downs says. “A hypothetical equity sponsor buys a company for 10x EBITDA. They get total debt financing of 6 to 6.5x EBITDA and they provide equity for the rest. That 6.5x debt financing could be 4 to 4.5x of senior debt and the rest in high-priced junior debt. But ABL might not be a multiple of EBITDA at all. You might actually provide more, if not all, capital as low-cost senior debt because you're not basing it on the EBITDA, you're basing it on the assets of the company.”


Myth: ABL is very high priced

Reality: Although they may have been expensive during the “loan of last resort” days, today’s ABLs are actually inexpensive because the recoveries are so good.

“If the bank is just margining assets for the ABL, they know that if the company ever does have trouble, the bank will be able to get their money back by selling the assets,” Downs explains. “From an ABL standpoint, if a bank lends $300 million to a company, they probably have $400 million in assets. And if their earnings fell off a cliff, they're still going to have $400 million worth of assets. So, the bank can still get its money back by just selling off those assets if necessary.”

Under that scenario, he notes, the loss given default – or expected loss if the loan were defaulted – would be virtually nil. “And since the loan has such a low loss given default, they can actually price it cheaper than a traditional cash flow loan.”


Myth: ABL requires high maintenance or extensive reporting

Reality: Although there is reporting involved, it isn’t nearly as extensive as it was “in the old days,” because the companies and collateral are digital. You can set up reports on day one that automatically run for each reporting period. More importantly, the effort required to report the level and value of collateral is often far less burdensome than managing the restrictive covenants placed on cash flow loans.

“On an ABL loan, what you primarily do is just maintain your liquidity,” Downs says. “That actually makes it easier to borrow in the institutional syndicated term loan B (secured) and the high yield market (unsecured). Those creditors know that we don't have traditional covenants, so if the company has a downturn, we're not necessarily going to put them in default. The borrower and junior lenders have time to help cure the earnings or liquidity shortfall before the ABL actually defaults.”

At U.S. Bank, we’re here to help you decide if an ABL is right for your organization. Contact your relationship manager or visit usbank.com to learn more.