ABL mythbusters: The truth about asset-based lending

May 26, 2021

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. 

 

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.

Related content

What corporate treasurers need to know about Virtual Account Management

Tailor Ridge eBill case study

5 times you may need a financial advisor

How to use debt to build wealth

4 benefits of independent loan agents

Gifting money to adult children: Give now or later?

Middle-market direct lending: Obstacles and opportunities

How I did it: Deciding whether to buy an RV

Take the stress out of buying your teen a car

Financial steps to take after the death of a spouse

Small business growth: 6 strategies for scaling your business

Unexpected expenses: 5 small business costs to know and how to finance them

Streamline operations with all-in-one small business financial support

Healthcare marketing: How to promote your medical practice

Beyond Mars, AeroVironment’s earthly expansion fueled by U.S. Bank

Key considerations for launching an ILP

Personal loans first-timer's guide: 7 questions to ask

Dear Money Mentor: When should I refinance a mortgage?

Evaluating interest rate risk creating risk management strategy

First-time homebuyer’s guide to getting a mortgage

Opening a business on a budget during COVID-19

How Everyday Funding can improve cash flow

What’s a subordination agreement, and why does it matter?

Understanding the true cost of borrowing: What is amortization, and why does it matter?

Parent checklist: Preparing for college

What are conforming loan limits and why are they increasing

Should you get a home equity loan or a home equity line of credit?

10 ways a global custodian can support your growth

Annual insurance review checklist

6 tips on trust fund distributions to beneficiaries

How to establish your business credit score

8 Ways for small business owners to manage their cash flow

What is a CLO?

How to choose the right custodian for your managed assets

When to consider switching banks for your business

Addressing financial uncertainty in international business

Leveraging the ASC-842 rule changes in equipment lease accounting

30-day adulting challenge: Financial wellness tasks to complete in a month

Allowance basics for parents and kids

Common unexpected expenses and three ways to pay for them

Dear Money Mentor: How do I set and track financial goals?

Money Moments: How to finance a home addition

How I did it: My house remodel

Is it the right time to refinance your mortgage?

4 questions to ask before you buy an investment property

What is a home equity line of credit (HELOC) and what can it be used for?

Is a home equity line of credit (HELOC) right for you?

10 uses for a home equity loan

How to use your home equity to finance home improvements

What to know when buying a home with your significant other

Webinar: Mortgage basics: What’s the difference between interest rate and annual percentage rate?

Webinar: Mortgage basics: How much house can you afford?

Webinar: Mortgage basics: Buying or renting – What’s right for you?

Webinar: Mortgage basics: What is refinancing, and is it right for you?

Webinar: Mortgage basics: Prequalification or pre-approval – What do I need?

Webinar: Mortgage basics: How does your credit score impact the homebuying experience?

Webinar: Mortgage basics: Finding the right home loan for you

Webinar: Mortgage basics: 3 Key steps in the homebuying process

8 steps to take before you buy a home

These small home improvement projects offer big returns on investment

What is refinancing a mortgage?

How do I prequalify for a mortgage?

6 questions to ask before buying a new home

Resources for managing financial matters after an unexpected death

Student checklist: Preparing for college

Webinar: Uncover the cost: College diploma

The A to Z’s of college loan terms

Co-signing 101: Applying for a loan with co-borrower

Practical money skills and financial tips for college students

How I did it: Paid off student loans

Is online banking safe?

Everything you need to know about consolidating debts

7 steps to keep your personal and business finances separate

Your quick guide to loans and obtaining credit

Test your loan savvy

Is a home equity loan for college the right choice for your student

How to apply for federal student aid through the FAFSA

Be careful when taking out student loans

Your financial aid guide: What are your options?

ABL mythbusters: The truth about asset-based lending

Collateral options for ABL: What’s eligible, what’s not?

Renewing your custody contracts? Negotiate the fees.

How jumbo loans can help home buyers and your builder business

How liquid asset secured financing helps with cash flow

When small companies buy big: The potential of asset-based lending

Common pitfalls to avoid in the equipment financing process

How to maximise your infrastructure finance project

Car shopping Buying versus leasing your next vehicle

Questions to ask before buying a car

What you should know about buying a car

How to choose the best car loan for you

What you need to know before buying a new or used car

Can you take advantage of the dead equity in your home?

How to get started creating your business plan

How to fund your business without using 401(k) savings

The different types of startup financing

Costs to consider when starting a business

How business owners are managing during the supply chain crisis

How to expand your business: Does a new location make sense?

Meet your business credit card support team

Business credit card 101

5 tips for managing your business cash flow

How to apply for a business credit card

How a small business is moving forward during COVID-19

Prioritizing payroll during the COVID-19 pandemic

5 tips to help you land a small business loan

Leverage credit wisely to plug business cash flow gaps

How to make the most of your business loan

Break free from cash flow management constraints

Investing in capital expenditures: What to discuss with key partners

Can ABL options fuel your business — and keep it running?

Finance or operating lease? Deciphering the legalese of equipment finance

Buying or leasing? Questions to ask before signing a contract

4 ways Request for Payments (RfP) changes consumer bill pay

ePOS cash register training tips and tricks

Cashless business pros and cons: Should you make the switch?

Protecting cash balances with sweep vehicles

Tech lifecycle refresh: A tale of two philosophies

At your service: Outsourcing loan agency work

Why retail merchandise returns will be a differentiator in 2022

Technology strategies to complement your business plan

Maximizing your infrastructure finance project with a full suite trustee and agent

Buried treasure: Maximizing analytics for treasury management

An investor’s guide to marketplace lending

Alternative assets: Advice for advisors

What type of loan is right for your business?

A simple guide to set up your online ordering restaurant

Higher education and the cashless society: Latest trends

Start of disclosure content

Loan approval is subject to credit approval and program guidelines. Not all loan programs are available in all states for all loan amounts. Interest rate and program terms are subject to change without notice. Mortgage, home equity and credit products are offered by U.S. Bank National Association. Deposit products are offered by U.S. Bank National Association. Member FDIC.

U.S. Bank is not responsible for and does not guarantee the products, services or performance of U.S. Bancorp Investments, Inc.