By Shaun McCabe, Partner, Browne Jacobson
As debt markets evolve to address economic conditions in the United Kingdom and globally, the willingness and appetite for asset-based lending (ABL) are increasing as businesses and lenders seek broader funding solutions. In recent months, ABL has become an increasingly prominent part of senior-debt funding structures.
ABL has been a funding option for many years, with mainstream and challenger banks as well as numerous independent funders providing ABL facilities. In summary, ABL is financing based on and secured by the business’s assets and structured to provide working capital by monetising the assets on the balance sheet (which can include receivables, plant and equipment, real property, inventory and intellectual property). ABL differs from traditional cash-flow lending based on borrowers’ historic and forecasted cash flows, which determine the levels of debt provided to businesses.
Changing economic conditions
During the COVID pandemic, the market for ABL was relatively quiet, with funders and businesses preferring the use of revolving credit, term loans and overdraft facilities (often backed by a guarantee from the UK Government as part of the CBILS [Coronavirus Business Interruption Loan Scheme], CLBILS [Coronavirus Large Business Interruption Loan Scheme] and BBLS [Bounce Back Loan Scheme]). Since then, rising interest rates and inflation have led to more caution in the debt market, with credit underwriters preferring to structure, in whole or in part, funding solutions based on asset values—given the improved collateral it offers to funders compared to cash-flow lending.
A significant number of CBILS and CLBILS facilities provided during the pandemic are reaching maturity and need to be refinanced. Unless repaid at maturity, those facilities will not benefit from the CBILS/CLBILS government-backed guarantee going forward. Lenders are increasingly focussing on credit risk, and in certain cases, the most viable (or possibly the only) funding option to refinance these facilities will be some form of ABL facility—especially given the increased security it offers funders compared with other types of lending. In certain sectors (for example, manufacturing), ABL may become one of the main financing sources available in the market.
ABL has always been an important funding source for businesses in stressed, distressed or turnaround situations. Even though the UK has avoided a recession, numerous businesses have been adversely impacted by inflationary pressures, rising interest rates and the cost-of-living crisis. Banks have increasingly flipped overdraft and revolving-credit facilities into receivable-financing facilities. ABL facilities have also refinanced bank funding for distressed borrowers in restructuring situations.
Pricing
For borrowers, ABL often represents a competitively priced option compared with cash-flow lending, given the facilities’ asset-backed nature. ABL pricing is a mix of interest (or discounting charges in invoice-financing facilities) and upfront and ongoing fees. This blended cost of capital is generally lower than a leveraged cash-flow loan. In a higher-interest-rate environment, borrowers have increasingly turned to ABL to source competitively priced funding.
Sponsor market, facility terms and committed facilities
In recent times, private-equity sponsors have become far more comfortable utilising ABL in their transactions, including management buyouts and acquisitions. Those ABL providers focussed on the sponsor community have worked hard with sponsors to allay their concerns. For instance, standard ABL documents have given ABL providers significant flexibility to alter limits and other terms in their documents. However, the “uncommitted” or “on demand” nature of the documentation has not suited sponsor-backed transactions.
Certain ABL providers have recognised this issue and agreed to provide more committed facilities. We have seen a number of private-equity transactions through which a sponsor has formed an ongoing relationship with an ABL, providing funding to several companies in its portfolio. In addition, the Loan Market Association (LMA) has recognised the importance of ABL to the debt market and published a borrowing-based facility agreement to facilitate market practices and standard terms for ABL facilities.
Innovations in ABL facilities
With macroeconomic conditions as they are, we have seen funders having broader conversations about funding solutions. Increasingly important is the need for flexible funding solutions to help businesses meet the challenges they face.
We have also seen certain ABL providers give more thought to creative and bespoke funding packages. For instance, one lender changed the nature of its facilities to enhance the flexibility of its ABL funding further and simplify and speed up business, unlocking the value tied up in assets. Rather than advancing funds against individual classes of assets (such as inventory or receivables), this ABL funder lends against a number of different fundable asset classes. This enables businesses to benefit from enhanced funding availability through their working-capital cycles and can be adapted to the needs of each borrower. For example, funding availability under an invoice-discounting facility may be impaired by “reserves” (in other words, an amount that the ABL may use to reduce funding availability—for example, because of an issue with certain customer invoices). By taking into account the value of other assets (rather than limiting funding for each individual asset class, such as receivables), the effect of this on funding availability may be offset or mitigated. These types of facilities are provided by way of either a term debt or revolving credit facility (or both), with a borrowing base certificate being produced monthly. These innovations will likely increase ABL funding for strategic opportunities, including supporting an acquisition buy-and-build strategy.
It is also worth noting that for particularly strong borrowers and those backed by private-equity houses, some ABL providers are willing to offer cash-flow lending as a bolt-on to ABL facilities.
Technological advances
Significant technological advances have been made in the systems employed by businesses and ABL providers (ABLs). In an environment where lean manufacturing is increasingly important to business competitiveness, businesses have invested heavily in technology to facilitate fast-moving inventory. These advances have allowed ABLs to monitor inventory in real-time and electronically, which, in turn, has caused them to become more comfortable funding against inventory values. ABLs have also invested in the platforms their customers use to operate and manage ABL facilities, therefore allowing businesses to receive the funds they need quickly.
Final thoughts
Undoubtedly, we will see ABL become more prevalent as a funding solution over the next few years, with the factors outlined above driving this trend. Liquidity is in the market (debt has been plentiful in the past few years), and lending appetite remains strong. But they are now tempered with more caution amongst credit underwriters faced with economic uncertainties. When an ABL structure is built correctly, it can effectively address the funding requirements of a business while providing necessary reassurance to lenders if the business does not perform as planned. Moreover, it offers the necessary flexibility as the business grows, whether organically or through acquisition. The willingness of ABL providers to adapt their funding solutions and raise their commitment levels will enhance ABL as an important source of funding in the UK economy.