Appropriately structuring the Asset Based Lending facility is critical to the success and ongoing performance of the credit. In setting up the structure for the facility it’s important to consider a range of factors covering:
- Data Integrity
- Asset eligibility and amortization
- Accounting policies
A miss in any of these areas can have downstream effects that might lead to uncomfortable conversations with the borrower or even a scenario where under seemingly benign market conditions the lender is now in an ‘over advanced’ position and must trigger a repayment from the borrower. In the worst instance, a lender might extend financing on collateral that’s ineligible or is inaccurately valued as the client’s information, such as the model year, was incorrect.
Data Integrity: Quality in, quality out
A key variable in the appraisal process is the company’s asset register. To the extent there is any errant information within the file this can drive a large disconnect in the appraisal values and create stress in the borrowing base as this persists. Any missing information should be prioritized so borrowers are held to a standard that supports an accurate lending facility. A lender should partner with the appraiser to ask key questions around:
- What’s driving the cost / NBV provided? Does the cost appear to be reasonable based off the nature of the purchase (new or used) and is the NBV accurate? Has cost been remarked based off a balance sheet review to a value other than acquisition cost such as Fair Value or a prior NBV as an asset was transferred?
- Are the model years representative or have they been derived from the acquisition date?
- Do they track and report on the usage, configuration, location and status of the assets?
Asset Management: Eligibility and Amortization
Within any collateral pool, there are often individual assets or groupings of assets that may not be suitable for inclusion in a borrowing base. This can include:
- Down Units: Companies typically run a constant line of down assets and it’s natural for units to cycle in / out of this bucket. In a distressed situation, where capital is limited, maintenance can become a lower priority. It’s possible for these to be neglected and these assets can be ‘red flags’ for prospective liquidation buyers
- Low Cost / Accessory Components: Often borrowers will have a supplemental inventory of attachments and other various low-cost items that support their core business. These assets may be not clearly tracked or easily identified. Dependent on these factors, these might be a candidate for ineligibility
- Old / Obsolete Assets: While the concept of ‘slow-moving’ assets or obsolescence is most often reserved for inventory valuations, there are scenarios where you might also consider this when looking at construction equipment. Is the asset no longer used or perhaps technologically obsolete? Is the age well past the typical observed in the market?
Trying to find opportunities to ‘squeeze’ dollars out of the assets most often leads to false inflation in the availability.
It’s common within ABL facilities, especially in cases where appraisals are less frequent, to incorporate an amortization factor on the outstanding balance. Within the construction equipment domain there are a variety of assets a company might own for different applications from high cost wear and tear rigid mining trucks to low impact skid steer loaders. Likewise, different asset classes can oftentimes exhibit varying degrees of deprecation. A good understanding of these variable residual value depreciation rates can enable a borrowing base structure that aptly aligns with the collateral in question.
Accounting Policies: Depreciation and its implications
Assets can be deployed / utilized in a variety of functions within a company’s business and often dependent upon this they have a different depreciation policy assigned to them. Lenders should ask: Is the policy reasonable? How would this impact my projections as I model future availability? Overly ‘aggressive’ policies will lead to high volatility in the advance rate as assets tend to lose value at a rapid rate and the resultant minimized NBV denominators can cause high fluctuation in key lending ratios. Likewise, overly conservative policies lead to natural questions from a borrower around “Why is my NBV higher than OLV? This doesn’t make sense.” A reasonable and understood policy will minimize these sorts of questions and help in modeling future advance rates. Similarly, most equipment rental / dealer companies will have a New Stock, Used Stock, and Rental business division. These divisions might all be subject to different depreciation policies and potentially recovery characteristics, generally sales stock is not depreciated where rental assets are. Developing an advance rate against each of those is key so changes to the mix of these business units don’t impact availability.
Lenders should be keen to establish the best foundation possible for the Iending facility and the Appraiser should serve as a key partner in helping assess the potential fleet. In the final part of this series we’ll discuss key areas for collateral monitoring as part of the ongoing ABL management.