Page 7 - MUFG Spring 2021

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phases of the economic cycle. We perform field examinations, obtain independent third- party appraisals of inventory and have the ability to institute cash dominion. It is viewed by most institutions as a safer and more structured way of lending. Therefore, it’s an incredibly competitive market right now. I would say that most institutions are very much invested in ABL.
What kind of companies find this kind of financing most attractive historically? What kind of companies are looking at it right now?
So many things were unknown at the time. We didn’t have a line of sight as to how long sales would be impacted, or if a greater percentage of accounts receivable would be stretched. Cash flow facilities have maintenance covenants which would clearly be impacted by stay at home orders, store closings, etc.
ABL facilities typically have a springing covenant but they are only tested if liquidity falls below a set threshold. The liquidity that a borrowing base advance generates provides companies more runway before potentially tripping a springing covenant. Asset levels are more certain in an economic downturn as compared to EBIDTA levels. Inventory values can be negatively impacted but managing a business to a borrowing base is easier than uncertain EBITDA levels. Although the pace of cash flow to ABL conversions have fallen off dramatically since the early months of the pandemic, until there is more economic certainty, the trend could continue (albeit at a much slower pace) into 2021.
Although we are now nine months into the crisis, there are still uncertainties. Once a vaccine is widely available, will consumers return to old shopping habits, or will brick and mortar stores see an even steeper decline. Inventory values have appeared to stabilize, but a glut of product from additional store closures could impact values once again.
What are some of the implications of this for the broader banking sector and for the broader economy?
The Covid 19 crisis, and the economic challenges that it created will have a lasting impact. I don't expect that there will be a rush to return to cash flow based facilities once the economy is stable. . Asset-based lending is much more mainstream today. Generally, once borrowers get used to the additional reporting requirements, they remain in ABL structures. The benefits are obvious when funding growth or dealing with operational challenges. ABL is very much a product that is designed to support customers through all economic cycles.
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Historically, we typically saw a little bit of movement from cash flow to ABL or ABL back to cash flow every year or two. It is a normal progression. In March of this year, once the Covid 19 epidemic started to have a significant impact through stay at home orders, non- essential business shutdowns, etc. we started to see a much more proactive move from cash flow to ABL borrowers, primarily in the retail sector. In most cases, Companies were being proactive, looking to generate the most liquidity and avoid tripping covenants.
Asset based lending can be attractive to companies of all sizes. It's utilized by middle market companies with revenues as low as 100 million dollars to large corporate borrowers with revenues well into the billions. The most common trait that we see in asset-based borrowers is large quantities of inventory. Typically, the largest concentrations within the ABL industry are in retail, equipment rental, food and beverage companies and general distribution. The primary reason is that cash flow based revolvers set credit limits based on financial metrics, (multiples of EBITDA, leverage ratios, etc..) in determining overall credit limits. In contrast, ABL credit facilities are based on collateral values. The typical advance rates are 85% of eligible AR and 85 % of the net orderly liquidation value of inventory. Using this methodology generally provides greater access to liquidity.
Q from secured cash flow facilities into asset A
Q What trends are you seeing in terms of companies or lenders converting facilities
based facilities.
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SPRING 2021 / MUFG TRANSACTION BANKING AMERICAS GROUP