Asset-Based Lending (ABL)

Asset-based lending (ABL) is a loan, most often a revolving line of credit, secured by a company's working assets: accounts receivable, inventory and sometimes equipment. The lender sizes the credit by the value of that collateral rather than by earnings alone. The OCC (Office of the Comptroller of the Currency), which supervises national banks in the US, describes ABL as fully secured credit used by companies with high debt or uneven earnings. Healthy companies use it too, because it often comes with fewer financial covenants.

The heart of ABL is the borrowing base. Each type of collateral gets an advance rate, the share the lender will lend against. Say a distributor has $1,000,000 of eligible receivables and $500,000 of eligible inventory. At hypothetical advance rates of 80 percent and 50 percent, it can borrow up to $800,000 plus $250,000, or $1,050,000. As sales and collections move, that limit moves too.

Why it matters for lenders

ABL protects a lender by keeping close watch on collateral instead of relying mainly on forecasts. That protection only holds if the monitoring actually happens. Typical controls include:

• Borrowing base certificates, often weekly or monthly, where the borrower reports receivables, inventory and availability.
• Field exams, where auditors visit the borrower to test the books, sample invoices and credit memos, and check inventory.
• Cash dominion, where customer payments go to a lockbox the lender controls. Under springing dominion, the lender takes control only if the borrower trips a set trigger.
• Reserves, which are dollar deductions for risks such as dilution or the cost of selling off inventory.

When these controls slip, losses can come fast. Stale reports, receivables pledged to two lenders, and over-advances (loans above the borrowing base) are common sources of trouble. ABL is closely related to invoice factoring, but in ABL the borrower keeps ownership of its invoices and usually collects them itself.

How it works in practice

A lender's portfolio manager receives a monthly borrowing base certificate from a food distributor, with a receivables aging report and an inventory report. The manager removes ineligible items, such as invoices well past due, sales to affiliated companies, and amounts above a single-customer limit. Then the advance rates and reserves apply, and the result is compared with the loan balance to find availability. If the balance is above the base, the borrower must pay down the gap.

Done in spreadsheets, each certificate is rebuilt by hand and errors carry forward. Keeping certificates, eligibility rules, exam results and loan covenants on the same loan record helps a team spot trends, such as rising dilution, before they turn into losses.