Asset-Based Lending

Overview

ABL is a specialized loan product that provides fully collateralized credit facilities to borrowers that
may have high leverage, erratic earnings, or marginal cash flows. These loans are based on the assets
pledged as collateral and are structured to provide a flexible source of working capital by monetizing
assets on the balance sheet. While troubled companies often rely on ABL to provide turnaround,
recapitalization, and debtor-in-possession (DIP) financing, ABL is also used by healthy companies
seeking greater flexibility in executing operating plans without tripping restrictive financial
covenants.

The primary source of repayment for revolving ABL facilities is the conversion of the collateral to cash
over the company’s business cycle. Loan advances are limited to a percentage of eligible collateral
(the “borrowing base”). Strong controls and close monitoring are essential features of ABL. ABL
lenders may also provide term financing for borrowers requiring longer-term capital or funding
needs.

National banks may engage in ABL with no aggregate limitations, provided the volume and nature of
the lending do not pose unwarranted risk to the bank’s financial condition. Certain limitations apply
to FSAs as set forth in 12 USC 1464(c)(2) and 12 CFR 160.30. ABL loans typically would be classified as
commercial loans, which cannot exceed 20 percent of total assets provided the amounts in excess of
10 percent of total assets are used only for small business loans as defined in 12 CFR 160.3, “Lending
and Investment—Definitions.” An FSA, however, might engage in ABL under other authority,
depending on the circumstances. For example, to the extent an ABL loan is secured by
nonresidential real property, an FSA may make the loan under its nonresidential real property loan
authority.

Advantages

ABL’s popularity among borrowers is attributable to the following characteristics:

• ABL provides ready cash to support liquidity needs, eliminating the need to wait for the
collection of receivables.

• ABL provides important funding for companies in cyclical or seasonal industries by providing
liquidity during slow sales periods and periods of inventory buildup.

• ABL provides rapidly growing companies the cash to fund growth or replenish internal capital
used to fund growth by financing increases in receivables and inventory.

• ABL facilities are typically underwritten with a limited number of financial covenants; the
additional risk this poses to the bank is mitigated by conservative advance rates against liquid
collateral, strong collateral controls, and frequent monitoring.

• Borrowing terms and repayment schedules generally provide more flexibility and can be
customized to fit the individual business requirements or business cycle.

• ABL borrowers in many cases can monitor availability on a daily basis.

For lenders, ABL can be a profitable, well-secured, and low-risk line of business if strong controls are
established.

Disadvantages

ABL can present disadvantages for the borrower and the lender. For the borrower, an ABL facility is
often more expensive than other types of commercial lending. Interest rates and loan fees are
generally higher and the costs associated with frequent reporting requirements greater (despite this,
ABL may be the most economical type of financing available to the borrower). Another potential
disadvantage to the borrower is that loan agreements typically allow the lender to take control of the
borrower’s cash or more readily seize collateral if the borrowing base declines to a level that does
not support the loan.