Interview with: Doug Winget, FirstMerit Bank
source: by Matt McClellan, Smart Business Columbus | November 2010
For many companies, obtaining credit through conventional cash flow lending arrangements can be difficult. They may be having operational problems, undergoing rapid growth, dealing with an acquisition, or their borrowing needs might reflect their cyclical or seasonal industries.
For those companies, asset-based lending provides an alternative to the traditional lending model. Asset-based lending groups specialize in providing secured financing to customers with limited access to capital.
“Asset-based lending provides a simplistic structure,” says Doug Winget, senior vice president, head of asset-based lending and floorplan lending at FirstMerit Bank. “Typically, asset-based lending has fewer covenants than a cash flow structure and more availability from the assets. It also may not need a personal guarantee from the owner.”
Smart Business spoke with Winget about how asset-based lending can provide financing help to those who need it.
What is asset-based lending?
Asset-based lending is senior secured lending that allows the borrower to leverage their receivables, inventory, equipment and real estate. Advances are based upon eligible collateral, with formulas against receivables, inventory, equipment and real estate. The working capital line of credit is financed against eligible receivables and inventory.
What types of situations are best suited for this type of lending?
Companies that have sufficient receivables and inventory can leverage their working capital and get higher advance rates. They can use this for working capital financing, seasonal working capital borrowing needs, leveraged recaps, mergers and acquisition financing, and turnaround financing.
How can an organization determine if asset-based lending is the right choice?
If the company is looking for more availability from its working capital, that profile fits asset-based lending. ABL advance rates will be higher against accounts receivable and inventory, which provides more availability than a traditional middle-market cash flow structure. Companies that have a strong EBITDA and an earnings profile relative to working capital will likely have more availability from a cash flow product, but companies that are more asset-intensive will benefit from an asset-based structure.
What are the differences between ABL and middle-market?
One big difference between ABL and middle-market lending is cash dominion versus non-cash dominion. ABL structures require cash dominion. That means there is a controlled account agreement and the receipts of a company’s receivables come into a lockbox. Then the funds flow from the lockbox and are used to pay down the revolving debt. The bank essentially has control of the cash, which is a traditional fundamental aspect of asset-based lending.
Another big difference is that asset-based lending groups are more comfortable with leverage. They are not as leverage-focused as the traditional cash flow structure when you get above three times the ratio of debt to EBITDA. Asset-based groups don’t focus on this leverage ratio because they are comfortable within the assets. ABL groups are collateral focused, not leverage focused.
ABL is also a more patient financing solution. For companies in cyclical industries, ABL groups will work with them and be more patient than the traditional cash flow structure, as long as they stay within the assets and have sufficient liquidity.
Asset-based lending is a longer-term commitment. ABL deals are three-year commitments; traditional middle market deals are one- to two-year commitments.
The longer deal provides more certainty to the borrower. Also, it’s very time-consuming to restructure your deal every year or two. If you have a three-year deal, at the maximum you are only doing this every two years. Basically, a long-term deal gives you more certainty and less work.
What challenges do companies in cyclical industries face under traditional lending?
Cyclical industries have up and down periods. When they hit more difficult times and their leverage ratios get to be high, the bank may become uncomfortable with that structure — even if they are within their assets. They don’t have the monitoring that asset-based lending groups provide, so they need to be tighter on the leverage ratio. Traditional lending models might require the owner to sell assets or put cash equity into the business in some form to reduce leverage and debt.
What is involved in the monitoring process?
The borrower typically provides a monthly borrowing base certificate, which details their collateral and their revolving debt position. Then, they generally provide weekly (and sometimes daily) updates and roll forwards of accounts receivable. The bank will want to see quarterly or monthly financial statements as well as annual reviewed or audited financial statements.
How are covenants and the necessity of personal guarantees determined?
Typically, a cash flow structure may have three or four financial covenants, and an ABL structure will have only one financial covenant. Asset-based lenders are comfortable within the assets and the ongoing collateral monitoring. There is more reporting that is required with an asset-based structure, but the benefit is more availability, less financial covenants, and potentially no personal guarantee. If the bank is comfortable with the monitoring of the assets and the collateral it is advancing against, then it probably won’t require a personal guarantee.