Of course, even the most credible borrowers cannot borrow against 100 percent of their assets. Lenders first exclude ineligible assets, such as receivables that are more than 90 days overdue. They then typically grant loans worth 85 percent of the value of the remainder, and 50 percent to 65 percent of the value of inventories, with the exact level dependent on the quality of the assets and the risk tolerance of the lender.
Advance rates for inventory are a bit higher than in past years, lenders say, because of improved processes for monitoring the collateral, as well as increased competition. But some inventory is more difficult to value than others, especially such newer types as telecommunication switches, routers, and fiber-optic networks.
Even at 85 percent of receivables or 50 percent of inventory, though, an asset-based loan is often larger than what the borrower can get from a bank. That’s because banks are lending at lower multiples of cash flow than they were before the economy started slowing down — two and a half to three times earnings before interest, taxes, depreciation, and amortization versus as much as four times a year ago. In contrast, many companies’ assets have not yet declined much in value. “Cash-flow lenders are concerned with cash flow and the ability to repay debt,” says Daniel Chapa, business credit executive at Bank of America. “Our focus is not only on cash flow but also on the asset base and what we could collect from that collateral.”
Front-end fees, meanwhile, are lower for an asset-based loan because of the lower risk involved with a completely secured loan that is intensively monitored. For midsize companies, those fees hover around 1.5 percent to 2 percent, compared with 2 percent to 2.5 percent for a traditional cash-flow loan. Interest rates on asset-based loans, moreover, are now only slightly higher than those on traditional loans, despite the greater cost incurred by an asset-based lender to keep tabs on the credit — doing periodic appraisals of the collateral and tracking the company’s financial progress.
The cost differential, which once was more substantial, has narrowed with competition and greater use of technology. For instance, Fleet Capital’s rates on asset-based loans have held steady in the past year, whereas cash-flow lending rates have risen.
On the flip side, asset-based borrowers must provide frequent reports on asset values, which may strike some CFOs as a burden. On top of regular financial reports, for instance, Fred Angelone, CFO of Circuit-Wise, delivers daily data on receivables levels and aging, and weekly information on inventories, to CIT. But Angelone isn’t complaining. “It’s nothing extraordinary,” he says, noting that he needs to have most of this information anyway.
A more serious potential disadvantage is that asset-based loan amounts will fall with a company’s fortunes. Witness what recently happened to Circuit-Wise. Because of fewer orders, management had to cut back production, and the company now expects to pull in around $85 million in revenues this year, compared with $103 million in 2000. Meanwhile, however, Circuit-Wise is still paying the same amount of loan interest, which, though based on its assets, has come to represent a higher level of cash flow.