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Commercial Finance Alert: Reversion to borrower-friendly terms in loan transactions

If things are going well for your business, it might be a good time to re-examine your financing needs to determine if you are in the best financing arrangement and to examine what opportunities may exist to improve your situation. This is especially true if your business rebounded from the economic downturn, but you remain in a credit facility not reflective of this financial turnaround. Although the current loan market may not be on par with the market prior to the credit crisis of 2008, the credit markets and interest rates for higher credit quality middle market companies are seeing a reversion to pre-crisis levels. 

It has been widely reported that the credit crisis greatly reduced the volume and types of loans being made by banks and other financial institutions. Recent senior loan officer opinion surveys on bank lending practices conducted by the Federal Reserve Board, however, paint a different picture. The most recent survey conducted in October 2011 indicates that a majority of banks, citing more aggressive competition from other lenders, have eased credit standards and terms on commercial loans over the last four quarters, including cutting loan spreads over cost of funds, reducing interest rate floors and offering more covenant-lite deals.

Financing options

If your company has demonstrated stable historical cash flows, certainty of financial projections, a cash flow cushion after giving effect to the financing transaction, and the ability to meet financial covenants on a quarterly basis, then cash flow financing may be an attractive financing avenue worth pursuing. However, another option that your company may want to consider is asset-based financing, especially if your company is in an industry heavily weighted with accounts receivable and inventory, including wholesalers, retailers, automotive, durable goods manufacturers, and metals and mining companies. Many middle market companies historically in less rigorously monitored unsecured or cash flow loan structures recently have migrated to a cheaper and more flexible alternative with asset-based loan (ABL) lenders.

Asset-based loans

In its simplest form, an ABL is a loan determined as a percentage of and secured by specific assets of the borrower, including working capital assets such as receivables and inventory (advance rates are currently between 70-80 percent of A/R and 40-50 percent of finished inventory). Although such “hard” assets remain king for ABL lenders, ABL lenders have become more flexible and have included intellectual property, trademarks and other intangible assets as components of the borrowing base, although often at lower advance rates or at premium pricing. Furthermore, ABL lenders will rely on certain other long-term assets (e.g., machinery, equipment, real estate) to provide a separate term loan as a part of an ABL credit facility.

Although ABLs can impose more collateral reporting requirements than a typical cash flow loan (e.g., borrowing base certifications, accounts receivable aging reports, appraisals, and field examinations), ABLs usually require fewer and less strict financial covenants and more favorable risk-adjusted pricing than an unsecured or cash flow structure (e.g., pricing based on LIBOR with a spread of 200 to 400 basis points for ABL vs. 300 to 500 for cash flow loans) as a result of the secured loan-to-value protections.

Additionally, certain ABL restrictions and/or requirements that were a constant only a short time ago are now being “watered-down” for the benefit of well-positioned borrowers, including, without limitation, the following:

  • Excess availability under the borrowing base: Requirement that a borrower maintain a minimum cushion of eligible assets minus debt outstanding. Such excess availability tests currently stand at between 10-15 percent, compared to 25-30 percent less than two years ago.
  • Springing financial covenants: While used only on the strongest credits, certain ABLs require testing of financial covenants only if excess availability declines below a certain level, which currently stands around 15 percent, compared to 25 percent less than two years ago.
  • Dividends: ABL lenders will make loans to finance a dividend recapitalization, so now may be a good time to consider using the proceeds of a financing transaction to take some money off the table and put it into your pockets while tax rates are still low. Also, although ABL facilities have historically prohibited ongoing dividends, ABL lenders may now permit regular and ongoing dividends, as long as the borrower is in compliance with its fixed charge and excess availability covenants, after giving effect to the dividend.
  • Overadvances: Similar to pre-2008 transactions, ABL lenders will consider lending 10-25 percent in excess of the asset value.

The market is slowly, but noticeably, reverting to pre-2008 levels, especially for higher credit quality middle market companies. If your business needs lending counsel or you would like to informally discuss your current lending arrangement, please contact:

James E. Stief

Jason M. Smith

Commercial Finance

Our Commercial Finance Group attorneys are very experienced and well positioned to help you navigate your financing needs. We have advised borrowers, financial institutions, and financial service providers in all aspects of senior, subordinated and mezzanine debt transactions. We have significant expertise in: asset-based financings; multi-state, multi-currency and cross-border secured financings; financings secured by unusual types of collateral; real estate financings; ESOP loans; healthcare financings; floor-plan financings; bridge financings; letter-of-credit facilities; interest rate swaps; and leveraged acquisition transactions. We will use our knowledge and expertise, as well as our connections in the industry, to develop the financing solutions that work best for you.

Carl J. Grassi, President
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© 2012 McDonald Hopkins LLC All Rights Reserved. This Alert is designed to provide current information for our clients, friends and their advisors regarding important legal developments. The foregoing discussion is general information rather than specific legal advice. Because it is necessary to apply legal principles to specific facts, always consult your legal advisor before using this discussion as a basis for a specific action.