Heading deeper into 2025, retailers face a raft of uncertainty and headwinds. Consumer confidence is volatile and still well below pre-pandemic levels, inflation has changed consumer spending habits and caused many shoppers to trade down or shop less, and there is the potential for interest rates to rise again as well as the looming specter of higher tariffs. Together, these pressures can create cash-flow shortfalls, which, combined with skint profit margins, can create a crisis.
We saw this play out through 48 retail bankruptcies in 2024.
Many retailers utilize asset-based loans (or ABLs) to finance their operations. Inventory is used as collateral for these loans, and lenders monitor and update their valuation (Net Orderly Liquidation Value or NOLV) to ensure their position is protected. Reductions in NOLV incites lenders to decrease borrowing availability, which retailers may not expect, and which subsequently creates a liquidity crisis that unfolds very rapidly.
There are several trends that are causing lenders to re-evaluate and decrease the NOLV on existing ABLs:
- Rising shrink: According to lenders we work with, shrink rates have been more than double what was expected in recent liquidations, causing them to reconsider the historical rates they have used.
- Softer demand in liquidation sales: Traffic has fallen against historical levels, making the cost of recovering the principle of the loan more expensive.
- Increased costs of Chapter 11: This leaves less for the lender to recover, and they are adjusting their assumptions accordingly.
- Risk adversity: Lenders are becoming increasingly risk averse, ordering fresh appraisals on inventory and adjusting their NOLV based on findings.
ABLs are a critical lifeline for many retailers, and these trends have made the borrowing capacity less uncertain. As retailers head into the doldrums of the pre-spring season, and have a better sense of their final results and cash positions, we recommend the following moves:
- Reforecasting liquidity with a realistic view of consumer demand and gross profit; stress test models for additional softening of demand or tightening of profit margins
- Being proactive in discussions on lender-ordered appraisals. Challenge calculations as appropriate to make sure that NOLV reflects the true value of the inventory.
- Keeping an eye on recovery around furniture, fixtures, and equipment. The market has been flooded recently with extra fixtures and equipment, causing valuations to fall significantly.
- Identifying ways to cut additional costs and accelerate existing efforts. Suppliers are also concerned about the current climate and often willing to work with retailers on efficiency efforts to ensure they have strong partners heading into spring.
ABLs can still be a powerful tool, but retailers need to be more thoughtful in their approach to modeling cash flow and having discussions with lenders. Being proactive in understanding your cash position with realistic assumptions, reducing the costs associated with running the business, and actively engaging in discussions on inventory appraisals can help avoid a surprise cash crunch in 2025.
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