Asset-Based Lending: At Times Covenant-Lite, But Not Control-Lite

Asset-based lending (ABL) and adjacent areas of asset-focused finance continually shift towards the center ground of mainstream corporate finance. Flexibility, underpinned by collateral-driven risk, is in demand. The market continues to diverge (in some instances, becoming even more finely-tuned to complex credit, special situations, and restructuring), but its growth is generally well documented, with regulatory capital treatment and multiple other drivers potentially accelerating the same, particularly outside of the traditional banking sector.

So, what should modern stakeholders look out for? ABL structures typically feature fewer traditional financial covenants than cash-flow lending, but involve real operational visibility, asset monitoring, and dynamic controls. Generally, these activate far more swiftly than a conventional financial covenant breach in a heavier term loan structure.

In short: covenant-lite does not equal control-lite. Discipline in ABL is enforced through its inherent structure; indeed, legitimate and relatively modest adjustments to eligibility criteria, valuation assumptions, or concentration limits, for example, can have a more immediate and/or material impact on availability.

This places considerable importance on careful drafting and negotiation in respect of elements going to collateral-related definitions, the scope and implementation of reserves, lender discretion, eligibility, operational covenants, cure rights, auditing, borrowing base mechanics, the nature of cash dominion, the frequency and composition of reporting, dilutions, availability, and other formulae and related provisions. This is in addition to more usual areas of focus, including, for example, events of default, the package of reps, warranties and undertakings, various thresholds, security principles, guarantor coverage, accounting, cross-border and other issues, and, yes, more traditional incurrence or other financial covenants, if those form part of the overall financing.

General upsides in a more granular and proactive ABL structure, however, include confidence, predictability, and scalability. For instance, liquidity can increase as business grows, seasonal fluctuations in trading are smoothed-out, and operational performance, as opposed to earnings, supports access to capital. Put another way, with the right advice, structural controls in ABL are not punitive, but guardrails that create stability for stakeholders. To some degree, this goes to the success of ABL and asset-focused finance, and its emergence as a more central component of many corporate capital structures, across uses and credit spaces.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.