Asset-based lending (ABL) facilities are commonly used by industrial and working-capital-intensive businesses to secure financing. An ABL allows a company to use assets, including accounts receivable, inventory, equipment and real estate, to secure borrowings.
ABLs are prevalent across sectors including:
- Apparel
- Automotive
- Consumer products
- Distribution
- Energy
- Food and beverage
- Industrial manufacturing and processing
- Metals
- Retail
An ABL allows the borrower to draw funds, repay draws, and redraw funds over the life of the loan. Cash generated from inventory sales and receivable collections (conversion of working assets) typically serves as the primary source of repayment. Compared to traditional cash flow loans, ABLs generally have fewer financial maintenance covenants but impose additional reporting and cash dominion requirements.
Cash Dominion Mechanics and Credit Implications:
What you may not know is that when cash dominion is in effect, a business’s incoming cash is deposited into a lender-controlled account and used to pay down the outstanding loan balance, freeing up borrowing capacity for the business’s cash needs. ABLs may require cash dominion throughout the loan term or on a “springing” basis, triggered by an event such as failing to meet a liquidity threshold. This mechanism increases collateral protection for lenders but limits the borrower’s ability to retain operating cash.
In practice, customer payments are directed to a lockbox and swept daily to pay down the loan balance. In periods of declining sales or economic stress, reduced receivables and inventory can shrink the borrowing base, tightening availability. Late customer payments further exacerbate this dynamic, as significantly overdue receivables may be excluded from collateral calculations. With less availability and no control over incoming cash, companies may face liquidity challenges unless they maintain substantial cash reserves or alternative funding sources.
Action Plan:
From a credit analysis standpoint, it is important to determine whether your customer has a lockbox arrangement in place. Obtaining a copy of the credit agreement may be difficult for privately held companies, but financial statements often disclose lockbox arrangements in the notes. You might also notice that the debt maturity of the loan is a few years out, but the financial statements show as a current liability. This is because of FASB accounting rule ASC470, which provides the framework on how this debt must be classified. For higher-risk borrowers, banks frequently require cash dominion to maintain tighter control over collateral. Understanding these mechanisms is critical for assessing risk and overall financial flexibility.
