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Fitch Publishes ’Rating Asset-Backed Lending Facilities’

August 25, 2015, 07:22 AM
Filed Under: Industry News

Fitch Ratings has published the second edition of Rating Asset-Backed Lending Facilities. This report reviews Fitch's methodologies in the recovery analysis of asset-based lending (ABL) facilities and compares results to actual bankruptcy outcomes.

The first half of the report focuses on structural attributes of ABL and compares ABL and cash-flow (CF)-based lending. The second half focuses on the recovery analysis of the ABL facilities with summaries of cases from Fitch's bankruptcy studies and illustrative examples showing the mechanism of Fitch's bespoke model.

The report's key findings include:

  • Inherently Secure Capital Structure: ABL relies on inherently secure structural features, different from traditional CF-based secured lending. Structural protections ensure that lenders will not be undersecured at any given time. The protections include the borrowing base formula that limits advances strictly 'inside of' the net realizable value of relatively liquid collateral, lender control over cash collections and frequent collateral monitoring. Consequently, the risk associated with ABL is considerably lower than that with CF-based lending.
  • Protection Against Being Undersecured: The advance rate used in ABL functions as a loan-to-distressed-value (LTV) ratio at the asset level, which protects the lenders from being undersecured even in the worst case scenario. The collateral valuation is based on distressed valuation estimates prepared by appraisal firms that draw on their experience as liquidation agents in recent bankruptcies. The distressed valuations are thus expected to closely mirror the equity bids (or 'guaranteed' price) that a potential liquidator would submit in a bankruptcy scenario.
  • Double-Edged Sword: The structural protections embedded in ABL limit the extent of loss in the case of distress. However, the same protection features can also significantly limit the options available to a distressed borrower to keep solvent. For instance, currently oil exploration and production companies are bearing the brunt of the tightened liquidity resulting from the recent fall in oil prices.
  • Advantages of ABL Facilities: ABL provides issuers greater flexibility in its debt structure, because ABL is secured by a set of current and non-current assets rather than a blanket lien. First-in last-out tranches increase liquidity by relying on an additional advance rate of the same collateral. Bifurcated liens ensure maximal protection and thus lower the overall cost of the facility.
  • Drivers for ABL Facilities: ABL helps issuers address many financial and operational issues more efficiently than traditional CF-based facilities can, due to its flexibility and oversecured nature. Performance Improvement, growth initiatives, M&A's and capital market opportunities are the main drivers of ABL.
  • Outstanding Recovery Outcomes: ABL facilities in 32 out of 34 bankruptcies reviewed by Fitch realized full recovery. These recovery outcomes are attributable to a mix of three key factors: (i) the overcollateralized status of pre-petition ABL facilities; (ii) a security interest in liquid collateral that was much sought-after by debtor-in-possession lenders as well; and (iii) lender dominion over cash, which helped reduce ABL balances prior to filing.

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