May 9, 2023

The Importance of Daily Calculation in Risk Monitoring and Borrowing Base

Kyle Meade
The Importance of Daily Calculation in Risk Monitoring and Borrowing Base

Asset Back Lending (ABL) is a type of private debt lending that is becoming increasingly popular in the world of finance. Lenders often require clients to provide a borrowing base certificate to confirm that the amount drawn against the revolver is supported by an appropriate borrowing base of accounts receivable and inventory. It is a great way to access capital, but it comes with risk. A key tool for managing this risk is calculating borrowing bases daily. This blog post will discuss the importance of daily calculation of borrowing bases for risk monitoring in ABL.

What is a borrowing base certificate?

The borrowing base is the value of the underlying collateral that acts as security for the loan. It’s an essential factor in risk monitoring because it ensures a loan is fully collateralized and helps determine the credit limit extended by a lender. While lenders have traditionally monitored borrowing bases manually and on a monthly or quarterly basis, fintech companies like Cascade use automated data feeds and analytics platforms to track borrowing bases quickly, accurately, and in nearly real-time. This allows lenders to analyze risk more efficiently, monitor changing economic trends more accurately, and make better decisions about credit exposure more frequently. In addition to helping lenders manage their portfolios more efficiently, daily borrowing base calculations also provide businesses with a more comprehensive picture of the current collateral value so they can rectify any deficiencies before they spiral out of control. Furthermore, as both parties have greater visibility of the underlying collateral, waterfalls can be run more frequently (daily), reducing cash drag, which doesn’t help either party. Daily calculation of borrowing bases has become an integral part of credit analysis and risk management, allowing businesses to quickly identify potential problems before they become major issues, ultimately protecting their bottom line.

How is a borrowing base calculated?

A borrowing base is a calculation used to determine the value of the borrower’s collateral. A discount factor is often applied to the adjusted value of collateral to determine the credit limit. In most cases, the borrowing base calculation comprises three major components: eligible asset pool, cash in a collection account, and advance rate, as well as a few fringe components: interest reserve, accrued lender’s interest, and more. For the purposes of this article, we’re going to focus on the eligible asset pool and cash in the collection account. Calculating the borrowing base in real time depends on live data feeds from multiple sources.

Eligible Asset Pool for Middle Market Companies

To calculate the eligible asset pool, which includes accounts receivable, there are three key factors: 1) confirming assets are eligible based on predefined criteria; 2) sorting assets into predefined buckets based on its delinquency state (current Days Past Due aka DPD); and 3) eliminating any excess concentration amounts. All of these calculations change on a daily basis and being able to get updated calculations is critical to any risk monitoring program.

Cash in Collection Account

The borrowing base is also calculated using the most recent cash balance in the collection account(s).  Having direct access to these accounts through APIs, SWIFT reporting, or other banking integrations provide lenders with security that cash is following any predetermined flow of funds agreement.  It also provides the ability to confirm real payments on loan tapes as cash movements should match between the collection account and loan tape.

Advance Rate in Capital Structure

More and more advance rates are being set dynamically to update based on changing conditions of a deal instead of setting them once and forgetting about them.  To ensure the borrowing base is being calculated accurately, it's important that all conditions that could change the advance rate are being monitored (portfolio covenants, financial covenants, reporting covenants, etc).

What to do when there is a deficiency in Direct Lending?

When there is a borrowing base deficiency, it’s important to act quickly to avoid a potential event of default. Borrowing base deficiencies can also impact corporate borrowers, affecting their ability to secure additional funding. A borrowing base deficiency can be caused by many different factors and being able to identify what is causing the deficiency is priority one. Once the cause is identified, it’s important to work with all parties involved to come up with a solution. Borrowing base deficiencies are typically resolved by either (i) assigning new receivables (ii) adding cash to the collection account (iii) providing a waiver for different criteria (eligibility criteria, excess concentration, etc). When the situation cannot be resolved, an event of default will typically occur, and the portfolio will enter a wind-down.

Being at the front of the line

When a deficiency exists it's important for lenders to be at the front of the line, whether that's getting new receivables or cash top-ups having seniority or reacting quickly is key. By proactively performing borrowing base calculations on a daily basis, lenders are able to secure their position in the creditor line and protect their investors' interests before other creditors have even realized there is a problem.

Cascade Debt is pioneering daily borrowing base calculations, get in touch with us to find out how we can support your risk management program.

Want to learn more? Schedule a strategy call with our team today.