Reasons include fear of covenant violation and demand for liquidity
New York, NY (May 4, 2020) – The financial hardship resulting from the COVID-19 pandemic is driving some companies to convert their revolving credit facilities from secured cash flow-based to asset-based lines of credit, according to Ed Gately, Head of Asset-Based Finance at Mitsubishi UFJ Financial Group (MUFG). Asset-based credit facilities are applicable to businesses in retail, wholesale and general distribution, where high levels of inventory are more common.
The reasons for converting to asset-based credit facilities
Mr. Gately cites two reasons for this conversion:
Mr. Gately believes there will be more conversions to asset-based facilities for some time—possibly over the next 12 to 18 months—until conditions normalize. “Shelter-in-place orders have the potential to shape longer-term patterns, and even after those orders are lifted, I don’t think people will return so quickly to their old consumption habits in terms of what they buy, where they buy it, and how much they spend,” he says. “Until businesses are able to fully rebound, we foresee more of them pursuing facility conversions.”
Mr. Gately adds that companies with asset-based revolvers are already drawing down on their credit facilities, borrowing to add cash to their balance sheets in order to make sure they have access to sufficient liquidity to weather this crisis.
The evolving terms of asset-based lending
Mr. Gately points out that asset-based lending terms are evolving as a result of the physical and economic consequences of the pandemic, which are making it difficult to conduct inventory appraisals in order to assess the value of companies’ loan collateral. “Not only is it an unsafe environment for appraisers to physically perform assessments of inventory,” he says, “but there’s also the question of timing: How do you appraise merchandise meant to be sold during a given season if it needs to be replaced with inventory for a subsequent season by the time you open for business?”
Mr. Gately cites apparel as one example of merchandise affected by seasonality, though he emphasizes that other types of merchandise, such as technology products and home appliances, are not exempt from seasonal and other considerations. “Ultimately, the monetary assessment of inventory is based on the price at which the appraiser believes the retailer can liquidate the inventory,” he says.
Mr. Gately adds that “we are still at the early stages of this crisis, and we haven’t yet seen the full financial implications of this pandemic for most companies.” He points out that “current levels of unemployment will affect consumer demand for some time, and until the economy normalizes, liquidation values could be impacted.”
Mr. Gately observes three ways in which asset-based lending terms are evolving:
MUFG is the world’s fifth-largest financial institution, with approximately $2.9 trillion in total assets.
About MUFG Americas Holdings Corporation
The U.S. operations of Mitsubishi UFJ Financial Group, Inc. (MUFG), one of the world’s leading financial groups, has total assets of $341.4 billion at December 31, 2019. As part of that total, MUFG Americas Holdings Corporation (MUAH), a financial holding company, bank holding company and intermediate holding company, has total assets of $170.8 billion at December 31, 2019. MUAH’s main subsidiaries are MUFG Union Bank, N.A. and MUFG Securities Americas Inc. MUFG Union Bank, N.A. provides a wide range of financial services to consumers, small businesses, middle-market companies, and major corporations. As of December 31, 2019, MUFG Union Bank, N.A. operated 349 branches, consisting