Liquidating illiquid collateral
The OCC identifies credit risk, operational risk, compliance risk, strategic risk and reputation risk as the primary risks associated with ABL.
The facility must be stand-alone and self-liquidating, with minimal reliance on illiquid collateral or allowance of over-advances, and secured by a senior lien on the borrower’s assets.
It must be supported by reliable projections of future liquidity and borrowing needs.
In addition, the bank’s ABL risk limits and expectations, approval procedures demonstrating sufficient senior-level supervision, underwriting standards, pricing policies and monitoring procedures must be discussed.
The OCC allocates a significant part of the handbook to the analysis that banks must undertake with respect to each ABL borrower.
As could be expected, the OCC also dedicates a notable section of the handbook to the establishing and monitoring of the borrowing base, as the successful limiting of the outstanding loan balance to the quality liquid assets assures ABL lenders of the greater likelihood of the repayment of the loan.
Establishing and implementing strong controls is a key element of an effective ABL risk management system.Among the necessary controls, OCC counts clear and tight loan agreements defining the borrowing base, the handling of cash proceeds, the monitoring and reporting requirements, as well as other collateral protections, including insurance and audits, and the perfection of lenders’ liens on the collateral.
As part of the analysis, receivable concentrations of 10% or more in a single account must be considered and limited.The OCC acknowledges that ABL is a specialized credit product that provides fully-collateralized credit facilities to borrowers that may not qualify for cash-flow loans due to high leverage structures, inconsistent earnings or insignificant cash flows.ABL also provides access to working capital for healthy companies interested in flexible credit structures without highly restrictive financial covenants.ABL loans are typically structured as revolving credit facilities where advances are limited to a percentage of eligible collateral (the borrowing base) and are repaid from the conversion of collateral to cash (sales of inventory and collection of accounts receivable) over the borrower’s business cycle.Tight controls and close monitoring are critical to the soundness and profitability of ABL facilities.While the OCC recognizes that, if properly structured, ABL loans can be profitable, fully collateralized and, in fact, low-risk, it also emphasizes that the administration and monitoring of ABL portfolios can be very time- and cost-intensive for banks and are particularly susceptible to borrower fraud.