Many ABL professionals have little to no workout or bankruptcy experience thanks to the past ten years of relative calm. This article details the anatomy of an ABL workout and serves as a primer for many readers and a refresher course for more experienced lenders.

If you are in the asset-based lending (“ABL”) space, either as a lender or an advisor, you may well look back on the last ten years (and very possibly beyond) as the halcyon days of loan portfolio management. Problem loans have been few and far between, and borrower bankruptcy filings were a rare occurrence. Workout departments were downsized or eliminated. Even during the early, dark days of the COVID pandemic, an abundance of stimulus money and a lack of pressure from regulators, combined with a fairly robust economy, kept most loan portfolios in good shape. Yes, there were a spate of retail- and hospitality-related bankruptcies, but many of these were resolved quickly and, in some cases, successfully.

That’s the good news. The downside of all of this is that many ABL professionals have acquired little to no workout or bankruptcy experience, and those professionals who are more “seasoned” have had little practice in recent years. This article will describe the usual anatomy of an ABL workout in some detail, and hopefully will serve as a primer for some, and a refresher course for others. The authors recognize the diversity of the ABL market (e.g., small- market deals, middle-market deals, large sponsor-driven deals and leveraged loans), as well as the many industries that utilize ABL facilities for liquidity. As such, considerations for how to deal with any workout situation may be driven by many factors. This article does not attempt to address every contingency. That said, there are some issues and considerations that are common to most ABL workouts, for which the authors hope this article will provide some guidance.

The Scenario

So, let’s start with a typical scenario. Your borrower has defaulted on a financial covenant for the last three reporting periods. You have granted waivers and charged a fee each time. That’s fine, but the underlying issues causing the events of default have not been addressed or resolved. Liquidity starts to erode, or perhaps is entirely gone. When this occurs, there will be a request for an over advance. Quite often in these situations, a review of the borrower’s accounts payable aging will reveal deterioration, i.e., payables are stretched to key vendors and suppliers. This will have an impact on inventory mix, quantity and pricing. You may not see it without a field exam and/ or an appraisal, but once the payables become stretched, your borrower’s inventory will eventually deteriorate. Cherry picking, or selling off the best, most desired inventory, is common in these situations to generate short-term liquidity, but without adequate vendor support, replenishment becomes difficult or impossible. This causes your overall inventory mix to erode and vitiates whatever appraisal on which you were relying. (Note: At this point, if you have not previously done so, familiarize yourself with all of the underlying assumptions of the appraisal, as you may well discover that the facts have already changed and the appraisal will not hold.) The decline in the accounts receivable performance may follow as short shipping or discounting becomes more prevalent as a result of inventory issues. Turnover (or DSO) slows and dilution increases. Fraud risk also increases at this point, as some borrowers may be tempted to misrepresent or obscure adverse financial or collateral activity in desperation to save the business, but this article is not about fraud, so assume that fraud does not occur. For those of you who have not yet witnessed this scenario, it is coming. The writers cannot say precisely when, but you can be reasonably assured that this scenario or a similar one will begin to appear in portfolios as supply chain issues, inflation, labor shortages and a weakening economy take hold. So, what do you do?

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