A borrowing base certificate is a report that borrowers send to their lenders detailing the assets that are eligible to collateralize a loan. Borrowing base certificates allow lenders to monitor their collateral and ensure that borrowers are operating within the terms of their loan agreements.
Borrowing base certificates list a company’s accounts receivable, inventory, and other assets that lenders accept as collateral. They also show any changes in the value of those assets over time. The certificate calculates a borrowing base – the maximum amount that the lender will loan against the pledged assets. The borrowing company cannot borrow more than the borrowing base allows.
When is a Borrowing Base Certificate Used?
Borrowing base certificates are commonly used in asset-based lending, which bases loans primarily on the liquidation value of the borrower’s assets rather than their cash flow. These types of loans are flexible facilities that provide working capital to businesses.
Asset-based loans and borrowing base certificates facilitate lending in situations where conventional criteria for creditworthiness are difficult to determine or unavailable. Some examples include:
- Early-stage companies without much operating history. A lending facility supported by accounts receivable or inventory may provide financing options.
- Companies with losses or inconsistent cash flow. The liquidation value of assets can support lending even when earnings are negative.
- Turnarounds or bankruptcies. Lenders can structure facilities around assets not previously encumbered.
- Acquisitions requiring leverage. Asset-based loans allow layering debt onto a newly acquired company’s balance sheet.
Lenders routinely require borrowing base certificates from any borrower with an asset-based loan, line of credit, or revolving credit facility. Requirements vary but tend to follow a monthly or quarterly schedule. The frequency usually depends on the volatility of the pledged assets; more volatile collateral requires more frequent reporting. Most credit agreements also require additional borrowing base certificates under certain conditions like significant drops in collateral value or sales of pledged assets.
Why Do Lenders Require Borrowing Base Certificates?
For lenders, borrowing base certificates serve several risk management purposes:
- Ongoing Collateral Monitoring: By capturing detailed data on asset types, quality, eligibility, and valuation – borrowing certificates provide lenders with the current status of their collateral. Sudden changes prompt additional review.
- Early Detection of Issues: Trends in inventory, sales, collections, dilution, etc. provide operational insights and may indicate developing problems.
- Loan Sizing and Structure: The borrowing base determines the upper limit for a loan at origination. Ongoing certificates prevent over-advances against the agreed upon assets.
- Manage Exposure: Frequent borrowing base certificates allow lenders to adjust facility availability in relation to the value of the pledged assets.
- Covenant Compliance: Reporting requirements embedded in borrowing base certificates allow lenders to regularly monitor financial and operational covenants.
- Obligations and Restrictions: Detailed borrowing base reporting reminds borrowers of their obligations under the credit agreements and restrictions on asset sales, liens, acquisitions, and investments.
Ultimately, borrowing base certificates keep lenders fully informed on their collateral. This protects lenders from lending too much against assets that may suddenly fall in value while also creating an early warning system for spotting problems.
What Information is Included in a Borrowing Base Certificate?
While the exact contents will vary between lenders and borrowers, borrowing base certificates start with the quantity and value of eligible assets. Typical components include:
Accounts Receivable
- Balance outstanding
- Ineligible receivables deduction
- Concentration caps
- Days sales outstanding
- Past due totals
- Charge-offs
- Credits/rebates/discounts
- Retainage
- Foreign accounts without credit insurance
- Governmental accounts over cap
Inventory
- Balance by category
- Ineligible inventory deduction
- Inventory supported by appraisal or third-party evidence
- Locations without required access
- Consigned inventory
- Supply/price imbalances
- Intercompany profits
- Downtime for equipment
- Slow-moving or obsolete
Fixed Assets
- Balance by category
- Ineligible asset deduction
- Appraised orderly liquidation value
- Capital expenditures
- Depreciation
Other Eligible Assets
- Cash surrender value of life insurance policies
- Tax refunds
- Patents/intangibles
- Securities
- Real estate
Ineligible Assets
- Any assets deemed ineligible per loan docs
- Intangible assets
- Affiliate/related party receivables
- Inventory/equipment locations not accessible
- Countries under sanction or other restrictions
- Environmentally-impaired assets
Deductions and Reserves
- Rent for leased assets
- Principal and interest payments
- Royalties
- Agent fees
- Bank product obligations
- Priority payables
The certificate then calculates the total eligible borrowing base collateral value net of deductions and reserves to determine availability. It compares this amount to the current outstanding loan balance for excess or insufficient borrowing capacity.
How Do Lenders Use Borrowing Base Certificates?
Lenders use the detailed data within borrowing base certificates to understand the current collateral coverage of their loans. By submitting frequent certificates, the borrower provides the lender with timely information to determine appropriate levels of advance rates and availability.
When new certificates come in, lenders focus attention on significant changes impacting the borrowing base:
- Large sales, shipments, or collections swinging accounts receivable
- Inventory build or liquidation altering eligibility
- Changes in value estimates by appraisers
- Acquisitions or divestitures changing fixed assets
- Deterioration in asset quality or eligibility
Lenders have the right to adjust advance rates or impose availability reserves if they view the collateral quality or mix changing for the worse. By increasing advance rates and minimizing reserves, lenders show a positive view on the strength of the borrowing base.
Conversely, lenders may use stricter advance rates, impose special reserves, or trigger appraisals and exams if they have concerns over the borrowing base collateral. They can essentially “dial down” availability if circumstances warrant.
Lenders also use trend analysis from period to period borrowing base certificates to spot developing problems. Rising past dues or dilution in receivables, stubbornly high inventory levels, or declining appraised values are some examples of trends lending to tighter monitoring and potential changes to the borrowing availability.
Borrowing base certificates also allow lenders to regularly check compliance with financial covenants incorporated into most credit agreements tied to asset-based loans. Common covenants include fixed charge coverage ratios, minimum levels of EBITDA, restrictions on capital expenditures, and limits on additional debt obligations. Breaching any borrowing base covenant could have severe consequences like frozen availability or default.
What is Included in the Borrowing Base Calculation?
The actual borrowing base calculation quantifies the collateral position available to support the loan. While methods vary between lenders and borrowers, a typical borrowing base calculation includes:
Eligible Accounts Receivable
- Starts with outstanding trade accounts receivable
- Less ineligibles like > 90 days overdue
- Concentration deductions over 20% limit
- Apply 80% advance rate
- Times liquidity factor like 90% = Eligible Accounts Receivable Borrowing Base Value
Eligible Inventory
- Balance of finished goods inventory
- Less supplies, packing materials, consigned goods
- Apply 65% advance rate
- 50% for work in process
- 40% for raw materials = Eligible Inventory Borrowing Base Value
Eligible Fixed Assets
- Starts with appraised orderly liquidation value
- Less ineligibles like intangibles or capitalized expenses
- Apply 75% of orderly liquidation value = Eligible Fixed Assets Borrowing Base Value
Total Gross Borrowing Base Value
- Sum of eligible assets above
Less Availability Reserves
- Rent for 3 months
- Interest expense
- Property taxes
- Other reserves like bank product exposure
Total Net Borrowing Base Value
Compare Net Borrowing Base Value to Outstanding Loan Balance for unused availability. Maximum borrowing ability is limited to the net borrowing base value.
What is the Formula for Calculating a Borrowing Base?
The calculation behind every borrowing base revolves around the following general formula:
Gross Borrowing Base
- Ineligible assets
- Concentration deductions
- Advance rates
- Liquidity factors
- Reserves = Net Borrowing Base
Expressed as:
Gross BB – Ineligibles – Concentrations x Advance Rates x Liquidity Factors – Reserves = Net Borrowing Base
Plugging in hypothetical values for each element:
$1,000,000 – $100,000 – $50,000 x 80% x 90% – $25,000 = $630,000
So in this example, the gross borrowing base begins as $1 million of pledged assets. After removing ineligibles and concentrations, applying typical 80% advance rates and 90% liquidity factors, then taking reserves, the final net borrowing base equals $630,000.
The advance rates approximate collateral haircuts to protect lenders from sudden drops in asset value. The liquidity adjustment accounts for the lead time in converting assets to cash if the lender must liquidate. Reserves set aside cash to continue funding costs of operations and loan interest obligations if issues arise. All these factors make borrowing base availability conservatively below full gross amounts which creates a cushion for lenders.
Can the Borrowing Base Formula Change?
The general borrowing base formula and its components can always change over time or at the lender’s discretion. For example:
Gross Assets – If the collateral mix shifts or new assets get added, it alters gross borrowing availability.
Ineligibles – If certain assets become impaired or lose value, a lender may exclude more from eligible borrowing base value.
Concentrations – If balances cluster excessively with certain big customers or inventory types, lenders may impose tougher concentration charges.
Advance Rates – When advancing against distressed assets or industries, lenders lower rates to protect against further collateral erosion.
Liquidity Factors – In times of uncertainty, lenders may adjust discounts on asset valuations to account for decreases in marketability.
Reserves – Unexpected events can trigger new reserves if business performance worsens or collateral erodes further.
Lenders closely monitor the borrowing base formula to ensure sufficient collateral cushion as conditions change. They work to balance appropriate availability to the borrower while prudently assessing lending risk against pledged assets.
Conclusion
A borrowing base certificate is an important risk management tool in asset-based lending. It allows lenders to gauge collateral coverage relative to outstanding loan balances. The detailed presentation of eligible assets and formula behind borrowing base calculations provide significant insights for both lenders and borrowers.
By requiring frequent borrowing base reporting, lenders can adjust advance rates if collateral values shift and impose reserves when conditions warrant. Certificates also monitor for covenant compliance and collateral control throughout the credit relationship. For borrowers, providing timely certificates mandates disciplined tracking of operational metrics tied closely to working capital assets that serve as loan collateral. A borrowing base certificate benefits both parties by promoting a well-informed lending decision and exposure level acceptable to all sides.