Examining the Asset Based Lending landscape

Asset Based Lending (‘ABL’) has matured significantly in the last ten years, and is now seen by many in the advisory community as a ‘first-choice’ funding solution in refinancing, M&A and restructuring cases. Equally, UK lenders see the product as a front-line offering as it provides benefits to borrowers as well as the opportunity to deploy greater lending with collateral backing.

Drivers of demand

The UK economy is facing several headwinds into 2025, with the Bank of England recently cutting its GDP growth forecast to 0.75% for the year and reports highlighting a significant number of profit warnings in 2024. This comes against a backdrop of upcoming changes to National Minimum Wage and Employer’s National Insurance contributions, which will undoubtedly have a major impact on firms’ profitability if they are unable to pass these incremental costs on to customers, without unduly impacting demand. Such reduced profitability will adversely impact any leveraged debt facilities which typically have earnings and cashflow-based maintenance covenants, potentially leading to default or renegotiation.

We have long held the view that pure-play ABL facilities, given their nature, should not be managed through covenant links to EBITDA, and hence breaking this link is an obvious advantage for this type of lending – we therefore believe that there will be an uptick in demand for this type of facility in the coming year. ABL is well placed to capitalise on increased demand – lenders focus their underwriting decisions more on the robustness of assets, less on the earnings trend, hence a loan to value approach (with sufficient headroom) will attract many new entrants to the product in a refinancing scenario. Moreover, ABL has, over the years, seen a relative decline in the cost of its capital, and particularly in light of recent interest rate cuts, is an increasingly cost-advantageous source of debt for corporates.

We also see a likely increase in demand from Private Equity houses – especially those with continuing dry powder, and the rise of the non-core carve-out deals given the uncertainty of earnings noted previously. Equally, given the nature of ABL facilities, the opportunity to recapitalise a PE-owned position, again at a relatively low cost, is increasingly compelling for the owners. We believe reputation of ABL within Private Equity has improved considerably in the last five years – with more truly committed facilities, strong risk appetite and the generally supportive outlook of ABL providers winning an increasing number of converts to the sector, with some sponsors now demonstrating a preference for ABL over more traditional leveraged finance, especially where they can combine asset-based working capital facilities with term debt under one roof, to maximise capital structure efficiency.

However, some of the same factors that will drive demand for ABL will also pose challenges for those using ABL, increasing risk for the lenders offering it. That’s what’s behind our expectation that this year is also likely to bring an increase in ABL-related restructuring activity. 2025 is likely to see an elevated number of businesses entering stress or distress, with areas that are traditionally large takers of ABL – such as recruitment, manufacturing and logistics – feeling the strain as borrowers and customers alike navigate a challenging trading environment. It will therefore be increasingly important for lenders to conduct thorough due diligence on potential customers, and to seek support and advice from restructuring experts as soon as any concerning cracks appear in their clients’ businesses or those of their customers. Quick, proactive action maximises the opportunity for lenders and their partners to protect the value of any lending, or to plan for its recovery in worst case scenarios.

The road ahead

For borrowers and lenders alike, the coming months will be marked with both opportunity and headwinds for the ABL industry.

As always, good planning, careful due diligence and maximising advice from experts – whether that be Debt Advisory, Financial Advisory or restructuring experts – will be key to ensuring that the benefits of this powerful financing option are fully realised.