What is a Borrowing Base?
A borrowing base is the volume of funding a lender agrees to provide to a company, contingent on the value of the collateral the company pledges. Typically, this is assessed through a method known as margining, where a discount factor, determined by the lender, is multiplied by the collateral value. The resultant figure represents the loan amount a lender will extend to the company.
Understanding Borrowing Bases
Various assets may be utilized as collateral, including accounts receivable, inventory, and equipment. When a company seeks financing, the lender evaluates the company’s overall health, both in terms of strengths and vulnerabilities. Based on perceived risk, a discount factor—say 85%—is determined. In a scenario where a borrower offers $100,000 worth of collateral, the optimal loan amount would be 85% of the collateral value, resulting in $85,000.
Example: Oil and gas companies often borrow against production field values or proven order quantities. Here, the lender receives a monthly quota instead.
Why Lenders Use a Borrowing Base
Lenders are inclined towards borrowing base loans because they are secured against specific assets, minimizing risk. The borrowing base can be dynamically adjusted for asset depreciation, ensuring ongoing lender protection. For instance, if collateral value diminishes, the credit limit is lowered correspondingly. Conversely, should collateral value heighten, the available credit increases up to a specified limit.
The Mechanics
Borrowers must provide the lender with sales, collections, and inventory data critical for calculating the borrowing base. For middle-market and larger asset-based loans, borrowers may periodically submit certificates outlining business transactions and statuses. This might encompass itemized company receivables when the borrowing base hinges on such accounts.
Regular lender reviews of the borrower’s operations may be conducted, which can include dispatching appraisers to confirm the collateral’s value remains consistent with loan conditions.
Concrete Example of a Borrowing Base in Action
Consider Cabot Oil & Gas Corporation, which as of March 31, 2016, had no borrowings under its revolving credit facility. Their borrowing base undergoes an annual recalibration every April 1, although lenders may request recalibrations upon significant property transactions. As of April 19, 2016, Cabot’s borrowing base was adjusted from $3.4 billion to $3.2 billion.
Related Terms: Accounts Receivable, Collateral, Credit Limit, Marginal Lending, Revolving Credit Facility.
References
- U.S. Securities and Exchange. “Cabot Oil & Gas Corporation Form 10-Q, March 31, 2016”, Page 8.
