What is a 'Borrowing Base'
A borrowing base is the amount of money a lender will loan to a company based on the value of the collateral the company pledges. The borrowing base is usually determined by a method called margining, in which the lender determines a discount factor that is multiplied by the value of the collateral. The result is the amount that will be loaned to the company.
BREAKING DOWN 'Borrowing Base'There are various assets that can be used as collateral, including accounts receivable, inventory and equipment. For example, if a company goes to a lender to borrow money, the lender will assess the company's strengths and weaknesses, and evaluate the borrower's risk. Based on the risk that the lending company feels is associated with the loan to the company, a discount factor of 85% may be determined. If the borrower is offering collateral that is worth $100,000, the maximum amount the lending company will give the company is equal to 85% of $100,000, or $85,000.
Why Lenders Use a Borrowing Base
With a borrowing base, lenders feel more comfortable making a loan, since it is against specific assets. The assets are typically not used to back other loans, or the lenders will have the first claim. They may even extend more credit under this formula.
The borrowing base can be adjusted downward, protecting the lender. If the value of the collateral falls, the credit limit also declines. Should the collateral increase, the borrowing base will also rise, up to a predetermined limit.
The borrower must provide the lender with certain information to determine the borrowing base. This includes information on sales and collections, along with inventory. Middle-market and large asset-based loans generally require the borrower to give the lender a certificate with detailed calculations, such as which receivables are eligible, if the borrowing base is determined this way. The certificate is delivered periodically, which is spelled out in the credit agreement.
The lenders may also conduct regular investigations. This involves checking the borrower’s business and having an appraiser value the collateral that is used in calculating the borrowing base.
A Real Life Example
Cabot Oil & Gas Corporation did not have any borrowings outstanding under its revolving credit facility as of March 31, 2016. However, its borrowing base is redetermined annually on April 1. The company or banks may request a redetermination semi-annually, or whenever Cabot acquires or sells oil and gas properties. On April 19, 2016, the borrowing base was lowered to $3.2 billion from $3.4 billion.