When most people hear the words “air ball,” they probably think about when a basketball player shoots and the ball doesn’t touch the rim or the net — only air. Those of us in the commercial lending field have a different and less amusing interpretation.
An air ball in the context of commercial lending is the difference between a loan and the value of hard assets supporting that loan. If the loan is greater than the borrower’s hard asset value, then you have an air ball. So, if you have a $450,000 revolver supported by $350,000 in current assets, properly margined, then you have a $100,000 air ball.
Assets are, in many cases, overstated from a lender’s perspective, so an air ball may be even larger than it appears after an examination of dilution of A/R and age of inventory. Today, many community and commercial banks still find themselves in situations where some loans exceed the value of hard assets after those assets are closely examined.
An air ball situation places both the lender and the borrower in a difficult position. If your borrower’s business has stabilized and it simply doesn’t have the hard assets to cover the loan, you have a couple of options. First, if the borrower is in default, you could decide to move against the collateral. In this case, you will likely take a loss if you made an unmonitored or unmargined loan.
If the borrower is not in default, you can muddle along, but you’ll have to deal with regulatory requirements for reserving against bad loans. If loan covenants are tripped, your bank might be required to reserve as much as 10 percent of the commitment. If it is a rated loan showing current performance issues, this can require a 15-30 percent reserve.
How a Commercial Finance Company Can Help
Bringing in a commercial finance company during the workout will help reduce overall exposure and provide your bank with accurate information feedback. A commercial finance company will provide a revolving line of credit based on the margining of current assets. This will reduce total loan exposure and reveal the true nature of the air ball, which can then be structured as a “last-out” air ball whereby the liquidity provided by a commercial finance company will help the company grow toward a solution. A commercial finance company can release any excess cash flow that is generated, which can used to pay down the airball via periodic cash flow sweeps.
The advantage to your bank is that you lower your overall credit exposure, put a floor on what the potential loss could be, and keep your client’s treasury management business in the process. The borrower gets access to liquidity and growth capital and the services and experience of a seasoned lender like a commercial finance company. Best of all, there is still the possibility of recouping the air ball and the client becoming bigger and better down the road.
If a loan situation is too far gone, it might not make sense to attempt a turnaround. Ownership must be fully committed to the success of the company before a turnaround is attempted. In this situation, a commercial finance company’s ongoing services will keep cash flow issues to a minimum while freeing up ownership to focus on the core issues of the turnaround.
Good Workout Candidates
The best commercial finance company workout candidates are small to mid-sized businesses in the manufacturing, distribution or business services industries that have the potential for an increase in sales. Businesses must also have a reasonable potential profit margin, committed management and ownership, and a patient and understanding banker.
The best thing to do is contact your local a commercial finance company Business Development Officer and discuss your particular air ball scenario. Be prepared to provide your BDO with the current loan balance and structure and a current borrower balance sheet and income statement, which will aid in determining the potential size of the air ball. If the situation warrants, we would then ask for a warm introduction.
The borrower would be asked to provide us with a standard package of financial information, and within a few days will provide a written proposal for discussion purposes. At this time, we will discuss the security issues all three parties must sign onto.
A commercial finance company will ask your bank to subordinate the current assets (A/R and inventory) to the commercial finance company’s lien’s position; in return, they will commit to directing all funds to a specified account at your institution. Your bank will keep its first position on all the other collateral while retaining a second position on the current assets. In addition, the client will be asked to allow your bank to have complete access to all the A/R reports.
A commercial finance company’s professional A/R management services ensure that your clients’ A/R aging reports are accurate and always up to date. We also ensure that proper credit policies are followed at all times.
Air ball situations can be difficult for all parties involved, but creative financing solutions can help.
Rodney Schansman serves as Ftrans’ CEO and member of the Board of Directors and is responsible for leadership and strategic direction of the company. He is a 25-year veteran of commercial finance, healthcare finance and private equity.