Definition
A borrowing base is the maximum amount a lender will extend to a borrower based on the value of specific collateral the borrower pledges. Lenders discount (margin) those collateral values to allow for declines in market value or collectability; the discounted total becomes the credit limit available to the borrower.
Why lenders use borrowing bases (short)
– Ties credit to identifiable assets, lowering unsecured exposure.
– Allows automatic adjustments: if collateral value falls, the available credit falls; if it rises, the borrowing limit can increase (subject to contract caps).
– Facilitates monitoring through scheduled reports and appraisals so lenders can limit losses early.
Key terms (defined)
– Collateral: assets pledged to secure a loan (accounts receivable, inventory, equipment, mineral reserves, etc.).
– Margining: applying a discount to the asset’s nominal value to create a conservative loan amount.
– Advance rate: the percentage of an asset’s value a lender will lend against (e.g., 80% of eligible receivables).
– Redetermination: a scheduled or ad hoc reassessment of the borrowing base by the lender.
– Borrowing base certificate: a borrower’s report that itemizes eligible assets and totals used to calculate the borrowing base.
How a borrowing base is calculated — stepwise
1. Identify eligible assets per the loan agreement (e.g., only receivables less than 90 days past due; finished goods inventory; proven oil-and-gas reserves).
2. Value each asset class according to the agreement (book value, net realizable value, or appraised value).
3. Apply asset-specific advance rates (margining). Typical patterns: receivables often have higher advance rates than inventory; specialized assets (e.g., drilling reserves) have bespoke rates.
4. Subtract agreed reserves or ineligible items (e.g., concentrations of single-customer receivables, slow-moving inventory).
5. Sum the discounted values to get the borrowing base.
6. Apply any contractual cap (the facility maximum) to determine the final available credit.
Checklist for borrowers preparing for a borrowing-base facility
– Gather detailed schedules of receivables (aging, customer concentrations).
– Produce inventory listings with locations, condition, and valuation method.
– Assemble appraisals or production reports for specialized assets (oil & gas, equipment).
– Prepare a borrowing-base certificate in the format required by the lender.
– Expect periodic redetermination dates and ad hoc audits or physical inspections.
– Understand advance rates and what makes assets “eligible” or “ineligible.”
– Know covenant triggers (e.g., required minimum borrowing-base coverage) and notice obligations.
Worked numeric example
Assume a company offers:
– Eligible receivables: $500,000; agreed advance rate = 80% → lending value = 0.80 × $500,000 =