Borrowing Base Revolvers: Liquidity for Risky Firms

33 Pages Posted: 18 Jan 2011

See all articles by Mark J. Flannery

Mark J. Flannery

University of Florida - Department of Finance, Insurance and Real Estate

Sara (Xiaohong) Wang

University of Florida - Department of Finance, Insurance and Real Estate

Date Written: January 6, 2011

Abstract

How do risky firms with low cash flow finance their liquidity needs? This paper investigates a relatively common, but little-studied type of credit line, for which funds availability is limited by the firm’s time-varying asset composition. A "borrowing base" line of credit provides funds as a proportion of (e.g.) the amount of the borrower’s accounts receivable. This quantity constraint serves as a sort of time-varying covenant: if the firm sells no output, its accounts receivable will be low and the bank lends only a small amount. We find that borrowing base ("BB") revolvers are taken more often by borrowers with high risk and low profits or cash flow. Compared to other types of secured credit lines, the BB loan rate is relatively insensitive to the borrower’s initial risk profile because the lender has security and the loan terms automatically limit credit extended to unsuccessful firms. Borrowers use the BB to reduce their borrowing cost, gain a more generous credit limit, and operate with fewer financial covenants.

Keywords: Line of Credit, Corporate Liquidity, Borrowing Base Revolver, Borrower Risk, Loan Spread, Fund Availability, Covenants

JEL Classification: G20, G21, G32

Suggested Citation

Flannery, Mark Jeffrey and Wang, Sara (Xiaohong), Borrowing Base Revolvers: Liquidity for Risky Firms (January 6, 2011). Available at SSRN: https://ssrn.com/abstract=1741306 or http://dx.doi.org/10.2139/ssrn.1741306

Mark Jeffrey Flannery

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States
352-392-3184 (Phone)
352-392-0103 (Fax)

Sara (Xiaohong) Wang (Contact Author)

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States
352-392-8913 (Phone)

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