Collateral monitoring: the example of wholesale product inventory.(Selected Topic)

Introduction

Conducting initial due diligence with an eye toward ongoing collateral monitoring is critical to managing risk over the life of the loan. The lender establishes the borrowing base structure, reporting requirements, and covenants in an effort to continually gauge the health of the loan. For asset-based loans secured in whole or in part by inventory, the initial and subsequent inventory appraisals provide the foundation on which ongoing collateral monitoring is based. This article will highlight important components in the due diligence process and the subsequent monitoring of inventory collateral that will help the lender effectively manage risk.

Initial Due Diligence

Coordination of Field Examiner and Appraiser

The lender engages both a field examiner and an appraiser to verify and value the collateral and the systems that report it. While field examiners and inventory appraisers conduct two different scopes of work, together they ensure a sound understanding of the underlying business and its information reporting. The lender should make sure the source information reviewed by the examiners and the appraiser is the same. A simple reconciliation of source information summarizing on-hand and in-transit inventories as well as potential ineligibles, such as damages or returns, will uncover any inconsistencies. In addition, a dialogue between the examiner and appraiser regarding the company's accounting methods, systems capabilities and reporting can uncover possible problems and help develop a common understanding of the underlying information. The lender can then utilize this common understanding to structure the scope and frequency of required reporting, reexamination and reappraisal.

Understanding the Company

The lender looks to the appraiser to set the net orderly liquidation value of the inventory collateral. In order to determine inventory values, the appraiser must gain a sound understanding of the company: how it conducts business, how their particular market behaves, and finally how these activities are shown in the company's financial and collateral reporting. The company may have specific practices or conventions that impact the net recovery on ...