Asset Based Lending – Ideal For Commercial Borrowers

by erin on November 29, 2010

In a general sense, asset based lending refers to any form of lending involving an asset being provided by the borrower for security that will be forfeited in the event of default. This form of lending is also known as secured lending. A private mortgage loan from a niche lender is an example of asset based financing. By contrast, credit card borrowing is an example of lending that is not asset based financing.

The definition outline above is quite broad. As suggested by the two examples cited above, it captures many consumer loans, even a mainstream home or property mortgage loan from a bank or financial institution. In practice, asset based financing is used to refer to a narrower type of lending focused mainly on commercial borrowers.

When used in this more limited sense, asset based borrowers are mainly small-to-medium sized firms or the subsidiaries of large corporations. Lenders include specialist lending units within both corporate and investment and banks, as well as niche lenders focused more or less exclusively on asset based financing.

Used in this more restricted sense, asset based finance refers to loans secured against tangible assets including inventory, accounts receivable, machinery and equipment, commercial vehicle fleets as well as intangible assets like trademarks and intellectual property.

Receivables factoring is a common form of asset based lending. In this instance, the relevant asset is the debtors that owe a firm payment on outstanding invoices. This asset is not used as security; rather its legal title is formally assigned to the lender which then becomes the new owner of the asset. The lender or factoring firm carries the risk of debtor default. To control this risk, the lender may, in the loan documentation, stipulate a right to control who the borrowing company takes-on as a customer in order to ensure customers will pay.

Large organizations, particularly those that can tap public debt markets by issuing debentures, notes and bonds, are not themselves frequent participants in asset based loan markets, although it may from time to time be convenient for their subsidiaries to access this form of financing. Large corporations generally have lower cost borrowing alternatives available. By contrast, small-to-medium firms have more limited borrowing options and hence tend to be the most active asset based borrowers.

When evaluating a loan application, asset based lenders rely heavily on the assets offered as security. This collateral is often assigned a higher weighting than the sustainable cash flow of the borrower. As a consequence, the lender sets little priority on obtaining proof of income or cash flow from the borrower.

An asset based line of credit will generally have a revolving, rather than fixed, credit limit that fluctuates based on the operational needs of the borrower. This requires the lender to regularly monitor and inspect the borrower.

In conclusion, asset based lending is a form of subprime financing, but not exclusively so. Where low grade borrowers are counterparty or a debtor in possession, lenders will usually seek to set loan rates with a higher embedded risk component. Asset based loans may also have high associated set-up, ongoing administration and break fees.

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