Asset Based Lending An Origin Of Borrowing For Less Than Prime Borrowers
asset based loan is a relatively specialized form of debt financing that relies heavily on an asset or assets as security to underpin the loan. In the event of loan default, the ownership of the stipulated security item is seized by the lender. In its most general sense, this type of financing falls within the broad category known as equity or secured lending.
This type of funding can be vital for many non-prime quality debtor in possession, particularly small private firm that generally have limited financing options. Borrowers in this market segment usually have a credit history that is in some way unsatisfactory. The borrower may not have a credit history or it is very short. Worse still, it may point to a poor repayment record. The borrower may not yet have sufficient cash flow to support a conventional loan. Whatever the case, an asset based loan may serve a critical funding need for an asset-rich borrower.
Lenders in this segment typically limit the loans to a 50 or 65 loan to value ratio (LTV). For example, if the assessed value of an asset is $2.0 million, a lender might lend between $0.5 million to $0.65 million.
A lender usually feels comfortable that a 35-50 percent equity stake in the asset by the borrower represents enough equity to allow the lender, in the case of foreclosure, to take possession of the property, sell it and use the proceeds to recover its full loan amount and cover any outstanding expenses. Those expenses likely include outstanding accumulated interest, taxes and legal fees.
An asset based loan may be established with a revolving credit limit that fluctuates in line with the business needs of the borrower. If set-up this way, it increases monitoring demands placed on the lender and so higher fees may be applied.
Lenders in this segment are mainly specialist units, operating either as stand-alone firms or as divisions within larger financial institutions. Hedge funds may also engage in focused, high value transactions in this debt market centered on large, discrete and special situations. Their transactions are usually designed to support a broader trade or transaction strategy.
For instance, a corporate firm may owns a project that has been developed to the stage of generating positive cash flow. The project may need fresh capital to increase capacity. The firm approaches a hedge fund to arrange debt funding for the project with it being offered as collateral. The hedge fund identifies several potential buyers of the project. It provides the loan to the firm confident it can quickly arrange a new buyer for the project in the event of loan default. The hedge fund believes the buyers would pay a premium above the loan amount. As it happens, adverse market conditions force the borrower into loan default. The hedge fund seizes possession of the project and on-sells it at a profit.
In conclusion asset based loan can be a convenient and vital form of financing for many borrowers, particularly smaller firms with less-than-prime credit histories. Like most loans, this form of financing usually involves set-up fees, ongoing administration fees and break fees. These fees are usually a tiny fraction of the total loan value. The precise structure and level of the rates and fees will reflect the nature of the risks assumed by the lender for the debtor in possession.