Asset Based Loan Solutions - An Option Best Suited For Commercial Borrowers
In its most general meaning, asset based lending describes any lending where assets offered by borrowers to act as security or collateral in support of a loan. That security will be forfeited by the borrower in the case of default. Clearly, asset based loans are secured loans.
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.
Asset based finance may be secured with either tangible or intangible assets. Tangible assets commonly used include inventory, plant & equipment, accounts receivable, machinery, vehicle fleets as well as infrastructure assets such as trains, ships and airplanes. Intangible assets include trademarks and patents as well as business or product franchises.
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 corporations, especially those that borrow in directly from investors in public markets, are rarely significant participants in asset based loans except for a few specialist instances such as the financing of airplanes, ships, trains and so on. Large corporations usually enjoy lower cost debt alternatives compared to asset based structures.
When assessing a loan request, lenders assign often assign the asset a greater weighting than the underlying cash flow stream of the borrower. As a result, the lender sets a low priority on requesting the borrower document proof of its cash flow or income.
Hedge funds may also engage highly specific asset backed lending, not as a stand-alone activity but as part of a wider trading strategy. For example, a company operating a cash flow positive project may require capital to expand capacity and approaches the hedge fund for a loan offering the project as collateral. The fund extends the loan having identified several potential buyers of the project and assessed they are likely to pay a substantial premium above the loan value. The borrowing company eventually defaults on the loan and the fund takes possession of the project. The fund places the project on sale and sells at a profit.
In conclusion, asset based lending is a form of subprime finance. Loan rates therefore have a higher embedded risk component. They may also have high associated set-up, ongoing administration and break fees. This form of borrowing is commonly accessed if a firm has a low credit rating or is a debtor in possession. Start-up companies, young firms without an established cash flow record or firms that are already carrying large debts are examples of firms that may be sub-prime borrowers and likely candidates for asset based loans.