For example, a company might learn that a key competitor, battered by the recession, is now in the market for a buyer and ready to make a deal. For another example, a retail business experiencing a flurry of consumer interest might need to boost inventory, but can’t be sure current sales levels will continue and as such is reluctant to make a major investment.
In short, opportunity abounds, but at a time when middle-market businesses with room to expand might be stymied by lack of capital, less than stellar credit or simply no time to work through the more traditional financing options.
For these companies, financing through asset-based lending might be the ideal alternative to traditional and commercial borrowing. In simplest terms, asset-based lending is financing secured by an asset. In exchange for money, borrowers offer equipment, inventory, real estate, accounts receivable and other liquid assets. Recently, lenders are considering new asset classes not previously used in the traditional asset-based lending structure, such as brand or trade name. Lenders maximize the collaterals’ lendable value, focusing more on that than leverage.
Asset-based lending is an attractive option during volatile and uncertain economic times. When the economy is lagging, businesses’ balance sheets tend to decline slower than the revenue rate. When the economy is growing, asset-based lending helps businesses deal with cash flow that lags behind revenue growth. Overall, asset-based lending gives middle-market companies flexibility and access to capital not available with traditional or commercial financing.
In 2011, refinancing pushed asset-based lending issuances to record highs, according to the Asset-Based Lending Loan Market Update published by KeyBanc Capital Markets. To date, 2012 asset-based lending appears to be running at more typical rates.
The Loan Market Update indicates that 2012 started slow, but gained momentum several weeks into the quarter. Even so, first quarter volume of $19.1 billion was 33.6 percent lower than first quarter 2011.
KeyBank is seeing considerable interest in asset-based lending from businesses in the retail, general manufacturing and transportation and logistics sectors from across the bank’s footprint. KeyBank expects to double its asset based lending business in 2012 by committing even more resources to asset-based financing.
The need for asset-based lending is primarily driven by companies’ balance-sheet leverage and cash-flow characteristics. Successful asset based lending borrowers typically have high leverage, tight cash flow and strong working capital assets in the form of robust accounts receivables and inventory. Asset based lending has an application when companies are experiencing rapid growth, making acquisitions, needs to finance dividends, requires recapitalization or is involved in a restructuring and turnarounds.
Asset-based lending is a good fit for many businesses in a variety of sectors and industries, but asset-based lending is a particularly good fit for industries and sectors that have a high reliance on working capital assets. For example, manufacturing, distribution, wholesale, retail and service businesses are all good candidates for asset-based lending. Businesses that have a seasonal business cycle often find asset-based lending a good solution for capital challenges that crop up because the business requires inventory investments in one quarter, with no return on that investment until the second quarter.
The asset-based lending process should start with the borrower finding the right lender for the purpose. Businesses contemplating asset-based lending should consider the following characteristics when evaluating lenders:
- Does the lender have detailed knowledge of the borrowers’ industry so they can provide a realistic assessment of the business’ assets and needs?
- Does the lender have a seasoned loan portfolio managed by experienced bankers?
- Does the lender have the ability to advocate to the business and provide support through good times and bad?
Prospective lenders will evaluate the business’ needs and recommend the appropriate financing product. For example, secured revolving credit facilities are an appropriate choice for a business that supplies seasonal products and so needs to finance inventory, while short-term over-advance facilities might be a better choice for a company that has just gotten new business and needs funds to service that new business.
At KeyBank, loan sizes range from $5 million to $50 million, and the bank has the ability to arrange and syndicate much larger loans. While asset-based loan rates once were typically significantly higher than traditional bank loans, increasingly lenders offer a wider range of possible rates. Rates are based on prime rate or LIBOR, and vary depending on the borrowers’ balance sheet, the borrowers’ industry and the liquidity of the recourse asset. Generally speaking, the more liquid the asset put up as collateral, the lower the rate.
Businesses that anticipate using asset-based lending should evaluate the internal reporting systems to ensure they maximize their borrowing capacity. Asset-based lending matches a company’s collateral pool to the company’s loan balance and to the company’s financial statements. These interrelated factors are monitored through monthly reports that are required as part of the lending process. Generally speaking, businesses with lower liquidity should anticipate more monitoring so lenders can be sure that the business is obtaining as much credit as possible.
Once the purview of companies that could not attract other forms of capital – equity or debt – asset-based lending is now considered a sophisticated product that should be part of every business’ financing strategy. Asset-based lending is valued by borrowers due to its lower cost, high flexibility and consistency, despite economic factors.