by Ben Pate
The term asset based loans refers to any type of loan where an asset is presented by the borrower as collateral or security to support the loan. Ownership of this collateral will transfer to the lender if the borrower defaults on the loan. This form of loan is also referred to as an equity loan or a secured loan. Private mortgages and receivables factoring are two well-known forms of asset based finance.
Conventional lenders usually take the existing market price of an asset as its appraised value. Asset based lenders, by contrast, may consider appraised value to be best seen as the fundamental value. In these cases, accounts receivable financing options can be attractive even for high quality borrowers. This point is highlighted in the example below.
Mainstream lenders usually set a loan amount with reference to the prevailing market price of an asset not its fundamental value. This can be unattractive for borrowers if the fundamental asset value is above the market price. In these cases, conventional loans can be unnecessarily restrictive and penalize borrowers that have identified opportunities to acquire assets at discounts versus fundamental value.
An experienced property investor has identified an opportunity to acquire commercial real estate for $20.0 million as a distressed sale from a forced seller. The investor calculates this price to represent a discount of $16.0 million versus a $36 million fundamental property value.
When evaluating loan applications, asset based lenders rely heavily on assets offered as collateral. This security is typically assigned a high weighting relative to the sustainable or underlying cash flow of the borrower. As a result, lenders set low priority on obtaining income or cash details flow from borrowers.
For higher-risk borrowers, asset based lenders may require the granted line of credit be established as a blocked account necessitating approvals by the lender before withdrawals can be made. This stipulation provides the lender with tight control over the funds and allows it to closely review their deployment.
Hedge funds may also engage in high value, asset based loans centered on large, discrete, and specialized assets. They typically participate in these transactions not as a stand-alone activity but rather to support a wider trading or transaction strategy. To illustrate, a firm that owns and operates a positive cash flow project needs new capital to increase capacity. It enters discussion with a hedge fund to arrange a loan with the project as collateral. The fund grants the loan after identifying the project is of interest to a number of potential buyers and assessed these buyers are likely to pay a premium above the loan amount extended to the current owner. Adverse market conditions eventually force the borrowing company into loan default; the hedge fund takes possession of the project and immediately divests it at a profit.
Conventional lenders usually take the existing market price of an asset as its appraised value. Asset based lenders, by contrast, may consider appraised value to be best seen as the fundamental value. In these cases, accounts receivable financing options can be attractive even for high quality borrowers. This point is highlighted in the example below.
Mainstream lenders usually set a loan amount with reference to the prevailing market price of an asset not its fundamental value. This can be unattractive for borrowers if the fundamental asset value is above the market price. In these cases, conventional loans can be unnecessarily restrictive and penalize borrowers that have identified opportunities to acquire assets at discounts versus fundamental value.
An experienced property investor has identified an opportunity to acquire commercial real estate for $20.0 million as a distressed sale from a forced seller. The investor calculates this price to represent a discount of $16.0 million versus a $36 million fundamental property value.
When evaluating loan applications, asset based lenders rely heavily on assets offered as collateral. This security is typically assigned a high weighting relative to the sustainable or underlying cash flow of the borrower. As a result, lenders set low priority on obtaining income or cash details flow from borrowers.
For higher-risk borrowers, asset based lenders may require the granted line of credit be established as a blocked account necessitating approvals by the lender before withdrawals can be made. This stipulation provides the lender with tight control over the funds and allows it to closely review their deployment.
Hedge funds may also engage in high value, asset based loans centered on large, discrete, and specialized assets. They typically participate in these transactions not as a stand-alone activity but rather to support a wider trading or transaction strategy. To illustrate, a firm that owns and operates a positive cash flow project needs new capital to increase capacity. It enters discussion with a hedge fund to arrange a loan with the project as collateral. The fund grants the loan after identifying the project is of interest to a number of potential buyers and assessed these buyers are likely to pay a premium above the loan amount extended to the current owner. Adverse market conditions eventually force the borrowing company into loan default; the hedge fund takes possession of the project and immediately divests it at a profit.
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In summary, asset based loans can be an attractive financing option even for high quality borrowers. By contrast, some asset based finance lenders acknowledge that the market price of an asset can be substantially below its true fundamental value, opening up attractive trading opportunities for borrowers, and base their loans accordingly.
