Asset based loans 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.
In the case of invoice (or accounts receivable) factoring, the security is the receivables balance owed to the firm by debtor in possession as payment on outstanding invoices. The typical structure for a factoring transaction is for the receivables balance to be legally assigned to the lender (or factoring firm) which then becomes the new owner of those constituent receivable amounts.
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.
In the event there is a shortfall and the lender does not achieve full recovery, the lender generally has two further options available. First, the lender can claim the amount for payment under a lender insurance policy. Second, the lender can sue the borrower in civil proceeding for payment of the outstanding amount.
Lenders in this market segment tend to specialist financiers. They may be stand-alone operators (including hedge funds) or business units within large investment banks, commercial banks or other financial institutions. Hedge funds operating in this segment have a very focused interest concentrated on a limited number of high value transactions, largely driven by special situations. Their transactions are few, large and concentrated on a limited number of clients. The transactions are mostly structured around a broader trading strategy.
Asset-based borrowers are mostly small or medium businesses as well as subsidiaries of major corporations. These borrowers have few financing alternatives. They are considered non-investment grade by debt investors.
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. 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.
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Tags: asset based lending, asset based loan, asset based loans, Credit Debt Consolidation