Information Regarding Asset Based Lending

Usually, asset based lending have strict loan-to-value limits

. These vary from lender to lender and depend on the type security. Indicatively, lenders may limit a loan to somewhere from 50% to 70% of the appraised value of the asset taken as security. For example, if the asset has an appraised value of $1.0 million, the asset based lender may lend up to $0.7 million against that asset. The precise meaning of the term appraised value is important.

Conventional lenders usually equate appraised value with the price at which the asset is being acquired, that is, the current market price of the asset. By contrast, asset based lenders may be more prepared to view appraised value as the true underlying or fundamental value of the asset. If so, asset based finance can even be attractive for high grade borrowers. This point is made clear by the following example.

Asset based borrowers tend to be mainly smaller and medium sized firms, including sole proprietors, family-owned firms and subsidiary entities of large corporations. Asset based lenders include specialist units within banks and other financial institutions, including dedicated asset based lenders, investment banks and hedge funds. Accounts receivable factoring is asset based finance. Much commercial property lending is also commonly asset based.

Assume a property investment professional has an opportunity to purchase a commercial property from a distressed seller at a price of $10.0 million. The property professional assesses this price to be at a deep discount of $8.0 million to the true underlying fundamental value of the property. In other words, the property professional estimates that fundamental value to be $18.0 million.

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.

The bank has a policy of limiting its exposure in any one property to a maximum of 70% of its value. It deems the value of the property to be the $10.0 million purchase price. Implicitly, in rejecting the loan proposal, the bank rejects the view that the property is really worth $18.0 million.

The investment professional then approaches an asset based lender with the same loan proposal. The asset based lender performs its own due diligence on the property, complete with valuation advice from an independent expert, and concludes that the true value of the property is indeed closer to $18.0 million than the $10.0 million purchase price. It therefore views the borrowers equity contribution towards the property as being $1.0 million $8.0 million = $11 million rather than merely $1 million and approves a $9.0 million loan allowing the property professional to proceed with the purchase. Versus conventional loans, the asset based lender will customize the loan terms to ensure it receives an adequate return that satisfactorily rewards.

by: Ben Pate

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