ABLs Enjoy New Luster Amid Credit Drought

Even as most sources of credit have dried up over the past few months, one has been going strong: the asset-based lending market. In fact, total committed credit lines among asset-based lenders increased 5.6 percent in the first quarter of 2008, reports the Commercial Finance Association (CFA), a New York-based trade group. And this is after a jump of 4.4 percent in the final quarter of 2007. In all, the industry is nearing $500 billion in total loans outstanding.

As its name suggests, asset-based financing refers to loans made against the assets a company uses to operate its business. The assets generally include inventory, capital equipment, and/or real estate.

One driver behind the growth in asset-based loans is, not surprisingly, the tightening lending policies at many banks. “The cash flow [lending] business has tightened, and businesses that need financing have to go somewhere,” says Andrej Suskavcevic, chief executive officer with the CFA.

Moreover, many cash flow lenders are moving away from the excessively low interest rates and skimpy covenants of the past few years, says Gregg Wise, senior managing director with GMAC Commercial Finance's structured finance division. This makes asset-based lending relatively more competitive.

At the same time, a growing number of hedge funds and private equity players are offering asset-based loans, says Suskavcevic. In some cases, an asset-based loan is part of a larger deal. For example, a manufacturer may obtain a cash flow line of credit, along with an asset-backed loan, to support its launch of a new product line.

From the lender's point of view, asset-based financing can be considered less risky than a loan based just on a company's expected cash flows, as the assets offer the lender protection. Even if the company's performance drops drastically, the assets should retain their value. “We look at the balance sheet and income statement, but they don't weigh as heavily on the credit decision,” says Robert Martucci, senior vice president with Rosenthal Business Credit, New York. “This is because we look at the performance of the asset.”

As a result, asset-based loans usually lack the financial covenants that accompany most cash flow loans, Wise notes. For instance, many loans that are tied to a company's cash flow stipulate a maximum debt-to-EBITDA ratio the company can carry. This typically wouldn't be found on an asset-based loan.

This is not to say that asset-based lenders simply open up their checkbooks. They first need to verify the value of the assets backing the loan. So, before lending against machinery, the lender may have an independent appraisal firm value the equipment. If the loan is against inventory, the lender typically will require weekly or monthly reports on inventory levels.