Asset based loan refers to debt financing supported by assets as collateral or security for the loan. Ownership of the collateral transfers to the lender if the borrower defaults on the loan. This form of loan is also sometimes more generically referred to as an equity or secured loan.
This form of lending can be a vital source of credit for many less than prime quality debtor in possession. Borrowers in this market segment usually have no credit history or one that is very short or indicative of very poor performance. They may also have little income to support repayments and may need part of the loan to finance repayments until the asset is either sold or refinanced, or a new income stream kick-in.
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.
In the case of higher-risk borrowers, lenders may require the line of credit to be set-up as a blocked account where withdrawals must be approved by the lender. This stipulation provides the lender with tight control over the funds and allows it to review reasons for their deployment.
Loans may be structured or distributed in different formats depending on the needs of the borrower. For example, the loan may be arranged as a revolving line of credit allowing the borrower to draw on funds up to the credit limit or any lesser amount. Interest payments are based only on the funds drawn, a feature attractive to borrowers.
Lenders in this segment are mainly specialist units, operating either as stand-alone firms or as divisions within larger financial institutions. Hedge funds may also engage in focused, high value transactions in this debt market centered on large, discrete and special situations. Their transactions are usually designed to support a broader trade or transaction strategy.
For instance, a corporate firm may owns a project that has been developed to the stage of generating positive cash flow. The project may need fresh capital to increase capacity. The firm approaches a hedge fund to arrange debt funding for the project with it being offered as collateral. The hedge fund identifies several potential buyers of the project. It provides the loan to the firm confident it can quickly arrange a new buyer for the project in the event of loan default. The hedge fund believes the buyers would pay a premium above the loan amount. As it happens, adverse market conditions force the borrower into loan default. The hedge fund seizes possession of the project and on-sells it at a profit.
This form of lending can be a vital source of credit for many less than prime quality debtor in possession. Borrowers in this market segment usually have no credit history or one that is very short or indicative of very poor performance. They may also have little income to support repayments and may need part of the loan to finance repayments until the asset is either sold or refinanced, or a new income stream kick-in.
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.
In the case of higher-risk borrowers, lenders may require the line of credit to be set-up as a blocked account where withdrawals must be approved by the lender. This stipulation provides the lender with tight control over the funds and allows it to review reasons for their deployment.
Loans may be structured or distributed in different formats depending on the needs of the borrower. For example, the loan may be arranged as a revolving line of credit allowing the borrower to draw on funds up to the credit limit or any lesser amount. Interest payments are based only on the funds drawn, a feature attractive to borrowers.
Lenders in this segment are mainly specialist units, operating either as stand-alone firms or as divisions within larger financial institutions. Hedge funds may also engage in focused, high value transactions in this debt market centered on large, discrete and special situations. Their transactions are usually designed to support a broader trade or transaction strategy.
For instance, a corporate firm may owns a project that has been developed to the stage of generating positive cash flow. The project may need fresh capital to increase capacity. The firm approaches a hedge fund to arrange debt funding for the project with it being offered as collateral. The hedge fund identifies several potential buyers of the project. It provides the loan to the firm confident it can quickly arrange a new buyer for the project in the event of loan default. The hedge fund believes the buyers would pay a premium above the loan amount. As it happens, adverse market conditions force the borrower into loan default. The hedge fund seizes possession of the project and on-sells it at a profit.
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To conclude, asset based loans is typically involves a single category of asset taken as security. The lending is viewed as subprime finance accessed by debtor in possession with poor credit history.
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