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An asset based business line of credit is usually designed for the same purpose as a normal business line of credit – to allow the company to bridge itself between the timing of cash flows of payments it receives and expenses. The primary timing issue involves what are known as accounts receivables – the delay between selling something to a customer and receiving payment for it. A non-asset based line of credit will have a credit limit set on account opening by the accounts receivables size, to ensure that it is used for the correct purpose. An asset based line of credit however, will generally have a revolving credit limit that fluctuates based on the actual accounts receivables balances that the company has on an ongoing basis. This requires the lender to monitor and audit the company to evaluate the accounts receivables size, but also allows for larger limit lines of credits, and can allow companies to borrow that normally would not be able to. Generally, terms stipulating seizure of collateral in the event of default allow the lender to profitably collect the money owed to the company should the company default on its obligations to the lender.
Factoring of receivables, is a subset of asset-based lending (which uses inventory or other assets as collateral). The lender mitigates its risk by controlling who the company does business with to make sure that the company’s customers can actually pay.
Lines of credits may require that the company deposit all of its funds into a “blocked” account. The lender then approves any withdrawals from that account by the company and controls when the company pays down the line of credit balance.
Still another subset of a collateralized loan is a Pledging of Receivables and an Assignment of Receivables as Collateral for the Debt. In many instances, Receivables are transferred to the lender when they are Pledged as Collateral. When the Receivables are Pledged as Collateral, or Assigned with the condition that the Lender “has Recourse” in the event the Receivables are uncollectible, the Receivables continue to be reported as the borrower’s asset on the borrower’s Balance Sheet and only a Footnote is required to indicate these Receivables are used as Collateral for debt. The debt is reported as a Liability on the borrower’s Balance Sheet and as an Asset (a Receivable) on the Lender’s Balance Sheet. In some situations, the lender can actually Repledge or Sell the Collateral the borrower used to secure the loan from the lender. In this instance, the borrower continues to recognize the Receivables as an asset on the borrower’s Balance Sheet, and the lender only records the Liability associated with the obligation to return the asset.
In the simplest meaning, asset-based lending is any kind of lending secured by an asset. This means, if the loan is not repaid, the asset is taken. In this sense, a mortgage is an example of an asset-backed loan. More commonly however, the phrase is used to describe lending to business and large corporations using assets not normally used in other loans. Typically, these loans are tied to inventory, accounts receivable, machinery and equipment.
This type of lending is usually done when the normal routes of raising funds, such as the capital markets (selling bonds to investors) or normal unsecured or mortgage secured bank lending is not possible. This is usually because the company was unable to raise capital in the normal marketplace or needs more immediate capital for project financing needs (such as inventory purchases, mergers, acquisitions and debt purchasing). It is usually accompanied by higher interest rates, and can be very lucrative for the parent company. For example, the bank Wells Fargo made more money from asset-based lending business than it did the rest of its corporate business (both lending and fee based services).
Many financial services companies now use asset-based lending package of structured and leveraged financial services. Most banks, both national investment banks (Goldman Sachs, RBC) and conglomerates (i.e. Citigroup, Wells Fargo), along with regional banks, offer these services to corporate clients.
Asset-based lenders are known for taking out tombstone ads in much the same way as investment banks.