While commercial banks, finance companies and other specialty players dominate the asset-based lending and factoring industry, community bank leaders are increasingly discovering that secured lending offers an opportunity to diversify a portfolio often heavily dominated by real estate. However, ABL and factoring require a different mindset than traditional lending. Asset-based loans are secured by collateral, such as accounts receivable or inventory, and require close monitoring. For a factoring deal, the quality of the banking customer’s invoices, and not the customer, is the concern because the debtor is the source of repayment.
Even with the recent downturn and banks pulling back on traditional lending, asset-based lending and factoring are on the rise. “In recent years, even as the economy slowed and lending standards tightened, many banks of varying sizes have become more active in secured and monitored commercial financing,” says Robert Trojan, CEO of the Commercial Finance Association, the trade association for asset-based lenders. “That so many banks moved into this space in a challenging credit environment is a testament to the stability and profitability of asset-based lending and factoring,” he adds. “More and more banks are finding that secured commercial lending is an effective way to strengthen their balance sheets.”
According to the Commercial Finance Association, the size of the overall U.S. asset-based lending market in 2012 was estimated to be $620 billion in terms of loans outstanding. Bert Goldberg, executive director of the International Factoring Association, an association of commercial finance companies, estimates that about $150 billion was factored in the United States last year. While community banks involved in secured lending are a small number, Goldberg says that it is a growing contingent. Small and midsized businesses are on the hunt for additional capital, and traditional lenders remain less than enthusiastic in servicing this market. Community bankers are recognizing that expanding their product bases into asset-based lending and factoring offers their existing clients, and potentially new ones, another way to access capital.
Understanding the Risks and Rewards
Tim Stute, managing director of the global investment bank Houlihan Lokey’s financial institutions group, says that ABL and factoring are a “natural outgrowth of small business lending that can generate an outsize return on equity for a bank.” He admits that all banks are starved for yield and asset growth, given the lackluster growth available in the targeted asset classes, especially for community banks with traditional portfolios of land development, construction and real estate. He adds, “It’s very competitive and rates are getting pushed down. Those that are willing to be more creative are trying to think of other areas of the lending continuum to get into at the moment.”
However, Stute reminds that ABL is a unique brand of lending. “You have to roll up your sleeves and protect your collateral, and that’s very different from the way that many bankers were trained.”
Borrowers looking for an asset-based loan might have limited cash flow and, perhaps, may be losing cash, but still have strong receivables. A traditional loan might not work, but a secured one could, he says. But you need the expertise and experience to deal with what most bankers would consider to be “stomach turning credits.” The situation is certainly one that asset-based lenders are facing in a greater number, given the recent recession. Factors also need to be mindful of the credit challenges of their customers and the customers’ debtors, especially in a downturn. The solution is a strong adherence to the secured lender’s policies and procedures.
The Industry Rundown
First Business Capital, a subsidiary of First Business Bank-Madison in Wisconsin, entered the asset-based lending market about 20 years ago, says Charles Batson, president and CEO. Looking at the marketplace today, Batson notes that he is seeing an increased awareness of secured lending among community bankers. But given the high cost of entry into the business and the infrastructure and considerable credit management tools needed, there’s no real “dabbling in specialized lending without a risk,” he adds. Batson argues that bringing seasoned secured lenders on board is essential — people skilled in collateral monitoring, robust underwriting, portfolio management and due diligence.
But with the right team, bank-sponsored asset-based lenders and factors offer the customer something that independent factors often cannot. Mark Woods, vice president of business development in the factoring division of Southern Bank Co. in Birmingham, Ala., says that banks, unlike independent factors, have a low cost of funds, making the factoring rates better for the banking customer. In the factoring relationship, whether through a bank or independent, customers are able to quickly boost their cash flows. Factors can also provide assistance in the credit verification process of a business’s customers. Plus, economic downturns are often when factors ramp up operations, providing cash when traditional lenders might balk at the deal.
A Relationship-Driven Business
Given the years of lender experience and the infrastructure costs needed to start ABL and factoring operations, a variety of larger banks, independent factors and other intermediaries are offering their services to community banks. The arrangements vary, running the gamut from mere servicing and back-office assistance to collateral evaluation and portfolio management. The intermediary can keep the deal outright or participate in the asset-based loan or factoring arrangement with the community bank. The intermediary might syndicate the secured loan to other lenders or even to private equity and hedge fund players.
Andy McGhee, co-founder of AloStar Bank of Commerce, a Birmingham, Ala.-based community business bank, and president of the asset-based lending unit AloStar Business Credit, believes that when community banks look for a partner in their ABL and factoring businesses, they need to look for an intermediary who has significant experience and “skin in the game.” AloStar takes in deals they originate, keeping 100 percent of the secured loan. But if a community bank brings AloStar Business Credit a transaction, AloStar will hold a minimum of 50 percent control on the deal. McGhee says that while AloStar Business Credit makes a decision about the customer, the banks need to make an independent decision on the customer, too.
David Grende, president and CEO of Siena Lending Group, a Stamford, Conn.-based independent commercial finance company, acknowledges that a rollout for a smaller community bank to get into ABL or factoring is often an arduous process. That is why community banks consider outsourcing a part or all of their ABL and factoring functions, he says. Siena Lending Group originates asset-based loans for its own balance sheet, as well as servicing and syndicating deals for community banks.
Says Grende, “The best fit is a community bank that has its own marketing officers on the street and the ability to originate some of their own products. If they have the interest and they have C&I lending they want to expand, ABL is a wonderful way to expand and move away from real estate.”
Myra Thomas is a contributing author based in Fanwood, N.J.
Copyright (c) December 2013 by BankNews Media