12.19.2014 Asset-based Lending: One Way to Grow Your Portfolio

As the financial crisis and recession grow more distant in the rear view mirror, many businesses are starting to plan for growth again. However, some of these companies will have a hard time qualifying for financing — especially those that have managed their receivables and inventory aggressively and put off making needed investments in capital expenditures in order to survive the recession and downturn.

Once they start ramping up growth, these companies are going to need to replenish working capital to fund additional inventory and receivables and fill orders. Companies that experienced losses in recent years or are already highly leveraged may not be able qualify for traditional bank loans and lines of credit.

Growth Financing via Asset-based Lending

These are the kinds of scenarios where asset-based lending (or ABL) can often help companies get the financing they need to shift back into a growth mode again. For years, startup and fast-growth companies have turned to ABL since it is often difficult for them to meet banks’ underwriting standards for traditional loans and credit lines. With the economic skies finally starting to brighten, more businesses might look to ABL to provide growth financing.

Does this mean your bank should venture into the asset-based lending waters? Offering asset-based loans is certainly one way to grow your loan portfolio. But if your bank is not experienced in asset-based lending, you first need to understand how ABL is different from traditional bank lending. Making asset-based loans requires looking at credit and at a borrower’s financials in a different way.

When considering whether or not to make a traditional loan to a business, you are mainly looking at projected cash flow to see if this will be sufficient to service the debt. This is gauged primarily by scrutinizing the business’ balance sheet and income statement. But when deciding whether or not to make an asset-based loan, your main consideration is how well the collateral — specifically, accounts receivable or inventory — will perform.

Therefore, you will need to carefully analyze collateral eligibility based on the borrower’s debtor base and the level of concentrations. You will also need to carefully monitor and verify collateral on an ongoing basis and receive regular inventory reports from the borrower, as well as reports on the liquidation values of finished goods and raw materials pledged as collateral.

Types of ABL

There are two main type of asset-based lending:

  • Factoring — Your bank will buy the business’ outstanding receivables at a discount and advance the company a percentage of their value (typically between 70 and 90 percent) at this time. The bank will release the balance of the receivable, minus the discount rate or factoring fee, once the invoice has been collected.
  • Accounts receivable (A/R) financing — Your bank will establish a borrowing base and lend money based on this amount against eligible collateral. To monitor this borrowing base, you may need to require monthly receivables and payables aging schedules from the business.

If your bank doesn’t have the systems and expertise in house needed for the level of collateral verification and monitoring required for ABL, you have several options. You could build an in-house ABL infrastructure, but this is time-consuming and expensive and might not be practical for your bank. Or you could buy or license an ABL software program that would save you the time and cost of building your own ABL systems from scratch.

Another option is to partner with a commercial finance company or factor that specializes in asset-based lending. Or you could simply refer businesses to a factor or finance company and let them handle the financing. Doing so will position your bank as a true solution provider in the eyes of your customers, who will likely return to your bank for traditional financing if they qualify at some time in the future.

12.11.2014 How Soaring Student Loan Debt Is Impacting the Economy

Young people and families in America are borrowing record amounts of money to go to college. According to the Consumer Financial Protection Bureau (CFPB), total student loan debt is now a staggering $1.2 trillion — yes, trillion with a t — making it the second largest type of consumer debt in the U.S. behind home mortgages. This is up four-fold from a decade ago, when total student loan debt in the U.S. was just $300 billion.

What’s more, two-thirds of U.S. college graduates now leave school with student loan debt averaging $26,600, according to The Institute for College Access and Success.

The Ripple Effect

In this blog, I don’t want to bombard you with more statistics about this crushing level of student loan debt, or debate whether or not a college education is worth taking on debt. Instead, I want to point out how record student loan debt is having a ripple effect that is negatively affecting many different segments of the economy.

Several new studies have demonstrated something that seems fairly obvious: High levels of student loan debt are forcing many young people to make different lifestyle and financial decisions than they might otherwise. When viewed on an aggregate basis, these decisions are having a negative impact on the U.S. economy.

For example, it appears that young people with lots of student loan debt are less likely to start new businesses. This makes sense, because individuals can only borrow so much money. Banks look carefully at an entrepreneur’s personal debt capacity when deciding whether or not to finance a new business start-up, so young entrepreneurs with heavy student loan debt are less likely to qualify for a business loan. Fewer small business start-ups could have a serious impact on the broad economy and employment over the long term, as up to 60 percent of all jobs are created by small businesses.

In addition, heavy student loan debt levels also seem to be discouraging young people from starting families. And when people aren’t getting married and having kids, they are less likely to buy homes, furniture, appliances and all the other purchases that coincide with home ownership. Research indicates that fewer 30-year-olds have bought homes since the recession began, especially 30-year-olds with a history of student loan debt. This is placing a further drag on economic growth, and new home construction, in particular.

Delayed Retirement Savings

Finally, most young people with heavy student loan debt are not getting an early start on saving for retirement. A long-term time horizon and the opportunity to benefit from compound returns over many years is the biggest benefit young people have when it comes to saving for retirement. Putting off opening an IRA or 401(k) account could cost young people tens, if not hundreds, of thousands of retirement dollars over the course of their lifetimes — and lead to a serious retirement crisis several decades down the road.

Of course, all of these trends will have an impact on banks, either directly or indirectly. If the trends continue, they will mean fewer small business loans and home mortgages and a weaker overall economy, which will further depress lending activity. This makes soaring student loan debt something to keep a close eye on going forward, regardless of whether or not you have children going to college.

12.8.2014 Should You Participate in Participation Loans?

With the economy showing signs that it may finally be gaining enough momentum for sustained growth, many banks are looking for opportunities to grow. Buying and selling participation loans is one strategy banks can implement to grow and diversify their loan portfolios, both geographically and across industries.

By buying participation loans, banks with large deposit bases can increase their loan volume by participating in loans made by banks outside of their market area. By selling participation loans, banks can further diversify their loan portfolios by geography and/or industry. In addition, selling participations may enable banks to make loans to customers they might otherwise have to turn down due to lending limits or regulatory rules (i.e., Regulation O) governing loans to board members and other insiders.

What Constitutes a Participation Loan?

In most instances, participation loans are traded between banks that already have an established relationship. These typically include non-competing banks that are located in different geographic areas, as well as correspondent banks and bankers’ banks.

In order to be a considered a participation loan, a loan must meet very specific criteria. For example, the selling bank cannot have any recourse rights, and each participant must possess a pro-rata interest in the financial asset. In addition, neither participant can pledge or exchange the entire asset unless all participant interest holders agree. And all cash flows from the asset must be allocated to participating interest holders proportionally to their ownership.

If a loan doesn’t meet these criteria, the seller must treat it as a secured borrowing. In particular, the loan cannot be removed from the selling bank’s balance sheet, which eliminates one of the main benefits of selling participation loans.

The Participation Agreement

Before buying or selling participation loans, it’s important to draft a participation agreement between the two banks. Such an agreement will detail all of the particular details of the loan (such as who will handle loan servicing, for example) and both the buying and selling bank’s specific rights and responsibilities as they relate to the participation loan.

A participation agreement should also require the selling bank to keep the buying bank regularly informed about all aspects of the loan, including the credit risk rating. In particular, the selling bank should provide financial information to the buying bank on a regular basis with regard to the loan’s credit risk rating.

Perhaps most important, the participation agreement should address each bank’s rights and responsibilities if the participation loan runs into trouble. For example, what rights (if any) does the buying bank have when it comes to demanding payment from the borrower, renewing the loan or moving into foreclosure? Or does the selling bank make all of these decisions?

Underwriting Guidelines for Participation Loans

Finally, you need to make sure participation loans are underwritten no differently than other loans when buying participations. Perform your own due diligence on borrowers instead of counting on the selling bank to perform due diligence for you, and review any outstanding environmental or appraisal issues with the borrower. Also insist that the selling bank provide you with a complete underwriting package on the loan.

Participation loans could be a path to portfolio growth and diversification in an improving economic environment. But proceed with caution, as they present unique risks as well as opportunities.