Asset based lending: Is it right for your bank?

Asset-based lending can be lucrative for community banks, but there are risks involved. We look at the pitfalls and how to avoid them.

By Katie Kuehner-Hebert

Not many community banks are into asset-based lending (ABL), but those that are involved in the risky business line say it can be very profitable if done right.

Lending on receivables, inventory or equipment can be tricky, as conventional underwriting standards on customers’ businesses is not enough. It also takes expertise in how companies’ invoices are paid and third-party software that is robust enough to manage those types of collateral.

Perhaps most importantly, ABL requires plenty of elbow grease. Community banks lending in this way must monitor the collateral throughout its entire life cycle, such as evaluating how much of a hospital’s receivables are really going to get paid by insurers, or whether there really are TVs in the boxes at a customer’s warehouse—and whether they actually turn on when plugged in.

“Not a lot of banks do ABL, so this enables us to differentiate ourselves from other community banks that don’t have this product,” says Rich Bradshaw, president, specialized lending at the $10.7 billion-asset United Community Bank in Blairsville, Ga. “ABL is also a good money maker,” he says. “You’re going to get business that you were not getting before, and the deals are going to be well priced, with a reasonable net interest margin and additional fees compared to other loans.”

For example, banks generally charge an unused line fee on ABL credits, as well as origination fees and charges for field audits to determine the quality of the collateral. United Community uses a third-party firm to conduct field audits, making sure customers’ receivables and inventory match up with the borrowing base certificates they’ve provided to the bank. On these certificates, customers list their receivables and inventory, and then the bank will determine how much it will lend.

Setting guidelines

Banks considering ABL need to first determine what types of receivables and inventory they will accept, Bradshaw says. There are higher advance rates on receivables than inventory. Generally, foreign receivables are excluded and government receivables need to be separately addressed because they take longer to be repaid. Banks should also consider credit insurance on foreign receivables.

Banks should then decide whether to lend just on finished goods or also work-in-progress, as well as the type of product the customer is selling.

“For example, if the inventory is frozen fish, the product is only good for so long,” Bradshaw says. “It also depends on whether the customer is a manufacturer or an assembler. If a customer is a manufacturer that builds engines, then the inventory should be the final product and not a bunch of parts.”

$20 million

Value of ABL deals First National Bank has on its books or in the pipeline

Perhaps the toughest challenge of ABL is monitoring for fraud, says Edward P. Lewan, president of Mackinac Commercial Credit, a division of the $978 million-asset mBank in Troy, Mich. The best mitigation is having ABL customers use a lockbox established by the bank, so that all of their clients’ payments come directly to the bank to pay down the ABL credit line.

“The key is dominion of funds, as we’re controlling the cash that comes from their customers directly into the lockbox,” Lewan says.

As well as field audits, Mackinac Commercial Credit’s staff makes random customer calls to confirm the amounts of sample invoices on the borrowing base certificates for each advance. It also tries to obtain personal guarantees from its ABL customers.

MBank’s chairman, Paul Tobias, says it’s critical to have ABL staffers with the expertise to understand each customer’s payment pattern.

“It’s important to be able to spot a sudden dip in collections or something that’s not quite right in terms of cash flow,” Tobias says. “But if you control the risk well, you can end up with loss ratios that are very comparable to loss ratios for commercial loans, yet the yields are significantly higher. For example, if we price a commercial loan at a 4.25 percent variable rate, Ed [Lewan] is going to probably get 8 percent, 9 percent or even 10 percent.”

Tracking solutions
Software and services provider ProfitStars offers ABL lenders accounts-receivable financing and other collateral management programs.

Banks using such software can track customers’ inventories to spot slow-moving products or determine when products are no longer eligible as collateral for the ABL credit line, says Jay McKinney, senior director of operations for ProfitStars Lending Solutions Group in Birmingham, Ala.

“If you control the risk well, you can end up with loss ratios that are very comparable to loss ratios for commercial loans, yet the yields are significantly higher.”
—Paul Tobias, mBank

Terry Renoux, the division’s group president in Brentwood, Tenn., says this kind of software makes it easier to track and manage receivables and inventory using new technology, such as the ability to electronically upload data about the collateral. “We’re seeing a big buzz, especially from community bankers, who realize they can do this paperless and be more efficient, and they don’t have to hire a bunch of people if they don’t have the wherewithal,” Renoux says.

In addition to software, ProfitStars’ ABL experts can accompany bankers to prospects’ facilities to help structure the credit lines and facilitate deals, he says. It will also help find other banks to participate in an ABL deal if it is too big for a small community bank.

The $375 million-asset First National Bank of Vinita in Vinita, Okla., uses software to handle the health care industry’s specialized receivables for patients with Medicare, Medicaid or private insurance, says J.R. Morris, its assistant vice president of commercial lending.

“Any given hospital may bill $40 million worth of receivables, but they may be really worth $10 million or $25 million” depending on how much insurers or the government are willing to pay, Morris says. “The software allows us to take the historical billing data and with intensive analysis match that up with the hospital’s true collection rates. This gives us a lot of comfort and confidence in what those receivables are really valued at.”

First National’s chief executive, Dee Robison, says the software helps the bank track different types of collateral not only for health care facilities, but also for other ABL customers in different industries.

The business line has proven to be very profitable, and it’s growing; First National booked $15 million of ABL deals last year throughout the Midwest and other regions and already has another $5 million in the pipeline.

“For a bank our size, those are very significant numbers,” Robison says. “Quite frankly, we can’t lend enough on conventional loans in our area of the country to be a bank of this size, so we have to stretch our wings quite a bit and operate in niches like this.”

Katie Kuehner-Hebert is a writer in California.