Asset based loan is a relatively specialized form of debt financing that relies heavily on an asset or assets as security to underpin the loan. In the event of loan default, the ownership of the stipulated security item is seized by the lender. In its most general sense, this type of financing falls within the broad category known as equity or secured lending.
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.
As an alternative, factoring transactions may be based on a pledging rather than assignment of receivables. If pledged, the receivables remain owned by the borrower firm and reported in its balance sheet with an explanation of the pledging in the Notes To Accounts.
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.
An asset based loan may be established with a revolving credit limit that fluctuates in line with the business needs of the borrower. If set-up this way, it increases monitoring demands placed on the lender and so higher fees may be applied.
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.
Asset-based borrowers are mostly small or medium businesses as well as subsidiaries of major corporations. These borrowers have few financing alternatives. They are considered non-investment grade by debt investors.