ABL and factoring: the real estate reality check.

The asset-based lending and factoring space in America has been enjoying what is perhaps, its all-time best and highest volume year.

For the first time ever, asset-based lending almost pierced $500B in "outstandings" (money in motion, cycled money). And factoring is now at about $127.6B in yearly volume, through an estimated group of more than 1000 "small", independent factors. Respectively, this represents 16.5% and 12.7% increases from a year ago.

One reason that has emerged: A growing trend among business owners and entrepreneurs who favor loans, borrowings, and payments being pegged to assets instead of the quality of a balance sheet. They now view it as an advantageous strategy.

Even though it may cost more, the terms and conditions of a business owner obtaining say, working capital or cash flow funds may be much more appealing given the speedy application/decision process that asset-based lenders and factors usually offer.

If a business faces challenges, whether they are distress issues (ie--peaks & valleys, loss of a major customer, weak receivables) or expansion plans (ie--start-up money to undertake new customers, adding more personnel, increasing plant and equipment)--the ABL or factor is relatively less concerned that this enterprise lost money the past several years, or has gone through a rocky, tumultuous period.

If the ABL or factor feels that the collateral position is strong and could be liquidated without the aid of the client, in that case real estate then becomes a desirable asset.

The majority of loan transactions done by members of the Commercial Finance Association use accounts receivable, product inventory along with equipment, machinery, and vehicles as collateral.

The appraised net worth percentage formula of these items which can be re-possessed usually represents the loan amount that an ABL can offer. In the case of a factor, the quality of a receivable, and its inventory, and the ability to collect on it is the main determinant.

Factors may look to have these receivables secured by other assets depending upon the risk/credit conditions of the deal.

(As a reminder, ABL's and factors do not lend on the basis of cash flow strength, but again on assets.)

Real estate is an asset where ABL's and factors have a hot-cold romantic relationship. While real estate almost always maintains some worth and value, there are periods when it is conducive for ABL's and factors to use it as a pledged asset ... and other times when it is not beneficial.

ABL's and factors typically take real estate as "boot" collateral (as opposed to "primary" collateral). It is usually used to beef up a thin transaction. It could be a primary residence, a summer home, a condo. Many small factors will provide second mortgages using these as a latch to tighten up the credit. Often it prevents the client from creating a problem because the factor could be affecting the client's personal life through taking such a mortgage position.

It minimizes the client's ability to liquidate the real estate assets because the client is unlikely to walk away from their equity, now tied to the lender. Sometimes, this situation is described as a "paper cop", an initial checkpoint.

ABL's normally don't accept real estate as collateral unless this is part of a large transaction where real estate is part of the fixed assets.

There are many situations where entrepreneurs or small business owners have for example, a small multi-family rental dwelling or a small strip shopping center. This entrepreneur may have extenuating circumstances which do not permit him to access a loan or capital. Many ABL's will then use this property as collateral, even though it then becomes a real estate loan, and asset-based lending usually denotes short-term lending.

Because of the bridge loan needs that many business owners in this category may face, they are more likely to gravitate to a small factor.

Real estate as an asset pledged on a loan can be very good provided it is prime property or in an up-andcoming area.

More often than not, the business owners seeking money from an ABL or factor with the intention of providing their property as collateral are in a situation where: 1) they do not have realistic expectations about what the real estate is really worth, or 2) it has already been pledged and leveraged so that the second mortgage potential has relatively little appeal.

Especially during these most recent precarious times, if a property is on an adjustable rate first mortgage which rises, or if the current marketplace conditions de-value the property by let's say, 20%--all of this radically alters the whole risk/credit quotient for a lending transaction. (It gets more complicated with ongoing costs like maintenance, utilities, and taxes.)

Unlike inventory which usually can be sold or move relatively quickly if it is properly appraised, with real estate as collateral, an ABL or factor has to be prepared to hold onto the property in question.

In some nations, such as China (which is gaining a more sophisticated and reputable banking system), real estate is the standard collateral for all lenders. It has been proven over the years, real estate doesn't go away. There is always a buyer to be found. (Many times, people do not receive what they think it is worth--but there is always a value.) Historically and consistently in the United States (and most industrial nations) there is only so much real estate available which in turn, influences rising prices.

An asset-based lender or factor who is open-minded to real estate as collateral is likely to help their client, in terms of strengthening loan quality. When a client may have stress factors--the Commercial Finance Association member who accepts "bricks & mortar", can enable that client to convert this value and worth into "working capital" (for goals like expansion or additional sales opportunities).

The moral to this article is for both lender and client to: Know your (real estate) collateral. Know your appraisal. Do not overreach.

Sheldon Kaye is director of the Commercial Finance Association, a national industry organization.

BY SHELDON KAYE,

EXECUTIVE VICE PRESIDENT,

ROSENTHAL BUSINESS CREDIT