Veterans Warn Asset-Based Lending Heating Up

With banks and other companies piling into asset-based lending, industry veterans are sounding the alarms.

They say the newcomers are raising risks for the entire field by offering low interest rates and easy terms.

"The unknowns are scrambling for a piece of the pie," said Thomas Smyth, senior vice president and market manager for Summit Bancorp.'s commercial finance subsidiary. "That forces the industry to go out on a ledge that a lot of us don't like to be on."

Asset-based lending, typically aimed at small and midsize businesses that don't qualify for traditional loans, has been growing explosively.

Outstanding asset-based loans surged 50%, to $169 billion, in the four years through 1996, says the Commercial Finance Association. During the same period, membership in the New York-based trade group increased 23%, to 295 lenders.

In the view of industry leaders, the field is now overcrowded.

"Lenders that are just getting started now have missed the boat," said Barry Kastner, executive vice president of Congress Financial Corp., a subsidiary of CoreStates Financial Corp.

Congress Financial, which has been in the asset-based lending business for 50 years, is regarded as one of the best bank-owned lenders. Last year it issued 113 credit lines for $2.3 billion, and Mr. Kastner says the unit should mesh well with First Union Corp., which last week agreed to acquire CoreStates.

With competition intensifying, the interest rates for larger transactions have dropped to about 1 percentage point over the prime rate, from two points a few years ago, Mr. Kastner said. At the same time, he said, loan covenants are getting looser. For example, lenders that might have required personal guarantees on loans in the past are dropping that requirement.

He said he worries that some of the new lenders don't have the experience to gauge how their loans would perform in a recession.

"Being that the economy is strong, these new entrants haven't really tested their credit skills or their ability to collect," Mr. Kastner said. "Eventually, the economic cycle will shift."

Asset-based lenders charge somewhat higher rates than traditional lenders and require borrowers to pledge assets such as inventory, receivables, or plant machinery. Another form of asset-based lending is factoring-buying receivable at a discount.

Though asset-based lending is historically the province of finance companies, banks have been lured to the field by the returns and the opportunity to expand customer bases.

Among the new entrants: Sumitomo Bank of California; New England Bank and Trust Co., West Hartford, Conn.; Dime Savings Bank of New York; and Merrill Lynch & Co.

"As long as people see the profit potential, they will continue to get into the market until it is truly saturated," said William Brown, managing director of Mason Dixon Commercial Finance. That company, a unit of Westminster, Md.-based Mason-Dixon Bancshares, began asset-based lending in August.

Mr. Brown, who has worked in asset-based lending for other institutions, said specific niches in the market still hold opportunity and offer higher returns than conventional small-business loans. Mason Dixon, he said, is focusing on smaller transactions-$250,000 and $2 million.

James A. Fisher, Dime's vice president and manager of asset-based lending, said the thrift expanded its commercial lending and asset-based lending to diversify its traditional base of mortgage lending.

Acknowledging the risks of the field, he said the thrift will pursue a "controlled growth" strategy and focus on transactions of 500,000 to $15 million.

"With the number of players in the market, some institutions are having to stretch their underwriting standards and when an economic downturn comes along there will be a shakeout in the market," Mr. Fisher said. "Those that are prudent will survive."

Though asset-based lending historically has focused on middle-market companies, a number of lenders in recent years have begun offering it to small businesses.

"I see a real opportunity to bring the services that have been available to middle-market companies to small businesses," said Charles Moret, a finance company veteran who now directs specialized lending for New England Bank and Trust.

Meanwhile, the field is not lacking for established players. They include Bank of New York Commercial Credit Corp., Fuji Bank's Heller First Capital Corp., NationsBank Business Credit, and CIT Group, which is 75% owned by Dai-Ichi Kangyo Bank Ltd. and recently issued stock to the public.

"The new entrants are coming into a business with fairly well-entrenched competitors," said David Gibbons, deputy comptroller for credit risk at the Office of the Comptroller of the Currency.

Mr. Gibbons said the OCC monitors banks more closely when they are moving into a new line of business. He said OCC officials have been worried about a deterioration of underwriting standards and lower pricing in commercial lending.

Often entrepreneurs turn to asset-based lenders when they are in a crisis situation-their bank has refused to extend anymore credit and they need money immediately to pay their vendors and employees. Other businesses use asset-based lenders because they have a long lag time between when they must pay their bills and when they receive payment from customers.

When a loan goes bad, asset-based lenders are left with the businesses' inventory, often warehouses full of clothing or receivables from mom-and- pop stores.

Mr. Kastner of Congress Financial said a key to making good loans is requiring borrowers to explain how they got into a cash-crunch and how they plan to resolve the situation.

"They are troubled companies," he said. "But they have a story to tell us to explain what happened and what they are going to do to fix it."

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