Like French cooking for amateur chefs, asset-based lending has typically carried a "don't-try -this-at-home" caution for community and midsized banks.
Lacking the scale and expertise to make loans collateralized by inventory and accounts receivable, small institutions have long ceded the asset-based lending business to larger banks, such as Bank of America, Wells Fargo and BB&T, and nonbank lenders like GE Capital and CIT.
But with many asset-based lenders tightening the spigot on smaller firms and focusing on bigger ones, some smaller, capital-rich banks such as the $8.4 billion-asset NewAlliance Bank in New Haven, Conn., and the $2.7 billion-asset Berkshire Bank in Pittsfield, Mass., are moving in to fill the void.
The two New England institutions, looking for new sources of revenue, formed asset-based lending divisions late last year to providing working capital to cash-strapped small businesses.
"There are a lot of larger banks that have cut back capacity to lend to these markets," says Michael Daly, Berkshire's president and CEO. "There's a great opportunity to expand our market share."
Some smaller banks have gotten into asset-based lending indirectly. Wary of booking new loans in this economy - even for longtime customers - some are referring loan requests to nonbank asset-based lenders and collecting a fee for that referral. This lets them hang on to the deposit relationship without taking on any more risk.
But industry observers expect more small and regional banks to start asset-based lending units of their own as profits from consumer and real estate loans - their bread-and-butter - wane.
Asset-based loans are typically made to borrowers who might not otherwise qualify for fully unsecured loans or need more liquidity than a term loan backed by earnings can provide. According to the Commercial Finance Association, an industry trade group, asset-based lending has grown into a $590 billion-market as loan volume increased an average of 10 percent a year from 2002 through 2008.
Aggregate data for 2009 was not available at press time, but all indications are that the growth is continuing. A recent CFA survey showed that asset-based loan commitments in the quarter that ended Sept. 30 had increased 29 percent over the previous quarter. Another survey of chief financial officers conducted by Bank of America Business Capital found that 49 percent of manufacturing firms expect to use asset-based lines of credit in 2010, up from 42 percent last year.
Many are turning to asset-based lending as banks pull back more traditional commercial-and-industrial lending. According to Federal Deposit Insurance Corp. data, the dollar volume of C&I loans in banks' portfolios fell by 15.4 percent between the third quarter of 2008 and the third quarter of 2009, to $1.2 trillion - the largest year-over-year drop since the FDIC began keeping statistics, says Andy Schmidt, a research director in TowerGroup's global payments area.
Borrowers are getting cut off "at the knees," says Chuck Elfsten, president of Ocean Pacific Capital, an asset-based lender in Irvine, Calif., that also matches borrowers to money-center lenders. One client had its $11 million credit line reduced to $4.5 million despite a 25-year relationship with its bank, Elfsten says.
NewAlliance and Berkshire are aiming to capitalize on the market unrest. Berkshire's new unit, formed in December, is run by Paul F. Flynn, Mark Foster and Jim Hickson, former asset-based lenders in the Boston office of TD Bank. (TD has been making changes under its new asset-based lending chief Barry Kastner, an ex-Wachovia executive.) NewAlliance unveiled its new division a month earlier. Andrew Moser, a 20-year veteran in asset-based lending, most recently with GMAC, is heading the unit, with Daniel O'Rourke, a former senior vice president at National City Bank, as the chief credit officer. Like Berkshire, NewAlliance will house its asset-based lending division in Boston.
"We were very fortunate - and I think its emblematic of what's going on in the industry - where some really top legacy people in businesses like leasing and asset-based lending find themselves available," said NewAlliance CEO Peyton Patterson, at a recent investor conference.
NewAlliance is better positioned than most banks to ramp up in asset-based lending because it is so well capitalized. Its total risk-based capital ratio of 17.55 percent at Sept. 30 was comfortably above the 10 percent ratio regulators require.
Moser says NewAlliance is primarily targeting businesses that don't meet the minimum funding level - usually $3 million and up - at most larger banks and finance companies. Both banks expect to get an edge on nonbank competitors by not requiring borrowers to pledge as much collateral (in the form of receivables or inventories), since they are already using other products and services that the banks offer.
"It's more a traditional bank relationship," says Michael Oleksak, the executive vice president of commercial banking at Berkshire.
Berkshire and NewAlliance are also in the right spot for recruiting clients: 65 percent of the nation's asset-based loans are concentrated in 12 states, including New York and Massachusetts, according to the CFA.
Companies in such industries as manufacturing, textiles, steel, agribusiness and retail typically use asset-based loans most, though Moser says the list is expanding to just about any firm that is having trouble obtaining a C&I loan. These are "primarily $150 million-and-under revenue companies" that generally don't have access to working capital in this environment, he says.
Officials at both Berkshire and NewAlliance stress that asset-based lending would be just another arrow in the quiver. Berkshire's Daly says these loans will not be a "dominant" part of his bank's portfolio, though he declines to give a figure. NewAlliance's Patterson estimates that within five years, asset-based loans will make up no more than 5 percent of its commercial loans.
Bert Knotts, a Washington, D.C., consultant who is working with NewAlliance, says asset-based lending makes sense for any small bank that has the necessary capital and is looking for new revenue streams.
Small banks have already lost a good deal of consumer business - credit cards, car loans and mortgages - to larger banks and, for many, "their traditional real estate product is gone," he says.
Asset-based lending is also a way to diversify risk in a loan portfolio. While mitigating risk by handing out loans to highly leveraged companies with cash-flow problems seems counterintuitive, Oleksak notes that asset-backed loans, besides being secured, require such constant attention - vetting operations, verifying the value of invoices and inventory - that "we can pick up issues before they become issues."
"With the financial crisis and way the market is right now with availability of capital, this is a stable and viable form of lending," says Andrej Suskavcevic, the CEO of the Commercial Finance Association. "And it's profitable as well."