Asset-Based Lending Guide for SMEs

Owners of a well-established business looking for financing usually apply for unsecured loans from banks and lending institutions. Unsecured term loan is one of the most common form of SME loan in Singapore.

When a business is in its infant stage with not much track record, the owners may have some difficulty obtaining an unsecured loan at a competitive rate. During recessionary periods. it'll be even tougher for smaller SMEs to access unsecured financing.

Features and mechanics of an asset-based loan

As a relatively new business owner, where could you turn to when you have a pressing need to finance your operational requirements?

One approach is to source for financial institutions offering asset-based loans (ABL).

Financial institutions offering ABLs will focus more on the borrower’s collateral rather than on his business’ financial standing or credit grading history.

Acceptable assets include account receivables, inventory, machinery, and real estate properties. However, accounts receivables comprise the bulk of collateral under ABL deals simply because they are easily convertible to cash.

Most SMEs in the start-up phase also do not have hard assets like properties or fixed deposits to pledge to banks for facilities.

Loans secured by receivables

Usually, lenders can advance cash between 70-90 percent of the value of receivables pledged. Assuming receivables invoices of $100,000 pledged, cash advance will be between $70k-$90K. This financing arrangement is also known as invoice financing or factoring.

When the borrower avails of a loan, the lender will collect the receivables from the borrower’s creditors.  After deducting all payables, fees, and charges, the financier will release the remaining balance to the borrower.

Revolving credit line facilities are normally extended to borrowers who pledge their receivables as security.  The lender sets the credit limit for the revolving credit line.  The borrower may avail any amount from the credit line for as long as he doesn’t exceed the limit, the credit line hasn’t expired, and that the receivables are maintained at the desired levels.  Any amount borrowed and settled under the credit line may be re-availed by the borrower.

An ABL is generally faster to process because it is collateral-based. Lenders will focus more on the quality and value of the collateral. They don’t have to spend weeks reviewing the borrower’s financial standing, credit history, and other requisites for evaluating a traditional unsecured business loan. Meanwhile, the borrower has fast access to funds that he can use immediately to finance asset acquisition or working capital, among others.

Loans secured by a mortgage on commercial or industrial properties

If need external funding to buy a small warehouse or an office space, you can turn to lenders offering loans backed by a mortgage on property. A commercial property mortgage loan is an example of an asset-based loan.

Typically, a lender will approve and grant mortgage loans to existing businesses with proven and steady streams of income. The borrower will have to put up at least 20 percent of the purchase price as a down payment for the property. An individual home owner could also pledge his personal residential property as a lien.

A lender may set this minimum to a higher percentage if the property to be purchased is categorized as a special-use property. A fitness center, car wash, or theme park are typical examples. If you are purchasing special-use property, expect the lender to increase the required down payment to around 30 percent minimum or more.

A typical mortgage loan may be paid up to a term of 20 years (or longer) in regular, equal monthly installments. Most banks will usually offer low ‘teaser’ rates for the first 2 years and gradually increase rates from the third year onward. Interest rate for mortgage loan is usually amortized and calculated on monthly rest principal reducing balance basis.

Importance of loan-to-value ratio among lenders

The lender will want to check if the value of your property will provide ample coverage on the amount of loan he is extending to you.  A lender wants a margin of safety – a fallback in case of a risk of nonpayment or default.

In an extreme recessionary economic environment, banks might request for margin top up if market value of properties fall below outstanding property loan amount. This usually happens when value of properties is on a free fall due to weakening macro economic environment.

Aside from assessing the borrower’s profile with traditional credit assessment models such as the 5Cs of lending, lenders will also assess the loan-to-value (LTV) ratio of the property.

Simple LTV computation

The LTV ratio is calculated by dividing the amount of loan by the appraised value (AV) of the property you have offered as a mortgage. If the purchase price is lower than the AV, the purchase price will be used instead. An acceptable LTV ratio is around 80 percent or lower.

For instance, if you are borrowing $800,000 for your commercial property mortgage loan, your property’s AV should at least be $1M to be able to satisfy the lender’s LTV requirement.  The lower the LTV, the better your chances of securing that loan.

In some cases, the lender may opt to accept a slightly higher LTV ratio but will definitely request for concessions or, make some adjustments like charging a higher interest rate.

Lenders help businesses by providing facilities such as asset-backed loans. Information and knowledge on typical business loan requirements will help you ascertain your financing eligibility and requirements. Whether you are buying capital assets or merely financing an operating expense, an asset-based loan is an effective funding tool that could help propel your business when leveraged on effectively.