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Asset-based Lending

A loan that is secured by an asset

What is Asset-based Lending?

Asset-based lending refers to a loan that is secured by an asset. In other words, in asset-based lending, the loan granted by the lender is collateralized with an asset (or assets) of the borrower.

 

Asset-based Lending

 

Quick Summary:

  • Asset-based lending refers to a loan that is secured by an asset.
  • Examples of assets that can be used to secure a loan include accounts receivable, inventory, marketable securities, and property, plant and equipment (PP&E).
  • Lenders commonly use the loan-to-value ratio to determine the amount of money they are willing to lend.

 

Understanding Asset-based Lending

In asset-based lending, the loan is secured by the assets of the borrower. Examples of assets that can be used to secure a loan include accounts receivable, inventory, marketable securities, and property, plant and equipment (PP&E). As the loan is secured by an asset, asset-based lending is considered less risky compared to unsecured lending (a loan that is not backed by an asset or assets) and, therefore, results in a lower interest rate charged. In addition, the more liquid the asset, the less risky the loan is considered and the lower the interest rate demanded.

For example, an asset-based loan secured by accounts receivable would be deemed safer than an asset-based loan secured by a property – the property is illiquid, and the creditor might find it difficult to liquidate the asset on the market quickly.

 

Asset-based Lending Amount

Asset-based lending commonly references the loan-to-value ratio. For example, a lender may state “the loan-to-value ratio for this asset-based loan is 80% of marketable securities.” It states that the lender would only be willing to provide a loan of up to 80% of the value of the marketable securities. The loan-to-value ratio depends on the type of asset – lenders are generally willing to offer a higher loan-to-value ratio for more liquid assets. The loan-to-value ratio is calculated as follows:

 

Asset-based Lending - Formula

 

Where:

  • Loan Amount is the amount that the lender is willing to loan; and
  • Asset Value is the value of the asset being used as collateral for the loan.

 

Generally, the loan-to-value ratios for receivables and inventories are 70% and 50%, respectively.

 

Example of Asset-Based Lending

A lender offers the following loan-to-value ratios for certain assets:

 

Asset-Based Lending - Example

 

A borrower requires a $100,000 loan and owns the following assets:

  • Marketable securities valued at $105,000
  • Accounts receivable valued at $120,000
  • Machinery valued at $250,000

 

If the borrower is only able to use one asset to secure the loan, which asset should the borrower use to secure a loan of at least $100,000?

  • Marketable securities = $105,000 x 85% = $89,250 maximum loan amount;
  • Accounts receivable = $120,000 x 70% = $84,000 maximum loan amount; and
  • Machinery = $250,000 x 40% = $100,000 maximum loan amount.

 

The borrower should use machinery to secure the maximum loan.

 

Advantages of Asset-based Lending

Asset-based lending offers the following advantages to the borrower:

  • Asset-based loans are easier and quicker to obtain than unsecured loans and lines of credit;
  • Such loans generally include fewer covenants; and
  • Asset-based loans generally come with a lower interest rate compared to other funding options.

 

Asset-based lending provides the following advantages for the lender:

  • Asset-based loans are less risky as it is collateralized with an asset (or assets); and
  • If the borrower defaults on the loan, the lender can obtain the assets that were used to secure the loan and liquidate them to settle the amount outstanding.

 

Related Readings

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful:

  • Annual Percentage Rate (APR)
  • Collateral
  • Debt Covenants
  • Private Money Loan