Asset-Based Lending Gains Allure, But Reg Worries Remain

As banks look to find new sources of revenue, more and more of them are ramping up in asset-based lending.

Some, including Investors Bancorp (ISBC) in Short Hills, N.J., First Internet Bancorp (INBK) in Indianapolis, and Mackinac Financial (MFNC) in Birmingham, Mich., are launching new asset-based lending divisions — often by plucking experienced lenders from larger banks — while others, like Capital One Financial (COF), are expanding existing units.

Banks are drawn to asset-based loans because they generate higher-than-average yields and diversify their loan portfolios. The loans are also ultrasafe; and chargeoffs are historically well below 1%, according to the Commercial Finance Association, a New York-based trade group that represents asset-based lenders.

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"This new line of business allows us to serve a greater base of businesses and accelerates our growth by generating additional high-quality assets," David Becker, First Internet's chief executive, said when the bank launched its asset-based lending arm in November.

Still, asset-based lending can be a challenging business for banks because it requires constant monitoring. Loans are collateralized by receivables and inventory, and many banks do not have the resources or expertise to keep constant tabs on that collateral.

Asset-based loans can also flummox examiners, who are used to judging borrowers' ability to repay by cash flow or income statements, not by inventory. Lenders often complain about an inconsistency in the way the loans are rated and, federally chartered banks at least, are hopeful that they will get more clarity on this early next year when the Office of the Comptroller of the Currency releases a handbook on asset-based lending.

In a recent interview with American Banker, Robert Trojan, the chief executive at the Commercial Finance Association, discussed the latest developments in asset-based lending and what to look for in the year ahead. Here is an edited transcript of that conversation.

We've seen a lot of announcements recently of banks getting into asset-based lending. What's driving this trend?

TROJAN: It's a terrific business because it's got a good yield and, if done right, it has very limited risk. Also, there's the interest of diversification of assets for regional and community banks. Coming into the economic downturn they were focused almost exclusively on real estate, and so this is a way to diversify their portfolios.

How are they doing it? Are they starting from scratch, plucking teams from other places?

You can start a team by utilizing seasoned veterans and some have done that very successfully. You can also work with companies that will advise you and run asset-based-lending back-office [functions] for you. Of course the credit decisions stay within the bank, but the back office can be outsourced to specialists who work on asset-based-lending processes and procedures.

Do you see even more banks getting into the business in 2014?

Absolutely. Banks are recognizing that it's a good, stable business. Plus we're seeing the economic numbers improve, and that means businesses will be looking to deploy capital.

Let's talk about utilization rates of credit lines. I know they fell pretty low in the aftermath of the financial crisis, but they have improved lately. What are you seeing?

Our latest credit utilization is at 42.8% for the third quarter, and this was higher than the previous quarter slightly, and up from 41.2% the same quarter last year.

In 2007 and 2008, it was 50%; in the deepest darkest days of the financial crisis it was in the low 30s.

So what will it take to get back to those precrisis levels?

That's a question of economic growth. It's going to require the economy to get back on track and more people working; the employment rate is down to 7%, but…there are a lot of discouraged and underemployed individuals out there, so we need to get America back to work

What are the industry's big concerns right now?

If I would have talked to my members two years ago, three years ago, five years ago, they'd be talking about deal activity, they'd be talking about deal flow — now every single one is talking about how much regulation there is. Also, the regulators look at asset-based lending inconsistently. If you get an examiner [who] is knowledgeable about asset-based lending, particularly the value of collateral and of monitoring, you will get a different answer than from an examiner who doesn't. [The result is that] our members will be much more conservative in terms of what deals to approve and how much to lend based on their expectations of what they think the regulators are going to say about a particular deal.

So if a bank has an examiner it doesn't believe understands the business, it might pass on a deal?

Absolutely.

But asset-based lending is not new. Why is this an important issue now?

Dodd-Frank. We're seeing the regulators focusing more and more on perceived risk, whether it's actual risk or not.

Do you think utilization rates would be higher if there was not this fear that regulators were going to downgrade deals?

Unquestionably.

So how do you fix it? What are you doing to make your concerns clear?

We're working closely in discussions with the OCC in particular to get the word out that collateral matters, and that the monitoring processes matter. They've been very good in listening to our concerns.

Would you want guidance from regulators on this?

Guidance is always good, but sometimes it becomes de facto regulation.

Still, even with these regulatory concerns, there's a lot of interest among banks in ramping up in asset-based lending. What's the outlook for 2014?

We are cautiously optimistic about what's happening. Some of our members in private would even say they are bullish. I might have said the same thing two years ago, but this time it feels different. Across regions, large players, small players, they are seeing [credit utilization rates go up]. If you take that in context with the economic data that's coming out — the GDP, the jobs, inventories — [optimism] just feels stronger going into 2014.