“Asset lenders capitalize on credit crunch”

by Tom Fredrickson

After newspaper articles began appearing in July about banks tightening credit, the phones started ringing at Capstone Group, a large hedge fund that specializes in asset-based lending.

Since then, deal flow is up about 50%, said Joe Ingrassia, a managing partner with Capstone.

As banks turn away their weakest customers, business is picking up for asset-based lenders, which are more than happy to fill the void because they earn higher interest rates in return for taking on more risk.

“The banks are turning business away or asking clients to leave,” said Neville Grusd, executive vice president of Merchant Factors Corp., an asset-based lender in Manhattan. “We can step into the breach.”

Asset-based lenders, which provide working capital to companies that lack the history, cash flow or strong balance sheet that lenders look for when they extend credit, generally are a distant second choice to banks because they often charge about three percentage points more in interest. Now, however, more borrowers are finding their way to asset-based lenders because they have no other choice.

While there are a few large players in the industry, such as CIT Group and GE Capital, and some banks have asset-based lending divisions, most of the industry consists of relatively small companies. New York state contains more than 100 asset-based lenders, with about $5 billion in outstanding loans.

So far, the industry has been taking on little risk. Asset-based lenders are getting the cream of the crop: borrowers who can easily back their loans with quantifiable assets such as receivables, inventory, equipment and real estate. “We have seen more business, but we are not seeing the dregs,” said Sheldon Kaye, head of asset-based lending at Rosenthal & Rosenthal in New York.

But with the economy slowing, asset-based lenders’ risks will multiply. Since they’re taking on customers not deemed creditworthy by banks, the lenders could suffer more in a downturn. In addition, based on past recessions, the weakening of the economy could reduce borrowing as the asset-based lenders themselves are forced to rein in their appetite for risk.

Asset-based lending activity has picked up over the last few years because of a strong economy. But growth rates have not rebounded to where the industry was in the late 1990s. With the explosion of loan securitization, banks were a source of competition as they were willing to take bigger risks because there was a ready market for their loans-a situation analogous to banks’ issuing subprime mortgages they sold to investors. Banks also faced increased competition from hedge fund lenders, so they became even more aggressive in extending loans to companies that once relied more on asset-based lenders.

As a consequence, companies like Rosenthal & Rosenthal, a 20-employee asset-based lending firm, had to work harder. “We would go around banging on doors, going to trade shows, meeting with accountants and networking,” said Mr. Kaye.

Now, the climate has changed. “We have seen more asset-based business in the last 60 days,” he said.
Once banks start pulling back on credit, the trend takes a while to play out. They can take months or years to clean their books of borrowers they no longer want. Often, they wait for a business to ask for an increase in its line of credit before forcing it to look elsewhere.

Time Out Group, which publishes event listings and articles in magazines and on the Web, turned to an asset-based lender, Manhattan-based Access Capital, to borrow money.

“Obviously, we were able to get more credit through an asset-based lender than through traditional banking,” said Dan Reilly, Time Out’s chief financial officer.

Miles Stuchin, president of Access, said his firm welcomed the business. “The company is growing quickly,” Mr. Stuchin said. “Its new media business is exploding.”