Asset-based lending: A credit union opportunity
Your credit union relationship managers are finding members that want to establish operating lines of credit (LOC’s) with the credit union. You want to serve the needs of your members, but you realize the challenges that come with working capital LOC’s. First, it can be a significant amount of up-front work and never materializes into a loan. Second, LOC’s can carry a couple of risks that if unchecked, can turn into problematic loans and increase regulatory scrutiny.
The latest OCC Comptroller’s Handbook goes so far as to state that “Tracking, monitoring, and reporting ABL (asset-based lending) collateral can be a manual, time-sensitive process prone to human error.”
A crucial component of asset-based loan management is collateral tracking, which is necessary for lenders to control risk and guarantee the security of their loans. Loans backed by specific assets, including real estate, equipment, inventory, or accounts receivable, are known as asset-based loans. You might also hear them referred to as borrowing based loans. Efficient collateral tracking entails keeping an eye on these assets’ worth and condition while the loan is outstanding.
Due diligence begins during the loan origination stage when the collateral tracking procedure gets started. Due diligence is a process through which a lender determines the marketability of the collateral that will serve as security for the LOC, and the borrower’s creditworthiness.
It’s critical to accurately value collateral. Lenders may use valuation models or independent appraisers to estimate the collateral’s present and prospective future values. Periodic evaluations could be necessary, particularly for assets that are illiquid or volatile.
To preserve their position, lenders must clearly demonstrate their security interest in the collateral. Depending on the type of collateral, this may entail registering mortgages or deeds of trust, filing financing statements under the Uniform Commercial Code, or pursuing other legal options.
Lenders should keep an eye on the collateral even after the loan is approved. Periodic updates on the collateral’s condition, such as accounts receivable aging reports, inventory levels, or financial statements, are frequently demanded of borrowers. In most situations, updated reports would be requested monthly, but this may be more frequent for larger loans.
Covenant compliance is another important piece of the puzzle. Loan agreements may contain requirements, including upholding certain collateral ratios or benchmarks for financial performance, that borrowers must follow. Lenders monitor adherence to these covenants and may take legal action in the event of noncompliance.
For larger credit exposures, field audits are important to physically confirm the existence and state of the collateral. In these cases, lenders would typically hire CPA’s to carry out quarterly field audits. Auditors may go to the borrower’s premises to look over equipment, verify accounts receivable, and gauge inventory levels. The requirement for a field audit would be stated within the credit union’s credit policy. In many cases, such audits would be required when the credit limit exceeds $5 million, but that will vary by credit union.
If a borrower fails to make payments on a loan, the lender may be required to sell the collateral, seize it, or cooperate with the borrower to address the failure. Accurate monitoring guarantees that the lender can respond quickly to safeguard its interests. This is especially true when dealing with accounts receivable and inventory. In the case of accounts receivable, the lender would also typically have recourse to any account debtors (member business customers) that have not paid their obligations in a timely manner.
In too many cases, credit unions are left using spreadsheets to track collateral. The possibility of accidental data loss, or data corruption without intention can have a very adverse effect on the profitability of a lending program.
During the life of the loan, lenders should keep thorough records pertaining to the collateral, such as appraisals, communications, lien filings, and audit reports.
In addition to safeguarding the lender’s interests, collateral tracking is necessary to give borrowers access to affordable financing. Lenders can provide better loan conditions and lower interest rates by guaranteeing the security of collateral, which is advantageous to both sides.
To sum up, collateral tracking is a thorough procedure that calls for rigorous preparation, research, constant observation, and the application of technology. It is essential to promoting ethical lending, defending the interests of lenders, and ensuring the viability of asset-based loans. With the right systems in place, credit unions can effectively manage collateral based LOC’s while maximizing the cash flow benefits for their member businesses. Given the number of new businesses established in recent years, credit unions should expect more requests for these types of loans. Of course, as the member businesses continue to grow, these facilities can lead to new loan requests for things like equipment, vehicles, and owner-occupied real estate. Perhaps the greatest benefit to managing collateral backed LOC’s is that your lenders will know these member business clients better than any others in your organization, since they have more exposure to weekly and monthly reports of sales and cash flow.
Citations:
https://www.lendovative.com/solutions
https://www.occ.treas.gov/publications-and-resources/publications/com
