Lender Of Last Resort

If your loan is too risky for a bank, an asset-based lender may be willing to provide the cash -- but it won't come cheap

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An asset-based lender (ABL) may not be the first place a cash-starved small business would look for financing, but it shouldn't be shunned as a source of working capital, either. In the past decade, commercial finance itself has evolved, and with it the reputation of ABLs, which use borrowers' assets to underwrite risk. Once derided as a bunch of bearded buzzards, asset-based lenders have earned a modicum of respect. After all, anyone willing to finance high-risk leveraged buyouts, as asset-based lenders have been doing by the dozens, can't be that bad.

Most of the independent ABL operations have been acquired by banks, and some banks have even started their own divisions. But some independents remain. Foothill Capital Corp., for one, is self-described as the nation's largest independent asset-based lender. The Los Angeles company originated in 1968 as a venture capital firm and gradually evolved to its present status.

Independent ABLs such as Foothill can lay claim to filling an important gap in capital structure by extending credit -- especially to small and midsize businesses -- in the face of pro formas that horrify traditional lenders. And they can accept as collateral tangible assets that would give the willies even to banks' own ABL divisions. Foothill recently made a substantial loan to a small business that rebuilds automobile carburetors. The company's most valuable possession was something only '78 Camaro owners could love: grease-caked old carburetor housings. Although there was no immediately apparent market for them, Foothill ventured a number. So what if the appraisal fell well short of the owner's estimation -- with empty carburetor shells, who could argue?

Rushing in where other financiers fear to tread, aggressive "hard-money" lenders often find themselves standing bravely between a shaky business and its extinction. If the liquidation value of the collateral doesn't build in a substantial margin for error, a secured lender can take a mighty cold bath should the fiscal climate change. Indeed, just such as unexpected reversal badly reddened Foothill's income in 1982 and 1983, when hard times in the oil-patch states decimated what once was rock-solid collateral. The freeze was so severe that Foothill's own credit rating wilted in the commercial paper market.

In consideration of gambles that could wipe out their own businesses, ABL money comes relatively dear. Four to six points over prime is common -- and that's not to mention a litany of fixed and variable add-on fees (loan origination, collateral management, packaging, auditing, and closing among them) that can effectively tack on several more points. An ABL's annualized target yield for a risky deal is apt to be in the high 20s, all told.

Not that it can't be advantageous for essentially healthy businesses to use high-priced capital from time to time. The Los Angeles Lakers Inc. and Los Angeles Kings Inc., whose ephemeral assets, like those of many professional sports, confound traditional lenders, recently tapped Foothill's understanding for $12 million. The advance helps tide them over barren cash-flow cycles until the turnstiles click again in season. And when MacGregor Sporting Goods Inc. needed cash recently to acquire a manufacturer of souvenirs, Foothill spotted them $6 million.

But lest we get overly rapturous, it should be understood that working-capital financing such as Foothill readily performs can also hasten a sickly business's slide into default. Usually, some creditor or other has legal divvies on the struggling company's checkbook, grabbing incoming cash just when it's needed for servicing the high-ticket loan. And that purse-holding creditor, of course, can well be the ABL itself.

The maximum Foothill is willing to go is calculated on the price at which its team of liquidators estimates the collateral pool can be quickly moved (less costs for insurance, rent, and other handling charges). If the asset is clearly going to be hard to dump on the open market, as a large computer or a CAT scanner might be, Foothill will try to get a put, an arrangement by which a prospective buyer is entitled to purchase the item at a predetermined bargain-basement price, if and when it is liquidated. In MacGregor's case, the collateral consisted of receivables and inventory, part of which was some 12,000 souvenir baseball hats. "If the company were to go out of business," emplains Peter E. Schwab, president and chief operating officer of Foothill Capital, the lending subsidiary of The Foothill Group Inc., "we'd call every concessionaire in the country and tell them, 'We've got your hats.' We're in [the hats] at so low an advance rate against their real value that we could say to the customers, if you'll take them tomorrow, we'll sell at our purchase price. Of course," he acknowledges, "it might not be so easy right after the World Series."

One ABL is known to have accepted unbagged charcoal briquettes as part of a collateral pool, and Foothill itself has been willing to rent freezers to store the perishables that one client was able to put up as security. "The hardest asset [to evaluate] is inventory; you're guessing on its resale value," says veteran loan maker Alan Jacobs, a Foothill vice-president and western regional marketing manager. "One of my prospects is a winery -- what do I know about wine?" Partly for that reason, a loan secured by inventory alone is deemed too risky; ABLs feel better when a pledge of receivables goes along with them.

Foothill is comfortable not only with exotic collateral, but also with unorthodox business setups. The resale value of forprofit hospitals, for example, has to be determined through formulas that don't apply to conventional structures, leaving potential for error. The standard for evaluating a medical facility presently is around $120 per bed. Provided the bed is legitimately filled: a lender was recently confronted with an enterprise that, when the ABL's appraisers came to visit, stuffed its empty beds with staff members posing as patients, so that the occupancy rate would appear reassuringly high.

When a bank couldn't put a package together for one legitimate health-care establishment, Foothill didn't hesitate to loan $12 million -- at prime plus four, plus three points. Secured by real estate and equipment, the obligation was interest-only for the first year, then amortized over a seven-and-a-half-year average life. Needless to say, Foothill gave itself plenty of recovery room, discounting the per-bed formula by 50% to $60 each, for starters. The entire package was structured and signed within three days.

While bankers are used to knowing exactly with whom and with what they're dealing, the trench-fighter heritage of independent asset-based lenders seems to goad them into taking on tougher challenges. Foothill marketing manager Jacobs tells the story of when he was working for another ABL and accepted new cameras as collateral for an advance to a company that ran retail photo-equipment concessions in department stores. The Nikons and other top-of-the-line cameras were "real good stuff -- a cinch as a collateral pool," he remembers thinking smugly. "I was in for only 50% of cost -- how could I lose?" Yet some Mean Street instinct told him to move the inventory into a public warehouse where he could keep an eye on it. He instructed the people there to count the cameras as they came and went, and to send him a computer printout every month. Sure enough, one day the owner left town, literally never to be seen again. Jacobs rushed over to the warehouse armed with his latest list. The crew had dutifully counted every camera; all were there, as reported. The hitch was, not a single one had a lens.

A rude awakening for you and me, maybe, but to a hard-bitten ABLer like Jacobs, no catastrophe. He rounded up "the cheapest lenses possible," and personally screwed them in. "On some of those cameras," he recalls with unexpected remorse, "it was a crime." Be that as it may, he placed the lot on distress sale, and the loan was recovered within a year.

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