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Asset-Based Loans Offer Firms Flexibility to Grow

SMS Technologies, a San Diego-based contract electronics manufacturer, has revenues that should reach $68 million this year, yet the growing company doesn’t have a conventional bank loan.

When it comes to financing materials to manufacture a variety of high-tech products, SMS, whose revenues will increase about $10 million from last year, uses a $13.5 million line of credit through Wachovia Bank’s asset-based lending division.

For SMS, the asset-based financing it draws down as production calls for it makes more sense, providing greater flexibility than a bank loan with regular monthly payments stretching over several years.

“The financing for our needs may vary, and because they’re unpredictable, this (method) fits better,” said SMS President Bob Blumberg.

Asset-based lending is often viewed as less appealing than borrowing money from a bank because interest rates are usually higher than what is charged for a typical business loan, but that isn’t always the case.

In some instances, finance companies match the best interest rates offered by banks.

“The stronger the client is and the better the performance of the collateral, the cheaper the rate,” said Mark Hafner, the president of Celtic Capital Corp., a Santa Monica-based commercial finance company.

Such companies differ from banks by not taking deposits from customers and making loans based on the assets of a business , usually its accounts receivables or sales invoices, inventory and real estate. Banks consider these factors, but make loans based on the overall financial health of a business, focusing on its balance sheet, cash flow and debt-to-equity ratios.

The non-bank lending industry has been growing rapidly in recent years as commercial banks have become more selective in who they lend to and enforce stricter regulations regarding how problem loans, or loans that aren’t paying off regularly, are classified on government-monitored financial reports.


A Growing Industry

The Commercial Finance Association, the trade group representing asset-based lenders, reported the total dollar amount advanced from members last year was $362 billion, up 8.4 percent from the prior year from $344 billion the previous year. That figure was nearly four times the $96 billion in outstanding loans made by the industry in 1990, according to the CFA.

At the lowest rung of the asset lending chain are factors , companies that lend money based on the accounts receivable or sales contracts of a business. Factors buy the contracts and provide financing based on percentage of the contracts.

The charge for the money depends on several variables, including the borrower’s industry and past track record, but mainly on the reliability of the receivable. Instead of conducting research on the borrower, factors concentrate on the borrower’s customers.

“We are a transaction lender, and we base what we lend on the credit-worthiness of their customers,” said Pat Burns, the president of Primary Funding, a San Diego factoring firm.

Primary Funding provides money to temporary staffing companies, security guard providers, janitorial businesses, printers and small manufacturers, among others. Most are getting between $50,000 and $300,000 monthly.

Thomas Sterling, co-owner of Secured Assets Income Funds in Encinitas, said because his factoring firm operates in one of the highest-risk industries , selling automobiles , he charges much higher interest rates. Combined with service fees, typical rates could range between 25 percent to 33 percent on an annualized basis, he said.

Sterling said the default rates in this region are running about 7 percent, another reason small auto dealers must pay a hefty price on their money.

Fraud and thievery also enter into the equation.

“Cars are mobile, and they can disappear,” he said.

After factors in the financing chain are smaller, privately held finance companies such as Celtic Capital, which was acquired this year by San Marcos-based Discovery Bancorp. Celtic provide lines of credit ranging from about $500,000 up to $5 million. Last year, Celtic did about a dozen deals with an average line of about $750,000, said Hafner.

Celtic’s clients can’t qualify for a bank loan for any number of reasons and sometimes have been dismissed from prior loan agreements by banks because they violated terms of their loans, Hafner said.

To ensure Celtic gets repaid, it closely monitors the accounts receivables and every other aspect of a borrower’s business.

Rather than purchase an invoice as factors do, smaller commercial finance firms often take liens on the collateral pledged on the money borrowed.


Different Focus

The focus on collateral differs from how banks treat their borrowers, said Larry Hartwig, the president of California Community Bank in Escondido.

For example, if a company puts up a bulldozer as collateral, the finance company may want to get regular reports on the mileage the machine has, and will often require maintaining insurance and extended warranties on the equipment, Hartwig said. Banks aren’t going to monitor their borrowers that closely.

Not only do commercial finance companies closely monitor reports on the business’s sales and inventory, many times they require periodic checks from the financing company’s auditors.

“We’re mitigating our risk by monitoring the loan a lot closer,” said Ron Vanek, senior vice president for Guaranty Business Credit Corp., a subsidiary of Guaranty Bank, a $15 billion bank based in Dallas.

“If a company goes out of business and we have to liquidate all the collateral, we want to make sure that we get paid on the money owed to us.”

While financing companies’ rates on loans are generally higher than what banks charge, sometimes businesses can obtain rates just as favorable as they would from banks, Vanek said.

One such customer, Tri-Anim Health Services Inc. in Sylmar, has been borrowing through various predecessor finance companies to Guaranty for about 17 years.

In the late 1980s, Tri-Anim, a distributor of health supplies, was a fast-growing business and took on more debt than its bank loan covenants permitted. Its bank lender, Security Pacific Bank, then told the business to look for an alternate financing arrangement, said Chief Financial Officer Eddie Avanessians.

“They gave us about three months to find another lender and move our accounts,” Avanessians said.

The change actually helped Tri-Anim to grow faster than had it stayed with a bank, he said.

“If we stayed, we would have had to get permission to do a lot of things,” Avanessians said. “If we were still with the bank, we probably wouldn’t have grown to a third of where we are now.”

This year, Tri-Anim is running at about $200 million in sales, up from about $15 million in 1988 when it moved its financing to an asset-based lender.

The business is doing so well, it now commands the 7 percent prime rate when it borrows on its revolving line of credit from Guaranty Business.

Another large asset-based lender, Wells Fargo Foothill, also serves much larger, fast- growing companies, many of them borrowing tens of millions of dollars.

“It’s not uncommon for us to have customers with several billion dollars in revenue,” said Mike Sadilek, the chief credit officer for Wells Fargo Foothill, a subsidiary of San Francisco-based Wells Fargo & Co.

A big part of Wells Fargo Foothill’s new business has come from a surge of buying smaller and middle-sized companies by private equity groups, Sadilek said.

Large, fast-growing companies often prefer borrowing money from finance companies because the loan covenants or terms aren’t as restrictive as those contained in traditional bank loans, Sadilek said.

“They’ve found that this type of financing is more flexible than bank financing is. It lets management run their business more effectively,” he said. “In many cases we can also lend them more money than a commercial bank would.”

At Union Bank of California’s commercial finance division, among its customers are large wholesalers, distributors and manufacturers, many of which have annual revenues above $30 million, said Mike Murphy, senior credit manager.

“We’re providing credit facilities from as low as $6 million up to about $50 million. Among the companies that we do participation deals with include Borders, Longs Drugs and Kmart,” Murphy said.

While his business is nowhere near the level of those retailing behemoths, SMS’ Blumberg says he’s content with the credit line he uses through Wachovia Bank’s financing unit.

The ability to tap into the credit line as his business gets new contracts is the driving reason for maintaining the arrangement, Blumberg said.

“I can’t tell you what my business is going to look like next May, whether it’s going to be fat or slim,” he said. “Within the line that we have, we can go up and down like a yo-yo as our business needs dictate.”

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