Mining the Balance Sheet

Asset-based loans are an increasingly attractive alternative to bank financing, and not just for those who can't borrow against cash flow.

In late February, Levitz Furniture emerged from bankruptcy and merged with rival Seaman Furniture, a deal made possible by an asset- based senior loan instead of a traditional bank loan against cash flow. The $95 million loan, extended primarily by Heller Financial Inc., of Chicago, using Levitz’s and Seaman’s inventory and receivables as collateral, helped the Woodbury, New York-based Seaman buy out its minority shareholders and the Boca Raton, Florida-based Levitz pay off the debtor-in-possession loan that provided operating funds while it was in reorganization.

Why an asset-based loan rather than a traditional cash-flow loan? Although Seaman is profitable, Levitz had no recent history of positive cash flow. Equally important, economic conditions had turned precarious. “With the economy slowing down, the environment is not conducive to getting a cash-flow loan for companies whose earnings may be impacted by the general economy,” says Peter McGeough, former CFO of Seaman and now CFO of Levitz.

Yet the same poor economy leaves midsize companies that have been unstable or are experiencing a drop-off in sales in need of liquidity — most often to finance a turnaround, pay down high levels of debt, carry out a bankruptcy reorganization, or finance the write-off of an underperforming operation. And while cash-flow-based, or unsecured, bank loans are not appropriate for these companies, capital from the shaky stock and bond markets may also be unavailable. But for Levitz and a growing number of companies, asset-based loans are increasingly filling the gap. That’s reflected in the total number of outstanding asset-based loans, which more than doubled from 1995 to 1999, the most recent year for which data is available.

A Blank from the Bank

In fact, cash-flow-based loans are increasingly out of reach even for many flourishing small and midsize concerns. That’s because banks, under pressure from regulators and hurting from problem loans, are imposing tougher standards and higher rates on all borrowers. As a result, borrowers of all kinds are finding asset-based loans more attractive, and the stigma once associated with this type of lending — that it signified a company down on its luck — has all but disappeared.

In the process, companies are finding that assets other than inventory and receivables can be mined for liquidity. Today, asset-based lenders will lend against the value of practically any asset. And these loans are flexible to the borrower in that they include few if any covenants, though some require control over a company’s cash. When seeking to extract liquidity from their real estate, moreover, companies will find that yet another alternative — a sale-leaseback transaction that will not encumber the balance sheet with added debt — has also become more attractive.

While demand for asset-based loans has been growing in the past 9 to 12 months, the growth has been most pronounced since the end of third-quarter 2000. In February, Heller’s credit committee was discussing two potential transactions a day, compared with one or two a week one year earlier. The increased demand, lenders say, is coming from all regions equally. Over the past several months, Heller has established new lending teams in Boston, Atlanta, San Francisco, Philadelphia, and Toronto, which broaden its scope beyond Chicago, New York, and Dallas.

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