Why Are Asset-Based Loans Priced Differently to Commercial Bank Loans?

An inside look into the cost structure of asset-based loans compared to commercial bank loans, and whether or not predatory pricing practices are at play.

Many small and medium-sized businesses don’t qualify for bank financing: either their credit scores are too low, the business is new, or other circumstances place them outside the strict lending parameters of a bank. Even if a business does qualify for a bank loan, the process may move too slowly for the company’s liking. Thankfully, alternative lenders like US Capital Partners can provide accounts receivable financing, machinery and equipment loans, purchase order financing, inventory loans, and much more. This type of financing, known as asset-based lending, or ABL, is on the sharp increase across many industries.

But why does ABL sometimes seem so expensive?

• Is ABL perceived as riskier than commercial and industrial (C&I) loans?
• Is this a case of predatory pricing by alternative lenders?
• Is this an issue of scale, where larger allocations become cheaper to administrate?

Comparing Cost Structures: An Inside Look

Interestingly, the default rates on ABL and C&I loans are actually similar to each other. In both types of financing for smaller businesses, the risk-adjusted premiums are therefore similar too. However, ABL and C&I loans have very different cost structures. The cost of initial underwriting and of monitoring over time is low for C&I loans, while in ABL these costs are much higher. This is because ABL underwriting is more robust, and there is continuous monitoring over the lifetime of the loan.

In other words, the risk-adjusted interest component in ABL is really modest, just as in commercial lending. It is underwriting and loan servicing costs that drive up the overall cost in ABL. These underwriting and loan servicing costs are more like fixed costs. They are proportionally higher for smaller credits. For larger companies, these costs are amortized over greater financing amounts.

Is There Any Predatory Pricing?

There is a common belief, especially among hedge fund managers and sponsors, that there are inefficiencies and predatory pricing in the small business lending space. But they are wrong. What is driving the cost of ABL is a very different cost structure. Lenders in this space need deep underwriting and collateral monitoring experience, and unlike for C&I loans, the specialized task of monitoring assets extends across the loan cycle.

The ABL market is made up of many “pools” of lenders that have different risk appetites. Within each such pool, there is an efficient, competitive environment. But as a borrower, you need to know which pool to “fish” in. Borrowers need to be cautious which group they approach, given the risk profile of their business. This is difficult for an entrepreneur to know, and lenders may not necessarily reveal that they are in the wrong pool for you.