The credit-wary environment that took hold of the loan market at the end of 2000 produced a resurging interest among lenders in asset-based loans. Now, it seems that this interest is being taken a step further as asset-based lenders look at ways of taking their asset-based loans off-balance-sheet by packaging them in CLOs.

Dan Gates, senior vice-president in the bank loan ratings group at Moody's Investors Service, says that the increased interest in asset-based lending is largely driven by a need to "have better control over security and reduce losses." With credit concerns intensifying, especially with default rates on the rise, lenders are more vigilantly monitoring how and to whom they lend their capital.

In an asset-based loan, asset coverage is considered especially strong. Banks are lending against the borrower's specific assets rather than making a credit judgment on a company based on projected cash flows. The structural features of this type of lending not only minimize the advances made toward the liquidation value of the collateral but also provide early warning signs against credit deterioration. They're generally viewed as a safer investment, according to a recent Fitch report

Further, asset-based lenders are a highly specialized group of lenders - which includes Heller Financial, Foothill, The CIT Group - who have the infrastructure in place to do the monitoring required for these types of loans. They are able to perform the intense, ongoing surveillance of the credit through the life of the loan.

The Hitch

The first CLO deals backed by asset-based loans are likely to come out in the third quarter of this year, analysts say. One challenge in structuring these CLOs will be to find ways of properly incorporating the asset-based structural features into a securitized product.

Unlike other senior secured loans that have gone into CLOs thus far, the majority of asset-based deals are working capital revolvers. When looking at a CLO from both an asset and a liability standpoint, this may pose a problem.

As the asset side fluctuates with revolver usage, the liability side would have to be able to fluctuate as well or else borrowers would have a negative draw if debt were outstanding with no asset supporting it. Aside from this, though lenders to these deals have committed specific amounts, the borrowings on these transactions are based on availability, so the committed amount is usually not available at any given time.

However, these revolvers usually have a core base of outstandings. A way around the problem of fluctuation would be to divide the revolver between core outstandings and additional borrowings. Only the core outstandings, which are constantly available, will be placed into the CLO. This would cause CLOs with this kind of collateral to be smaller, explained Michael Romer, author of the Fitch report.

Meanwhile, bankers expect to see fund managers running arbitrage CLOs to take a harder look at asset-based loans. They, too, are looking for ways to shore up assets in their collateral pools, and asset-based loans could be just the answer.

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