A Business Case for BB-360® – Volume II

^{By Pat True, Lendovative Technologies, Inc.}

Recent data from the OCC as well as bankrate.com indicates that 43% of small-to-medium sized businesses (SMB’s) seeking financing applied for a business line of credit, and the most common use of lines of credit is to support working capital needs. This aligns closely with findings that about 50% of SMB owners regularly rely on loans to manage cash flow and working capital needs. Additionally, both banks and credit unions offer secured and unsecured lines of credit, but many small business owners provide assets as collateral to obtain secured lines for working capital purposes. 

When lenders offer secured lines of credit to SMB’s, they confront several unique credit risks, despite the presence of collateral. Here are the most common risks to consider:

1. Asset-Specific Risks

• Collateral Value Fluctuation: The value of assets used to secure credit (e.g., equipment, inventory, receivables) can decline due to market factors, obsolescence, or poor maintenance, leaving the lender exposed if liquidation is necessary. 
• Difficult Collateral Liquidation: Selling repossessed assets can be costly, time-consuming, and may result in lower-than-expected recoveries, especially if assets are specialized or illiquid. 

2. Business Performance and Default Risk

• Failure of the Business: If the business fails or faces severe financial distress, even secured lines may become at risk due to insufficient asset value or other claims on assets. 
• Cash Flow Volatility: SMB’s often have unpredictable or seasonal cash flows, heightening the risk that they will miss payments or default entirely. 

3. Borrower Behavior and Credit Profile

• Fraud/Misuse: Borrowers may misrepresent collateral values or encumber assets elsewhere, increasing lender exposure.
• Multiple Liens: “Bare-blanket liens” covering all assets without strict covenants may inadvertently allow other creditors to stake claims, diluting the lender’s recovery prospects.

4. Structural and Legal Risks

• Legal Challenges: Perfecting and enforcing liens may encounter legal or procedural obstacles, especially if borrowers contest foreclosure or if asset ownership records are unclear. 
• Priority of Claims: Lenders may not always be the first in line for repayment; tax authorities or senior creditor liens may have priority. 

5. Industry and Economic Context

• Sector-Specific Risks: SMB’s in certain industries (like retail or construction) may face higher default rates due to economic swings or industry-specific pressures. 
• Macro-Economic Downturns: Wider economic weakness (e.g., recessions) can erode both business cash flow and asset values simultaneously.

6. Operational and Transaction Costs

• Monitoring Costs: Properly evaluating, monitoring, and maintaining security interests increases costs and operational complexity for lenders, especially challenging for small business lending. 
• Administrative Complexity: Drawdown flexibility means lenders can’t always predict when funds will be used or repaid, which complicates risk management and increases credit risk. 

Key Takeaways

Secured lines of credit can lower risk via collateral but do not eliminate risk for lenders. Poor asset quality, borrower distress, industry volatility, and operational challenges can result in credit losses. Lenders generally mitigate risk through thorough asset valuation, monitoring, legal due diligence, and covenants, but these carry their own cost and complexity. Ultimately, credit risk for lenders depends on the quality, value, and liquidity of both the collateral and the underlying business, along with sound risk management practices. 

The BB-360 solution from Lendovative Technologies offers the structure financial institutions need to safely manage lines of credit that are secured by assets such as accounts receivable and inventory. By offering these solutions to its clients, the financial institution can secure a long-term relationship with a growing business, leading to future lending needs, cash management and wealth management services, and much more as the business matures. Structured lines of credit can help set the foundation for successful long-term relationships that benefit both financial institutions and the SMB’s they seek to serve.

Patrick True

Lendovative Technologies, Inc.

As a forty-year veteran of commercial lending, I work with community banks and credit unions to help nurture small business relationships.