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Alternative Alternatives: Risk, Returns and Investment Strategy by Sona Blessing

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3

Asset-Based Lending

In the case of these strategies, although the source of risk is not entirely isolated from and alien to financial markets, as a borrower's ability to repay the loan could be partially conditioned by economic and financial developments, the risk is ‘time, deal, borrower/lender’ specific, i.e. unique, cannot be exactly recreated ‘as-is’, ‘individual considerations’, nonhomogeneous, markets are fragmented, intransparent and inefficient. ‘If’ the collateral that backs the loan has been valued and secured ‘correctly’, even if the borrower defaulted there is an element of ‘certainty’ of returns as the loan transformation risk in the ideal case would be zero. The challenge then lies in structuring the loan – and hence their inclusion as alternative alternatives.

3.1 Introduction

Asset-based lending refers to private loans with no securitised secondary market. As a strategy, asset-based lending is premised on idiosyncratic (essentially credit) risk transfer. Its effectiveness hinges on a lender's ability to evaluate the ‘quality’ of collateral (respectively soundness of the business model – cash flow generation – ‘repayment’ capability, loan corresponding to collateral verification), structuring the loan (i.e. specifying the terms and conditions (covenants) including legal) and if required ensuring title has been obtained (overly tight covenants could potentially ‘squeeze-out’/cause the borrower to default while if they are ‘loose’ could mean a loss of revenue/failure ...

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