An Asset backed Loan Note is a financial instrument depicting the terms and conditions of a loan between a borrower and the lender (Investor). In the event of the borrower defaulting, the Loan Note also provides details of any assets that can be sold thereby reducing the lender’s (Investor’s) losses (Risk).
Typically an Asset Backed Loan Note should include at least but not restricted to:
- The names, addresses and signatures of the Loan Note key individuals
- Amount of Capital (Principal Sum) loaned (invested)
- The Security and relevant conditions to be used in the event of default against the capital loaned
- The amount of interest payable and when paid and if applicable penalties for late payment
- The date when the capital must be returned
- Any additional bonuses/benefits that may apply
- Any Trustee details if applicable
Most Common Type of Asset Backed Loan Note
The most common type of asset backed Loan Notes are used by property developers to raise development capital for identified projects. The land and often subsequent property developments are used as assets providing security to the lenders. For the purposes of this article we will focus on property backed loan notes.
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Asset Backed Loan Note Concept and Principles
The lending cycle of an asset backed Loan Note can sometimes seem quite complex, but in practical terms works quite well when structured by an experienced development team. Most people will be familiar with the concept of a mortgage when buying a home and the principles are similar. Imagine however you were building your own home and were starting with simply buying the land to build your home. You can see that the process starts to become more complex and the risk elements to the lender increase.
There is no established valued property to use as security just land with planning permission (The Project). Traditional lending sources are of no use so alternative funding needs to be found to get the project off the ground and get the house built. Funding even from specialised lenders is only released in stages with each stage often requiring expensive valuation and approval. It is easy to see how cash-flow and building can be restricted and cumbersome in even a simple house building project.
Benefits of Asset Backed Loan Notes
Imagine then a multi-million pound project in the middle of a city with an identified opportunity with planning approval you can see why Loan Notes are used. The Asset Backed Loan Note speeds up the ‘early days’ development and allows the developer to move more quickly than they could do otherwise. The borrower gets the funding they want when they want it and the lender (investor) obtains an investment return usually paid as interest on the capital invested.
Of course the major banks may get involved but usually at a later stage when the project becomes more tangible. More often than not the development may be sold off to a large investment company to maximise returns for its investors. Either way once the development capital has been refinanced or sold the lender is assured of receiving their money as it is secured against the property development.
To summarise the benefits of an Asset Backed Loan Note are:
- Provides consist cash-flow for the developer
- Provides a return on capital loaned (Invested)
- Speeds up the initial project development
- Allows funding for projects that otherwise may not have been possible due to lack of funding by traditional sources
- Provides security for the lender in the event of a borrower default