Increase In Hedge Fund Lending

Hedge funds have traditionally invested in banks, but now some funds are actually acting as the banks themselves. As discussed in a recent Business Week article, hedge funds are turning out to be a lender of last resort for some companies as the credit crisis unfolds. In particular, small businesses that are unable to secure loans, and simply do not have the cash resources to ride the credit storm out, are turning to hedge funds for the necessary capital to continue operations. According to the Commercial Finance Association, a trade organization of asset-based lenders, the demand for such funds is on the rise.

Why are hedge funds interested? The loan terms, of course. Unlike traditional loans which may be offered for 2-3% over prime, so called "asset-based loans" can carry double digit interest rates (as high as 14% with fees for one example provided), along with double digit early payment penalties. Should you be worried about the risk as a hedge fund investor? Possibility, but often the loans are only given out to the most credit-worthy companies with a good business plan, and often only after performing a level of due diligence that would make a venture capitalist proud (in fact, some actually do deals that include options or equity stakes). As the name implies, asset-based loans require some type of asset to back the loan, be it hard assets such as inventories, or accounts receivable. In fact, some hedge funds actually require documentation and/or send people to check out the assets for themselves. Imagine that! Maybe the banks should take note.