By Stevan Buxbaum, Executive V.P.

It may not have been obvious, but a sea-change has taken place in the past few years in the asset-based lending industry. The enormous increase in liquidity in the marketplace has created a new generation of lenders, and their arrival may result in even bigger changes down the road.

A few years ago, asset-based lenders went through a substantial consolidation in which a lot of companies were rolled up by the industry’s biggest players. While the number of lenders was reduced, the demand for loans continued to grow, and that created an opportunity for a new group of lenders to service the market.

There certainly has been no shortage of capital to lend. Hedge funds and other opportunistic organizations have found themselves flush with cash, and they have tried to penetrate the market by making asset-based loans and creating second liens. These developments have created tremendous competition for large asset-based lenders. They have increasingly found themselves challenged by new entrepreneurial groups that are pushing the envelope when it comes to lending.

In some cases, those traditional lenders are finding it hard to compete, because they can’t provide structures that are as liberal as those offered by the new ones. In many cases, they are loosening their guidelines when it comes to lending or to buying participations in loans structured by larger lenders. They have to, since the newcomers simply don’t have the same institutional constraints as their old-line competitors.

As a result, the traditional players in many cases are finding it hard to reach their targeted numbers unless they are making giant-sized deals – the arena in which you find lenders like Bank of America, Goldman Sachs and J.P. Morgan. Those lenders, especially smaller banks that are focused on the middle market, are working very diligently to do business.

This is of more than passing interest to everyone involved in asset-based lending. If and when there is an economic retrenchment, a lot of the loans being made by the newcomers may turn out to lack the assets to cover them. In many cases, the market’s entrepreneurial players have been overly aggressive in their policies, making loans on a cash-flow basis but still marking them as asset-based loans.

There are plenty of examples already of lenders being hurt. Last year, a well-known nutritional supplements company found itself in trouble due a shift in diet fads; its business went from $500 million to $100 million almost in the blink of an eye. That spelled trouble for a hedge fund and a private equity group that had aggressively lent money to the company, both of which had made the mistake of overstating the enterprise value of the business. It was a case of irrational exuberance, and it illustrated the fact that a business’s value is a function of both the success of the company and the health of the marketplace.

When the next economic slump arrives, whenever that may be, these newcomers will learn something that the traditional lenders have always known: That flush times