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By Cary Springfield, International Banker
It is no secret that private credit has enjoyed surging interest in recent years. Within this booming industry, the area of asset-based finance (ABF) has perhaps enjoyed the most spectacular gains. And with technological innovation and more sophisticated risk-management techniques helping to boost the confidence of all involved stakeholders in the market, the ABF boom may only be getting started.
A form of credit investing, asset-based finance involves investments backed by the contractual cash flows of large, diversified pools of assets, such as financial assets—including auto loans, consumer loans and accounts receivable—and physical assets—including equipment, vehicles, real estate and even fine wine. Often, cash-flow-producing assets such as intellectual property and music royalties can also be pledged. This stands in stark contrast to other forms of corporate private credit, which typically rely on the borrower’s creditworthiness—itself often dependent on the borrower’s future operating cash flows from selling goods and services.
It’s fair to say that this sector has decisively taken off, with competition in the ABF market becoming fierce and drawing in Wall Street big-hitters, including Apollo Global Management and KKR & Co. (Kohlberg Kravis Roberts & Co.). According to the latter, the private global ABF market is worth more than $6.1 trillion today, nearly double its peak prior to the 2008 Global Financial Crisis (GFC) of $3.1 trillion in 2006. What’s more, the investment firm predicted the market will reach $9.2 trillion by 2029, which would be larger than the combined values of today’s syndicated-loan, high-yield bond and direct-lending markets.
“Structurally, today’s demand for credit isn’t slowing; it’s growing. Indeed, US household debt surpassed $18 trillion last year, up from $8 trillion in 2004. Taken together, current market dynamics signal sustained opportunities for ABF investors,” a July report from KKR noted. “More importantly, when markets dislocate, like in 2022 when inflation and rates spiked or in 2023 as Silicon Valley Bank failed, private lenders’ market-share gains often accelerate as their capital becomes more valuable to borrowers.”
Adding asset-backed financing may be an attractive complement and diversifier, with the potential to increase returns and reduce volatility within a private-credit allocation, explains Pacific Investment Management Company (PIMCO), a key player in the burgeoning ABF market. “This is driven by a borrower base, economic risk factors, and contractual cash flows that are all differentiating versus corporate direct lending,” PIMCO notes on its website. “A backdrop of tighter regulations also creates an attractive entry point as banks pull back and barriers-to-entry are high.”
Indeed, much of ABF’s growth can be explained by the deleveraging of the traditional financial sector, whereby banks face increasing regulatory pressure to reduce their exposures to businesses deemed too risky. As such, they have scaled back their lending appetites across various markets and asset classes, leaving non-bank lenders to plug the gap.
This growth trend also coincides with a sharp rise in demand for non-bank lending. “Mutual funds and hedge funds prefer assets with greater liquidity, insurers favour instruments with term funding and are often limited to investments that may be ‘rated,’ and private equity typically pursues investments with higher risk/return profiles,” according to alternative investment firm Brookfield Oaktree Wealth Solutions. “This underscores the significant opportunity ABF presents for private lenders, particularly experienced ones who can navigate the complexity of ABF borrowers’ financing needs, to earn a ‘complexity premium’ (over available spreads for traditional corporate lending or comparable asset-backed securities) in this currently underserved area.”
Another key driver of ABF’s growth is its broad appeal across numerous investor bases. “In our experience, the increasing interest in ABF stems from investors who are either fully allocated to traditional cashflow lending and are looking to diversify their credit exposure, or do not want to allocate to traditional cashflow lending as they have enough exposure to those borrowers elsewhere in their portfolio,” Luke Chan, partner and head of private credit at HighVista Strategies, explained to Alternative Credit Investor.
By offering more stable and predictable cash flows, ABF is an increasingly desirable component of private-credit portfolios. “Investors expanding their presence in the private markets are drawn to this asset class for its potential to enhance portfolio diversification while generating consistent yield,” Albane Poulin, head of private credit at Gravis Capital Management, also explained to the alternative credit magazine. “However, investing effectively in this space requires access to specialised resources, expertise in structuring and valuation, and deep sector knowledge.”
That expertise and specialist knowledge are perhaps most needed for underwriting and structuring contractual cash flows from large pools of obligors. Such tasks, according to Sridhar Bearelly, head of alternative credit at ICG, demand a different skill set than traditional corporate-credit lending backed by the operating cash flows of a single obligor.
“A major difference between ABF and other forms of corporate private credit stems from the granularity of its pool of underlying credit exposures,” Bearelly also observed. “A well-diversified corporate direct lending portfolio may comprise fewer than 60 companies. A well-diversified ABF portfolio, including corporate and consumer exposures, can consist of tens of thousands of underlying credit positions (on a look-through basis) because each investment is backed by its own underlying asset portfolio. This is one of the reasons why ABF can offer more predictable, stable realised returns.”
That said, investors are also voicing their concerns after the failures in September of two US companies—auto lender Tricolor Holdings and car-parts supplier First Brands Group—put the lending standards of private credit and ABF firms under scrutiny. This is especially significant given that both companies were given clean bills of health just a few weeks earlier, with Tricolor being rated a triple-A borrower and First Brands holding up to $10 billion in debt and off-balance-sheet financing. Both companies used ABF, with one investor who sold out of Tricolor debt telling the Financial Timesthat the company’s collapse was one of the “worst things I’ve ever seen in the asset-backed securities” market.
Investors are also scrutinising the nature and quality of the assets being pledged as collateral in ABF deals more closely. For example, specialist equipment might run down over time, or fine wine might spoil. “Collateral is only as valuable as the lender’s ability to enforce on it when required, or indeed its liquidity should the lender need to take possession,” Tamsin Coleman, head of private credit, Europe, at consulting firm Mercer, told Bloomberg.
Luke Chan urged investors to perform full due diligence on the assets against which they are lending. “The idea behind ABF is that lenders will gain exposure to collateral that can be liquidated in an enforcement scenario. However, if collateral is low quality, lenders may sustain losses,” the HighVista partner told Alternative Credit Investor, adding that investors must be prepared to accept ABF’s flexibility and the broad nature of assets that could potentially be used as collateral. “Unlike EBITDA-based lending, which can be executed upon by a generalist team, ABF requires specialised teams able to underwrite and work with each underlying collateral type.”
Nonetheless, many foresee ABF enjoying strong expansion over the next few years. According to Future Market Insights (FMI), for instance, the asset-based lending market will expand at a hefty compound annual growth rate (CAGR) of 11 percent between 2025 and 2035. The market-research firm has attributed much of this growth to enterprises increasingly turning to secured borrowing to unlock working capital amidst tightening credit conditions.
“The market is being driven by heightened demand for liquidity solutions that leverage company assets efficiently while minimizing risk for lenders,” FMI’s report, published on August 28, stated. “Corporates are favouring asset-based structures over unsecured loans due to their lower cost of capital and higher approval rates, particularly in periods of economic uncertainty. Lenders are also expanding their offerings in this space to cater to growing mid-market and large enterprise needs, supported by advancements in risk assessment and collateral management technologies.”
What’s more, market growth will accelerate sharply from 2028 to 2030, supported by technological innovations in credit evaluation, enhanced risk-management systems and regulatory reforms that bolster lender confidence. “The diversification of acceptable collateral assets and the rise of digital platforms streamlining loan origination and monitoring further amplify this growth,” FMI also noted.