Asset Based Lending

Why invest in Asset Based Lending

• Large, Diverse Opportunity Set: Large addressable asset class that reaches across many different segments of the economy.
• Downside Protection: Collateral that serves to protect principal risk and potentially appreciate with inflation.
• Attractive Income Solution: Underlying assets produce recurring, often contractual, cash flows
• High Barriers to Entry: Less competition as a scaled multi-sector approach requires a high level of resources
• Portfolio Diversification: Exposure to diversified sectors, idiosyncratic borrower events, and low correlation to general corporate credit.
• Flexibility in Deal Structures: ABL transactions can be structured in various ways to meet the needs of both the borrower and the investor. This flexibility allows investors to tailor their involvement based on risk preferences, return expectations, and the specific financial situation of the borrowing company and charge a premium for these customized capital solutions.

What are the main risks of Asset Based Lending

• Credit
• Origination volume

What characterizes Asset Based Lending?

• Industry/Sector: Typically, generalists across all industries and sectors, though some managers have an industry/sector focus, e.g., Real Estate.
• Instruments: First Lien, secured by hard assets that generate recurring or consistent cash flows.
• Maturity Profile: Typically, medium term (1-5Y), but it depends on the situation.
• Credit Quality: Moderate/Higher. Typically, the emphasis is on secured lending backed by high-quality collateral over unsecured credit.
• Interest Rate risk: None (floating rates) / Moderate (floating/fixed rates). Typically, interest rates for these loans are priced as a spread above a floating reference rate.
• Borrower Size: Small / Mid / Large. It can cover everything from single-family homes to large portfolios of assets, depending on strategy.
• Return Profile: Derived from contractual yield, OID and occasionally equity warrants. Unlevered target net return would typically be 10 – 15 %.
• ESG: Impact / Positive Screening / Negative Screening. Depending on the strategy.

Question 1.  What is driving the evolution of the opportunity set in Asset-Based Lending?

TwentyFour

When an unprecedented period of ultra-low interest rates and market stimulus was brought to a close in 2022, the competitive advantage banks enjoyed for more than a decade in the form of favorable funding and capital costs also began to disappear.

With stricter regulation now being finalized by the Basel “endgame”, the pressure on banks to optimize their balance sheets and direct precious capital to higher priority businesses is growing.

Through asset-backed finance (ABF), private credit investors now have a new opportunity to acquire or gain exposure to high quality pools of loans or other assets that would traditionally have been held by banks. In our view, European ABF opportunities are particularly attractive given the region’s tighter regulation, more conservative lending practices and superior through-the-cycle asset performance versus comparable US markets.

For investors with the expertise to analyze and source high quality asset pools, and the strength of relationships to maximize their opportunities, the levelling of the playing field between traditional lenders and alternative capital providers is a significant opportunity. That is to target attractive levels of income and total return at a premium to more mainstream areas of private credit such as direct lending.

KKR

Private Asset-Based Finance (ABF) has gained prominence amid the retreat of banks from lending post the 2008 Global Financial Crisis. This $5.2 trillion global private ABF market is expected to grow by almost 50% to reach $7.7 trillion in the next five years. Factors such as inflation, rising interest rates, and banking system volatility contribute to the increased demand for private ABF. By strategically pursing new, underserved, and/or mispriced lending opportunities, ABF investors aim to deliver attractive returns, offering diversification to institutional private credit portfolios. In navigating financial landscape changes, private ABF remains resilient, addressing evolving investor and borrower needs. Our firm strategically positions itself to capitalize on these opportunities in the ABF space.

Clear Haven

Asset-Based Lending is a broad category with private capital, banks, and insurance companies being key providers of capital to the sector. Inflation and higher rates have had significant direct and knock-on effects. The primary impact has been to materially increase lender’s yield requirements with the hope that higher costs reduce demand for borrowing (just as low rates would increase demand for borrowing). The sudden rise in rates also caught many banks flat-footed, causing major balance sheet mis-matches which are still being addressed. The forced pull-back in the banking sector in 2023 and 2024 further increased borrowing costs and severely constrained availability of capital, driving more borrowers to private capital. Persistent inflation and rate volatility has exacerbated these issues. Deep expertise and the ability to move quickly when borrowers require capital relief create ongoing advantages in identifying attractive opportunities and acquiring good risk at attractive returns.  

At a macro allocation level, asset based is now beginning to garner serious and increasing attention from allocators after 10+ years+ of focus on corporate direct lending.  As a result of this focus on direct lending, asset based is relatively under allocated as well as complementary to corporate credit.  Many allocators will pivot to asset based as they consider if they should have little or even zero allocation to this multi-trillion dollar asset class offering good relative value as well as diversification benefits.

Question 2.  What specific factors do you prioritize when evaluating the quality and valuation of assets proposed as collateral?

TwentyFour

We focus on identifying, selecting, sourcing and then funding high quality asset pools which we are confident will perform through the cycle. We prioritise diverse, granular pools of homogenous assets with stable cashflow and observable default performance. We also favour opportunities where the original lender has a long track record and established markets that benefit from strong lending regulation.

This is why we believe European loan pools are ideal “raw material” for ABF opportunities. The region’s consumer lending markets are highly regulated and homogenous, and it has a culture of more conservative risk appetite in corporate lending, both of which mean the credit performance of European assets has historically been better than US equivalents.

Our team spends significant time and resource meeting lenders across Europe to understanding local strengths, nuances and performance metrics that are fundamental to the robustness of the asset pool’s future cashflows. We combine this asset-first investment process with a flexible approach to accessing the assets, using our team’s expertise and experience to find optimal structures and avoid limiting the potential universe.

KKR

KKR’s approach to collateral differs by investment type, however all methods involve granular analysis. For Portfolio Acquisitions, KKR reviews individual loan attributes and analyzes factors such as historical delinquency roll rates, loss to liquidation, and borrower characteristics. Ongoing dialogue with banks shapes leverage assumptions, impacting projected returns. For Platform Investments and Associated Asset Flows, the team assesses historical default rates, loss, recovery, prepayment, and other inherent risks. For asset originators or aggregators, considerations include the cost to originate/aggregate, overhead, alignment of principals, compensation, and the deployment timeframe to reach scale. For Structured Investments, KKR stresses the structure with various deterioration scenarios and ensures a margin of safety by referencing historical distress periods.

Clear Haven

The question depends a bit on the type of asset, however track record, loss performance, profitability, and how the asset is expected to perform in GFC-type scenarios are all important factors. After determining the attractiveness of the asset itself, additional work must be done around regulatory considerations, structural limitations of the facility, financial strength of the originator, and operational/servicing redundancy. For the latter in particular, the ability to service the asset and control cash flow is critical in evaluating the risk of loss in a distressed scenario, which may be a macro or counterparty-specific event.

Question 3.  What underlying sub-asset classes does the Asset Based-Lending investable universe consist of, in your view?

TwentyFour

The vast majority of the opportunity falls under either consumer or corporate debt. The major sub-asset classes in consumer debt are residential mortgages, auto loans, credit card receivables and other consumer loans. For corporate debt the major sub-asset classes are commercial mortgages and corporate loans to investment grade small and medium-sized enterprises (SMEs), which also includes leveraged loans.
The European investment universe makes up around 20% of the global total. Asset pools themselves typically range from €200m to several billion in size, with each comprising thousands of individual loans or exposures. The market provides powerful transparency via the asset pool data available on a standardised loan-by-loan basis, as well as historical performance data, which enables investors to assess quality and future performance. It is common to receive data spanning 20 to 30 years, informing our stress testing and forward performance projections.

KKR

KKR categorizes the ABF opportunity set into four sectors: Consumer / Mortgage Finance (e.g., auto lending, residential loans, and other secured lending segments), Commercial Finance (e.g., SME business loans and receivables financing), Hard Assets (e.g., aircraft leasing and green energy), and Contractual Cash Flows (e.g., intellectual property and royalties). While many ABF investors may focus on a single segment or geographic region, we think this approach sacrifices some of the most important diversification benefits of a global, multi-asset approach. It's essential to note, however, that these four segments do not represent the entirety of the ABF market (although a substantial majority), and certain areas of asset-based lending are not within the focus scope for KKR ABF (e.g., payday lending).

Clear Haven

Clear Haven primarily operates with Consumer Finance (installment lending, auto, student lending, mortgage, credit cards, etc) and Commercial/SME Finance (installment lending, charge cards, invoice factoring, equipment finance, royalties, etc). Other categories would include Hard-Asset Finance (vessels, engines, aviation), Esoteric Assets (IP, litigation finance), and Commercial Real Estate Finance.