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?

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.

Optio

Asset Based Lending within the Private Credit market has grown significantly post-2008 financial crisis. Banks have faced stricter regulatory requirements restricting their ability to offer limited recourse loans. Companies are increasingly seeking alternative financing options to traditional bank loans and public bonds. ABL provides effective, flexible and efficient funding for companies secured by cash flowing assets (e.g. receivables).

From an investor point of view, private ABL offers attractive risk adjusted returns, risk diversification and exposure to income generating assets.

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?

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.

Optio

Optio acts on opportunities where current financing possibilities are inefficient and aims to partner with sustainable businesses, where they enable asset partners to accelerate their green transition journeys through capital management. Optio analyses each funding opportunity on an individual basis and undertakes detailed due diligence on a number of factors including:

1.      asset partner specifics such as market position, management, customer base, financing objectives and strategic plan;

2.      asset pool specifics such as underwriting, historic delinquency and default experience, recoveries and servicing;

3.      proposed funding structure specifics such as legal framework, covenant package, risk allocation (e.g. credit/ financial/ market/ asset) and operational impact.

In addition to the above, Optio models and analyses asset performance under a number of both short and long term stress scenarios.

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?

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).

Optio

Optio is focused on lending to hard assets that generate a current cash flow from a diversified pool of consumers and/ or businesses.

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.