As the private credit boom continues, investors are spotting opportunities in niche segments of the asset class. Asset-backed lending, or ABL, became popular last year as investors diversified their credit portfolio and hedged against inflation risk. Will the trend continue?
ABLs are typically borrowed capital that companies secure with collateral such as inventory, accounts receivable, or equipment. Rising interest rates, growing inflation and tighter liquidity pushed more ABL deals in 2023, according to a KKR report.
These conditions sparked a wave of ABL deals last year. Texas-based Obra Capital acquired the assets of KDP LLC to expand its capabilities in this arena while funds managed by Ares Management acquired a specialty finance loan portfolio worth $3.5 billion from PacWest Bancorp. PacWest’s decision to offload this portfolio reflects a trend of regional banks retreating from this space.
Sasha Jensen, founder and CEO of Jensen Partners, expects the trend to continue. “The asset-based finance asset class could grow from $5.2 trillion to $7.7 trillion by 2027, by our estimates, in large part because of a pullback by banks in funding these kinds of collateralized loans,” she says. “That pullback only accelerated as interest rates rose and questions about the asset-liability mismatch between short-term deposits and long-term debt obligations became more apparent with the collapse of Silicon Valley Bank, Signature Bank, and First Republic earlier [last] year.”
From the borrowers’ perspective, there are some trade offs according to Oliver Khan, partner at NewPoint Capital, a Toronto-based mid-market investment bank. “When a bank offers you an operating line they have a whole bunch of other business with you,” he says. “They’re already familiar with your business so you can forge a deal with better terms. They’re not just focused on a specific piece of collateral.”
Regional banks provided one-third of small and mid-sized enterprise financing, or $169 billion, in 2022, according to the Bank Policy Institute. The retreat of these banks may have pushed more companies to asset-based lenders.
Regardless, asset-based borrowing might have certain advantages for companies in specific industries or in specific situations, according to Khan. A retailer with lots of inventory and seasonal earnings, for instance, could benefit from the flexibility of these loans, while companies facing cash flow issues could lean on asset-backed lenders because they might not meet the standard for traditional borrowing and “ABL is typically more covenant-light,” he says.
Khan says growing optimism about the economy and rates in 2024 could put borrowers in a better position to negotiate these deals. Meanwhile, a recent Moody’s report noted that private lenders are dropping covenants on all forms of direct loans, especially for larger deals, in their battle against banks. This creates more options for borrowers, beyond asset-based financing, and more risk for direct lenders.
The market should expect continued growth in asset-backed financing as more investors recognize the core value of this asset class: stable returns, robust collateral and attractive terms for everyone involved. Despite the challenges, KKR calls it “an opportunity too big to ignore.”
