White Paper
Rapids of Private Credit: Opportunities in the Eddies of ABF

Direct corporate lending has grown nearly ninefold since 2015, intensifying competition across the leveraged corporate credit landscape. As a result, we are seeing more flexibility for borrowers, eroded documentation standards, compressed spreads and declining recovery rates.

In contrast, we see attractive opportunities in portions of Asset-Based Finance (ABF), where credit is secured by assets.

As examples, we highlight three collateral-backed “steady eddies,” or smaller market segments within private ABF that offer compelling risk-adjusted returns: 1) U.S. second-lien residential mortgage lending, 2) European small and medium size enterprise (SME) asset-based lending (ABL) and 3) U.S. mid-ticket equipment finance.

One of the drivers of the opportunity for private investors in ABF is the evolving role of traditional bank lenders and their increased partnership with non-bank lenders. Regulatory capital requirements have made certain loans less economical for banks, and have resulted in more warehouse lending to non-bank lenders. Private credit investors have stepped in, but most capital has flowed into corporate direct lending and the largest addressable markets in U.S. ABF, leaving parts of non-investment grade and non-rated underpenetrated.

From an investor protection standpoint, ABF transactions tend to be supported by large, diversified pools of loans that are self-amortizing or self-liquidating, with significant structural safeguards. By comparison, leveraged corporate debt is generally backed by enterprise valuations derived from EBITDA; that EBITDA can overstate underlying earnings when generous “add-backs” are used. Such debt is also typically longer in duration, with principal repaid at maturity. Moreover, direct corporate lending remains an untested asset class, with 30% of reported returns from the 2015 vintage not yet realized and even higher rates for subsequent vintages.

Collateral-backed financing expands access to credit at a lower cost for homeowners and businesses, while ABF’s structural protections, including covenants, performance triggers, and governance rights, can mitigate downside risk and enhance
credit quality.

On a relative value basis, the public equivalent of ABF, known as Asset-Backed Securities (ABS), currently offers 100-370 basis points of excess spread compared to equivalently rated corporates. Within private ABF, certain spreads appear even more compelling versus direct lending on a risk-adjusted basis given the lower expected loss rates, with the potential for additional upside in a securitization exit.