Skip to main content
Investors should consider diversifying their credit exposure with asset-backed lending strategies, which can offer diversification within a fixed income allocation, a potential inflation hedge, and downside protection with collateralized assets.

Many wealth advisors may be somewhat familiar with the value proposition of private credit — a strategy that has drawn increased attention over recent years for its potential to generate higher yields than public fixed income markets while providing downside protection. The surge in private credit offerings in recent years has mainly centered around direct lending strategies. Less attention has been paid to other opportunities within the private credit asset class, such as asset-backed (or asset-based) lending, that exhibit strong capital preservation characteristics and provide a complement to more familiar private credit strategies. These strategies — like aviation finance, first mortgage lending on commercial real estate, and equipment finance — can provide further diversification in a fixed income portfolio and often have greater visibility around the valuations of underlying assets.
 

A CLOSER LOOK AT ASSET-BACKED LENDING

In the broadest sense, private credit is debt originated or held by non-bank entities. Borrowers are often small and medium-sized companies seeking a tailored financing solution that is not accessible to them in the public credit markets or through bank lenders, who are subject to strict regulations. Increasingly, large companies are borrowing from private credit managers due to their ability to offer speed, flexibility, and certainty of execution that traditional banks often cannot, particularly in challenging market conditions.

There are a range of private credit strategies, but lender exposure can generally be divided into two buckets: 1) cash-flow lending, in which repayment of debt comes from an operating company’s cash flows (e.g., direct lending, subordinated debt), and 2) asset-backed lending, in which repayment comes from cash flows generated by a particular asset, which serves as direct collateral.


Exhibit 1: Global Private Asset-Backed Lending Market

A GROWING OPPORTUNITY SET

Global private asset-backed lending has grown 67% since 2006, and the market is expected to continue to grow from $5.2 trillion in 2022 to $7.7 trillion by 2027.1 Much of this growth can be attributed to the credit tightening of traditional bank lenders, driven by volatility in the banking system and post-Global Financial Crisis (GFC) regulation.

These factors contribute to a rising demand for private asset- backed lending, and opportunities for non-bank lenders to provide capital to creditworthy borrowers at attractive rates.

DETAILED DUE DILIGENCE

Asset-backed lending opens the door for specialized lenders to complete more detailed due diligence and underwrite loans based on their own thorough analyses and expertise with a specific asset type. In the commercial real estate space, for example, lenders have the flexibility to perform thorough evaluations of the property and tenants, and even survey the tenants to see what improvements may be required. This deep analysis allows lenders to more accurately assess, and only lend up to, the inherent value of the asset.

By contrast, traditional high-yield credit and leveraged loans are syndicated out by an investment bank to a large group of investors in a fast process, that permits little time for deep, independent due diligence.

Asset-backed lenders need highly specialized expertise and operational infrastructure to conduct proper due diligence, service loans, and manage assets in the event of foreclosure, which poses a significant barrier to entry.

TAILORED DEAL TERMS

Asset-backed lenders negotiate directly with companies seeking financing. Because they often have less competition and ample opportunity to specify and customize loan covenants, asset-backed lenders have a better ability to dictate terms and instill lender-friendly structural protections. For example, lenders are often able to establish proactive monitoring mechanisms and/or detailed reporting requirements that grant real-time visibility into the performance of an asset, helping to ensure the borrower is financially healthy.

Tailored, deal-specific terms in the private credit space are typically not available in the traditional high-yield credit and leveraged loan market, where pre-set terms are defined by an investment bank.

DOWNSIDE PROTECTION

Asset-backed lending inherently involves a direct claim on a physical asset, leaving lenders better protected in the event of borrower default. In the later stages of an economic cycle, lending against a senior-secured assets is an attractive option, given that a direct claim can expedite recovery in the event of a default. Moreover, the value of the collateral, particularly hard assets, generally rises with consumer prices, providing inflation protection.

Additionally, there are active secondary markets for the most common underlying assets. If a lender ends up owning an asset after a borrower defaults, liquid markets support clearer price discovery and the potential for substantial recovery, further bolstering downside protection. Consider aircraft assets that secure aviation loans: aircraft are durable, standardized assets with flexible uses, limited supply, and considerable residual value. Thousands of planes change hands every year in the secondary market — they are fungible assets that can be easily relocated. As such, investors in aviation debt benefit from the long-lasting, globally marketable asset.

CONCLUSION

Private credit has become a permanent feature of the lending landscape and continues to serve as a reliable alternative to banks as a source of capital. Yet many investors remain under-allocated to important segments of private credit. Investors should consider diversifying their credit exposure with asset-based lending strategies, which can offer diversification within a fixed income allocation, a potential inflation hedge, and downside protection with collateralized assets.

Was this article helpful?
YesNo

ENDNOTES

1. KKR, “Asset-Based Finance: A Fast-Growing Frontier in Private Credit,” May 15, 2023.


IMPORTANT INFORMATION

The material herein has been provided to you for informational purposes only by Institutional Capital Network, Inc. (“iCapital Network”) or one of its affiliates (iCapital Network together with its affiliates, “iCapital”). This material is the property of iCapital and may not be shared without the written permission of iCapital. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of iCapital.

This material is provided for informational purposes only and is not intended as, and may not be relied on in any manner as, legal, tax or investment advice, a recommendation, or as an offer or solicitation to buy or sell any security, financial product or instrument, or otherwise to participate in any particular trading strategy. This material does not intend to address the financial objectives, situation, or specific needs of any individual investor. You should consult your personal accounting, tax and legal advisors to understand the implications of any investment specific to your personal financial situation.

ALTERNATIVE INVESTMENTS ARE CONSIDERED COMPLEX PRODUCTS AND MAY NOT BE SUITABLE FOR ALL INVESTORS. Prospective investors should be aware that an investment in an alternative investment is speculative and involves a high degree of risk. Alternative Investments often engage in leveraging and other speculative investment practices that may increase the risk of investment loss; can be highly illiquid; may not be required to provide periodic pricing or valuation information to investors; may involve complex tax structures and delays in distributing important tax information; are not subject to the same regulatory requirements as mutual funds; and often charge high fees. There is no guarantee that an alternative investment will implement its investment strategy and/or achieve its objectives, generate profits, or avoid loss. An investment should only be considered by sophisticated investors who can afford to lose all or a substantial amount of their investment.

iCapital Markets LLC operates a platform that makes available financial products to financial professionals. In operating this platform, iCapital Markets LLC generally earns revenue based on the volume of transactions that take place in these products and would benefit by an increase in sales for these products.

The information contained herein is an opinion only, as of the date indicated, and should not be relied upon as the only important information available. Any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets is not necessarily indicative of the future or likely performance. The information contained herein is subject to change, incomplete, and may include information and/or data obtained from third party sources that iCapital believes, but does not guarantee, to be accurate. iCapital considers this third-party data reliable, but does not represent that it is accurate, complete and/or up to date, and it should not be relied on as such. iCapital makes no representation as to the accuracy or completeness of this material and accepts no liability for losses arising from the use of the material presented. No representation or warranty is made by iCapital as to the reasonableness or completeness of such forward-looking statements or to any other financial information contained herein.

Securities products and services are offered by iCapital Markets, an SEC-registered broker-dealer, member FINRA and SIPC, and an affiliate of iCapital, Inc. and Institutional Capital Network, Inc. These registrations and memberships in no way imply that the SEC, FINRA, or SIPC have endorsed any of the entities, products, or services discussed herein. Annuities and insurance services are provided by iCapital Annuities and Insurance Services LLC, an affiliate of iCapital, Inc. “iCapital” and “iCapital Network” are registered trademarks of Institutional Capital Network, Inc. Additional information is available upon request.

©2024 Institutional Capital Network, Inc. All Rights Reserved. | 2024.01

Back to Private Credit
Kunal Shah

Kunal Shah

Kunal is Managing Director and Head of Private Asset Research & Model Portfolios, focused on the identification, selection, and due diligence of private market funds. Previously, Kunal was a Principal in the private markets group at Meketa Investment Group, a leading global investment consultant serving pensions funds, endowments and foundations, and family offices. He received a BS in Business Administration with a concentration in Finance from Drexel University. See Full Bio.

John Peashey, CFA

John Peashey, CFA

John is a Vice President on the Research & Education team, focused on private markets. Prior to joining iCapital in 2021, he was a Director of Private Equity at Nippon Life Insurance, where he co-managed the North American private equity portfolio on behalf of Nippon Life's general account. Previously, John spent six years in investment and research roles at BBR Partners and Hermes BPK Partners. He earned a B.S. in business administration from Georgetown University, majoring in finance and international business. He is a CFA charterholder.