Asset-backed finance is growing fast and drawing new scrutiny
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The bankruptcy of First Brands Group has shed light on one of the fastest-growing areas of private credit: asset-based finance.
Private asset-backed finance, or ABF, involves lending to a company against a specific asset, revenue stream, or credit, rather than lending to a company based on its cash flow. According to KKR, the private ABF market has doubled since 2008 to more than $6 trillion today; The syndicated loan market is larger than the high-yield bond and direct lending markets combined.
The ABF market is expected to reach $9 trillion by 2029, according to KKR. The global investment firm said in a report that direct lending may have fueled private credit growth over the past decade, but ABF is now “following a similar path and has attracted attention for its historically attractive returns, diversification benefits and large market size.”
Asset-based financing is generally claimed to be less risky than direct lending. While banks have withdrawn from ABF since the financial crisis, private direct lenders have flocked in. Lenders often pool ABF loans, securing everything from financial assets (accounts receivable or consumer loans) or tangible assets like aircraft, warehouses, or even music copyrights. The pooled approach aims to provide a safer loan portfolio with greater diversification.
But some experts say the influx of capital into private loans and ABF strategies has resulted in lower standards and increasingly exotic assets being pledged as collateral. Auto parts company First Brands borrowed money against receivables or debts owed by its customers. In bankruptcy filings and lender affidavits, some lenders say the company may have pledged the same receivables to different lenders.
While some private lending firms, such as Apollo, recognized potential problems at First Brands and shorted the loan before the company filed for bankruptcy, others failed to spot the red flags.
Donald Clarke, chairman of Asset-Based Lending Consultants, said ABF was “high-risk, high-reward” lending that required particularly rigorous due diligence.
Lenders not only need to understand the underlying business and complete business model like typical lenders, but they also need to understand the specific collateral underwritten.
“The First Brands debacle revealed a lack of due diligence on the part of lenders – both banks and non-banks – who rushed to deploy capital,” said Clarke.
He said that given the rapid expansion of the ABF and the billions flowing into private loans, he expected more bad loans to emerge, especially if there was a downturn in lending.
“The race to allocate capital should be guided by the need for proper evaluation of the borrower and the proposed security,” he said. “Where there’s a lot of money to lend, there’s also a lot to lose.”
