Inside the rise of speciality finance

Asset-based strategies are proving a welcome diversification away from corporate credit risk.

Speciality finance is an asset class on the march. Dominated by asset-based lending strategies but also including consumer lending, insurance-linked loans, litigation finance, NAV lending, regulatory capital relief, royalties and trade finance, it is an alternative to direct lending that is piquing investor interest.

Benefiting from the twin tailwinds of LPs looking to diversify their private credit allocations beyond corporate direct lending and banks retreating when borrowers are hungry for loans, the growth of speciality finance in the US is driving private debt fundraising.

Angelo Gordon is the latest big name to target the space. It announced the final close in July of an asset-based credit fund with more than $1 billion of equity commitments, exceeding its $800 million target. It will focus on speciality private credit investments across a broad array of collateral types within consumer, real assets and other speciality lending markets.

KKR raised $2.1 billion for its first dedicated asset-based finance fund last year, primarily investing in pools of mortgage and consumer loans, as well as lending to companies against hard assets. Dan Pietrzak, global head of private credit at KKR, says: “A real tailwind right now is investor interest in the space. When we were talking to investors about this back in 2018 and 2019, they looked at us confused, but now speciality finance or asset-based finance is one of the top conversations they want to have.

“People are excited to grow their overall private credit allocations but would like some form of diversification away from corporate credit risk. The way these asset-backed deals perform will be uncorrelated to how the corporate credit market performs, and that is really attractive.”

Filling the void

According to a KKR white paper on the subject, the private asset-based finance asset class grew 15 percent from 2020 to 2022 and is expected to grow from $5.2 trillion to $7.7 trillion by 2027.

Pietrzak says: “The banks were big buyers of assets from speciality finance companies and they don’t necessarily want to do that right now.”

That allows fund managers like KKR to come in and fill that void, which, Pietrzak says, is good news for dealflow and for potential investor returns. “This is a big scalable market covering everything from auto loans to consumer loans, equipment financing and aircraft lending. There hasn’t been a huge amount of capital raised against it yet, but there is growing institutional investor appetite. We’re excited by what we are seeing right now,” he says.

Robert Molina, managing director and head of origination at Briarcliffe Credit Partners, which defines speciality finance as one of the four pillars of private credit, agrees that speciality finance has rich potential: “Within private credit, we are seeing the most traction when it comes to asset-based fundraising right now,” he says. “We came into the market with two asset-based lending strategies in the last two months and there has been a huge amount of interest.”

LPs are keen on asset-based lending because they find comfort in being secured by an identifiable asset, as opposed to cashflow. “Whether the asset is equipment, inventory or aircraft, having that security to lean against is of great interest,” he says.

New York-based Atalaya Capital Management’s speciality finance efforts include senior lending, asset purchases and junior capital investments in areas including consumer loans, commercial and small business loans, aviation leasing and litigation finance.

Ivan Zinn, founding partner and CIO at Atalaya, defines speciality finance as an asset class where finance is typically asset-based and backed by a bunch of consumer loans or small business loans that require specialist knowledge of that asset class.

He says regulation has sucked bank capital out of the system and pushed speciality finance into the hands of non-bank providers, particularly in the last 18 months, and adds: “Financial technology has also massively changed how everybody consumes, underwrites and provides credit. That is another factor amplifying growth in this market.”

Zinn says: “On the investor side, people have consumed a lot of private credit in the last decade and that has generally worked up until this point. Now they no longer want another corporate direct lender allocation, and they need some diversification. Here there are natural barriers to entry; we are not calling on private equity sponsors; our sourcing and our evaluation is completely different. What we are doing is certainly less well trafficked.”

Market dynamics

The macro environment has highlighted the ability of speciality lenders to pivot in response to market dynamics. Pietrzak says KKR’s strategy has not changed with the macro environment, but where they spend their time in terms of the asset classes has changed.

Noelle Sisco, managing director and portfolio strategist at Napier Park, an investor in speciality finance covering areas such as working capital finance, supply chain finance and equipment finance, says: “The nature of the opportunity hasn’t necessarily changed with the macro environment in the sense of what is being financed. That said, we are certainly seeking a heightened yield profile for the same unit of risk relative to a year ago, and seeking to incorporate structural protections in investments where we might be investing in a tranche, as well as over-collateralising.”

Tim Greatorex, co-president at Napier Park, says speciality finance strategies require an investment in resource and infrastructure to oversee large pools of smaller, esoteric loans. “You need really good automation alongside a sizeable team of expert analysts because everything has to be looked at on an asset-by-asset basis and you need to get very granular.”

NAV’s strong alignment

One area attracting huge interest is NAV financing, where the loans are secured against the value of the portfolio

NAV lending is a niche subset of speciality finance, pioneered by managers including 17Capital, that provides credit to funds, private equity firms and LPs secured against the value of their portfolios of investments. 17Capital has raised more than $11 billion in its history, with two distinct pools of capital providing preferred equity and NAV loans.

Greg Hardiman, managing director at the firm, says LPs look at NAV financing and see a market in a relatively early stage of development, more fragmented and less saturated than other private credit markets. They also view private equity users of NAV finance as top-tier, sizeable, institutionalised managers: “Allocating to this asset class is a way to get a unique risk-return exposure while ultimately backing or investing alongside very strong GPs,” he says.

“LPs are all thinking about ways to diversify their private credit allocations. NAV finance offers the opportunity to access diverse portfolios, while benefiting from strong alignment with both the underlying private equity managers and the LPs that are investing alongside them. NAV loans can be viewed as a way to diversify traditional senior secured credit exposure, while preferred equity may be compared to traditional mezzanine-type capital within a private credit allocation.”