For further proof of the irrationality of capitalism, look no further than the retail sector. Just as many businesses begin to wake up to the need to get on board with the digital revolution, Amazon, the symbol of the e-commerce shift, opens its first bricks and mortar store.
Retail is only a small part of the asset-based lending market, but businesses are increasingly securing loans on existing stock and unpaid invoices as a means of weathering the cyclical nature of the industry. A similar trend applies to manufacturers, distributors and wholesalers.
Asset-based lending is a deceptively simple concept but, until recently, has been the exclusive territory of banks.
ICG planted its flag in the market when it began including the option of ABL facilities as part of its private debt product 12 months ago, with the aim of distinguishing itself from the banks.
“Instead of offering a vanilla ABL product, we’re aiming to provide a more sophisticated structure that integrates the facility as part of the traditional leveraged loan,” says Max Mitchell, head of direct lending at ICG. Cross-border transactions, for instance, may be more suitable for a hybrid solution, but expertise in managing and monitoring an asset is essential in such circumstances as jurisdictions can value the assets differently, he adds.
ICG is open to providing ABL loans ranging between €30 million and €400 million and is one of the asset managers at the higher end of the private credit market to offer the service. Mitchell anticipates a growing percentage of transactions are likely to include an ABL facility in the future.
Banks are the dominant presence in the mid-market, while at the lower end of the corporate space a number of firms are channelling retail money into companies. But the trends driving the growth of the private credit market, such as bank retrenchment, are having the same impact in the ABL industry. The flexibility of credit funds means there is an attraction to borrowers, despite the heightened cost of the debt.
The push to diversify is constantly driving alternative credit providers. While real estate and infrastructure were the first frontiers fund managers gravitated to in their search beyond corporate credit, a second generation of funds are looking to sub-asset classes, says Antoine Josserand, head of Citi’s International Fund Distribution team in Europe.
“Investors who have become more comfortable with the broader asset class are comfortable with looking at the ABL sub-asset class or trade finance and that – combined with banks forced into reducing their portfolio – means the market is open for alternative financiers,” he says.
He cites the growth of aircraft leasing, where the relatively higher yield available – especially in the mid- to end-of-life segment, and trade finance with the offer of short-term loans on collateralised assets – means the market has taken off in the last few years. Other managers are looking at markets such as trains and shipping.
Evidence of a lack of awareness among potential recipients in Europe about the ABL market remains alarmingly high and points to great opportunities for those ready to take it. A recent survey from Close Brothers Invoice Finance, an invoice finance provider, found that the majority of small and medium-sized enterprises in the UK were not familiar with the instrument and instead continued to go with traditional forms of lending.
While there is ground to be gained, there is a still a high barrier to entry. The fundamentals are impossible to ignore. “Obtaining a high single-digit return on an ABL facility is a difficult bar to reach,” says Steven Chait, head of the ABL team at Wells Fargo Capital Finance.
But there is a role for credit funds to play in partnership with banks. Instead of providing a pure ABL facility, debt funds can work alongside their counterparts in the banks on a hybrid structure, whereby the manager can provide the junior capital to supplement a loan secured on assets originated by the bank. This type of partnership is how Chait sees the European market evolving in the future.
“Private debt managers do not have the capability to manage the daily revolver – they are more interested in deploying the capital and collecting the returns. However, as we engage further, more players in the market are discovering how our products can be complementary, and with their support, they’re helping ABL become a more mainstream and popular tool for long-term financing,” Chait says.
For a smaller private debt fund managing a mezzanine investment strategy, the proposition is an attractive one. Banks are a great sourcing network for transactions and the collaboration exposes fund managers to a new line of clients. At the other end of the market, the preference for larger players would be to remain the sole lender – where additional capital is required to complete the loan they can use the dry powder from the fund.
Europe can look to the US as a blueprint for how the market could develop. “ABL is very much part of the day-to-day debt finance scene in the US and is being pushed by the same players here,” says Georgia Quenby, a partner at law firm Reed Smith and a specialist in ABL investments.
“There are significantly more and bigger deals and a developed syndication market in the US and credit funds have been participating in that space for a while,” Quenby adds.
In a low-yield environment, investor demand has driven many into the corporate credit mainstream. For the ABL market, the trend is being pushed by a highly liquid environment for borrowers able to not only choose their credit provider, but customise their own solutions. And with such a high degree of downside protection, opting for ABL is a rational decision – especially for those operating in the most irrational of markets.