Large asset management firms have rushed into the world of hard assets the past decade with a specific focus on asset-based finance and the trend shows no signs of slowing down.
Building or buying an asset-based and asset-backed finance group has become table-stakes for any large asset manager, given their strong risk-adjusted yields, with historically low-loss rates. What’s more, the playbook for doing so is now: buy or build a platform, achieve scale and vertically expand once a platform is created.
The original lending model, which was created more than 20 years ago by the likes of Cerberus, Silver Point and Goldman Sachs Specialty Lending, has been so perfected in the past decade by new entrants including Ares, SLR and Benefit Street, that we are poised to enter a new phase of industry maturation. The timing for large asset managers to enter asset-based finance now is ideal, especially as banks start to pull back from the space and private credit enters a new phase of expansion into asset-based and asset-backed finance.
The growth has largely been financed through BDCs, which provided asset managers with a permanent financing vehicle, that in turn has had a profound impact on the ABL industry. The growth in BDCs has primarily led to consolidation and scale in terms of asset management firms acquiring or starting new ABL platforms at the upper-end of the market. Firms such as Ares, Apollo, SLR Capital, Barings and Blue Owl, among others, illustrate how many have already followed the playbook of entering asset-based finance. The combination of hard assets, low loss rates, countercyclical balance and permanent financing vehicle in the form of BDCs has made entering ABL a strategic priority of many asset managers. Market share gains should continue to shift towards non-banks given banks’ risk-off stance, impending regulation and narrowing spreads between bank and non-bank pricing.
It’s hard to envision a scenario where banks don’t retreat after an extensive multi-year growth period, capital concerns and expected legislation. The market for new entrants is starting to get crowded, but it’s hard to stop new entrants when the biggest barriers to entry are human and financial capital. This just means that buying an existing platform is not the only way in. A well-respected asset manager can buy or, alternatively, use its brand-name, existing calling efforts and resources to recruit a team and launch a de novo group within its platform rather than make an acquisition. Yes, the upfront people investment is sizeable, but the key differentiation is the ability to leverage an existing platform rather than look for a big or costly acquisition in a hyper-competitive market. In addition, there are still many asset managers with strong sponsor coverage teams selling cash flow loans, but not ABL.
In fact, many of these groups compete regularly against ABL groups that can also provide stretch term loans. The structures and complexity of today’s ABL market requires significant capital that is best served by being part of a very large organisation. It would be quite easy for these same groups to also offer the ABL option to the same constituency. Much easier to get into a new product line or business when your existing platform already generates the dealflow, which is arguably the hardest part of getting started. The list of multi-billion-dollar asset managers with direct lending, but no ABL is long and includes Alliance Bernstein, TCW, Crescent and Blackstone, among others.
These firms could choose to start their own ABL groups or also move to first-dollar risk-wise similar to Carlyle, Pathlight and Blue Torch. What this does is defensively stop new entrants in cashflow and also provide asset coverage without needing the heavy collateral monitoring and reporting that comes with ABL.
The dynamic for asset managers has become the same – if they are going to provide significant equity or term debt in a transaction it might make sense for them to control the ABL portion as well. This is how platform thinking goes: more products equals more assets and more optionality across a platform. It makes sense for large asset managers to add more products and the perception is that ABL is an easy product to add. Of course, the reality of trying to enter ABL is much different than the perception as there are clear constraints including dearth of sizeable platforms and cycle-tested talent, among other things.
One thing the global financial crisis didn’t do was over-regulate regional banks that did not pose a systemic risk or engage in risky trading behaviour. The question is whether new regulation will cause a dramatic shift to non-bank lenders in the lower and mid-markets similar to the benefit large funds gained from 2008 big-bank regulation. New capital continues to shift towards private debt. From an asset manager’s perspective the asset-based world still provides opportunities to deploy capital in a safe way while adding a complementary product to traditional cashflow groups. We are entering a new phase that will be defined by the leaders in private debt taking advantage of a great market cycle and government regulation.
Charlie Perer is co-founder and head of originations at SG Credit Partners.