The strategy offering security in times of stress

Asset-based lending looks set to grow in popularity but investors will need to wrestle with its complexity.

It could be argued that in times of severe market dislocation, such as we now find ourselves, the more credit solutions a manager can offer the better. Boston-based fund manager First Eagle Alternative Credit may have had this in mind when it added asset-based lending to its $23 billion direct lending platform earlier this month.

But there are specific reasons why fund managers should perhaps be thinking seriously about making ABL part of their strategic planning if they have not done so already. One is the sheer scale of the market. Providing a number is difficult as there are different views of which strategies should fall within the asset-based lending definition. However, we have heard $500 billion being mentioned and one source told us he thought ABL was perhaps 10 times larger than the direct lending market.

Another consideration is the security offered by ABL may make it a good strategy for current market circumstances. With defaults expected to pick up markedly as the year progresses, lenders with recourse to assets would appear to be in a more comfortable position than pure cashflow-based lenders.

As First Eagle president Chris Flynn put it, with these type of investments, “either the company rebounds, and we are repaid in the normal course, or if it doesn’t rebound, we are able to look to the specific assets for repayment. This is a very nice attribute of ABL investments – even in a stressed situation there should be a low loss given default”.

From the investor perspective, ABL is an interesting proposition. Some may have exposure to specialist managers, many of which make small single loans to a confined part of the ABL universe. We understand, however, that some of the big beasts of the private debt GP world are considering following the example of First Eagle – either ramping up existing ABL operations or launching new ones. This could provide the scale LPs need to really get behind ABL.

There are risks for investors that they need to consider, however. Fund managers that cover a wide range of ABL will be investing in diverse assets with different risk-return profiles, potentially ranging from hard assets such as aviation leasing to consumer/SME finance and even quirkier areas that may also fall within the ‘specialty finance’ definition, such as life settlements and regulatory capital. Investors need to understand the idiosyncrasies of each investment theme, including the amount of leverage that is being applied.

If discussions with various sources are anything to go by, we can expect asset-based lending to migrate further into the private debt universe in the months and years ahead – either as an add-on to an existing strategy (as per First Eagle) or as a new strategy in its own right. Investors should prepare to do their homework.

Write to the author at andy.t@peimedia.com.