Why a rerun of the GFC is not in the works

The mortgage market is healthier than many believe and asset-based finance offers big opportunities, says KKR.

A new KKR white paper argues that asset-based finance is “an opportunity too big to ignore” and seeks to relieve some apprehensions left over from the global financial crisis. Some of the factors that led to the crisis involved asset-based securities, but KKR maintains that ABF is not ABS. The two asset classes, KKR says, are “fundamentally different”.

In absolute terms, the ABF market is now worth $5.2 trillion. KKR expects it to reach $7.7 trillion by 2027.

The paper says the numbers suggest ABF has been an appropriate remedy for some of what has ailed markets in recent years (turmoil among traditional lenders, pullback of investors from such lenders, inflation and interest rate troubles, etc). It has therefore grown and is expected to continue to grow.

The remainder of the paper is a deep dive into four ABF sectors: consumers/mortgages; hard assets; commercial finance; and contractual cashflows. It is chiefly in the context of the first of those four sectors that KKR explains why we are not about to revisit the GFC.

The good news is that mortgage risk has not shown any sign of returning to the level reached before the global financial crisis of 2007-08. Yes, the recent spike in interest rates has again created an “affordability gap” and, again, there may be people and institutions willing to take the risks of bridging that gap as lenders.

But, on the other hand, leverage is currently much lower than it was when the mortgage and mortgage derivatives markets blew up 15 years ago. Furthermore, adjustable-rate mortgages – which were a big part of the problem – are now only a small part of the market. Fortuitously, covid-era stimulus has allowed households to build up savings, which the report calls a cost-of-living cushion.

Auto finance, an important part of the consumer segment, may be due for a restructuring of its basic economics. Notably, “short-term leases, formerly limited to car rental companies and corporate and government fleets, are becoming available to individual drivers. The innovation has the potential in time to turn independent dealerships into retail storefronts for vehicles leased directly from manufacturers”. This in turn could create a vast new ABF market.

Under the heading of “hard assets” KKR discusses aircraft leasing, green energy, rail cars and home rentals. The report warns against investment in aircraft leasing, where “extra layers of caution are warranted” because a very granular understanding of the industry is necessary for an informed decision. “Each carrier faces its own distinct set of obstacles… in route structure and relations with government and regulators.”

As for commercial finance, the report notes that interest in equipment and asset finance has picked up notably, with large and sophisticated borrowers among those expressing interest in it.

These borrowers have been pledging both more and higher-quality collateral. Such trends, of course, offer opportunities to ABF lenders. It’s a market we can expect to keep on growing – and without the need to fear a GFC rerun.

Write to the author at christopher.f@pei.group