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Asset-based lending market opportunity: wide open with potential yield

27 October 2023

 

Edward Cong
Partner, Portfolio Manager
Marathon Asset Management

Jonathan Glass
Managing Director, Business Development
Marathon Asset Management

 

At an estimated $3 trillion1 globally, the opportunity in asset-based lending is impossible to ignore, and today it belongs to non-bank lenders. Private asset-based lending is critical to the global economy, financing assets such as aircraft, FDA-approved therapeutics, cars, real estate, and many types of equipment. Higher yields, wider spreads, and conservative deal structures present an attractive entry point for those seeking exposure to the credit market’s best-kept secret.

 

Key takeaways

  • Higher interest rates, increasing capital requirements, and fundamental credit concerns are prompting a secular shift within lending—away from banks and toward alternative sources of capital.
  • The hunt for yield has ended, and the hunt for capital has begun as supply-and-demand dynamics that once favored borrowers now favor lenders.
  • Credit investors now have an opportunity to earn equity-like returns in asset-secured debts with strong documentation and covenants.
  • Private investors looking to complement existing portfolios that exhibit relatively high corporate risk exposure with alternative yield sources, differentiated return drivers, and through-cycle investment strategies, have the opportunity to benefit from asset-based lending that has existed in institutional markets for decades.

Yesterday’s yield desert has become an oasis for today’s asset-based lenders

It’s a great time to be a lender. Credit dynamics have shifted over recent months, and the era of lower for longer is gone. While borrowers benefited from zero interest-rate policy (ZIRP) during the COVID-19 pandemic, one of the sharpest U.S. Federal Reserve tightening trajectories on record has since given lenders the upper hand—and that edge may prove enduring.

Higher base rates have lifted yields—where they’re likely to remain

Benchmark lending rates, January 2020–September 2023 (%)

Source: U.S. Federal Reserve, Marathon Asset Management, September 2023.

In addition to higher base rates, wider spreads have made all-in yields that much more attractive to those contemplating credit allocations. While the lender’s hunt for yield continued into 2022, we believe 2023 has become all about the borrower’s hunt for capital. Lenders are in a favorable position to negotiate attractive pricing with robust asset and structural protections. This investment environment favors disciplined credit investors ready to deploy capital.

It’s an even better time to be a non-bank lender

The regional banking sector is retrenching and pulling away from asset-based lending, neither financing nor originating the volume of asset-secured loans it once did. Regional banks play a critical role in extending credit to U.S. commercial real estate, residential real estate, and commercial and industrial loans, holding 68%, 37%, and 32%, respectively, of all loans and debt in these sectors.2

Share of loans held by small domestic banks by select sectors

Source: U.S. Federal Reserve, Marathon Asset Management, 4/1/23. Small domestically chartered commercial banks are defined as all domestically chartered banks outside of the top 25.

However, recent surveys of senior loan officers reveal that banks are lending less. Financial conditions are likely to tighten further with banks becoming subject to higher regulatory capital requirements as they continue to grapple with mismatched assets and liabilities. As a result, we are witnessing banks lending less, driving up the cost of taking out a loan or refinancing. While that’s bad news for borrowers looking for asset-based credit, we believe it’s good news for non-bank lenders that can step into the void left by banks across large swaths of the everyday economy.

Banks will be less likely to lend ... While that’s bad news for borrowers ... it’s good news for non-bank lenders that can step into the void.



Tightening bank standards point toward opportunity for non-bank lenders

Net % of banks tightening standards for commercial and industrial loans

Source: U.S. Federal Reserve, Marathon Asset Management, September 2023.

We believe that backdrop has set up a golden era of credit for disciplined alternative lenders. Instead of defending existing positions that were underwritten in a more relaxed, borrower-friendly environment, those who remained prudent providers of capital throughout the ZIRP era can now seize the day by offering bespoke asset-based financing solutions that contribute to investment portfolios through the potential for:

  • Current income commensurate with historical total returns on equity
  • Diversification and drivers differentiated from stocks, bonds, and other private credit classes focused on corporate risk
  • Durability and stability amid a rising interest-rate and inflationary regime given the asset-based cash flows
  • Downside protection through structural security backed by hard or financial assets

Asset-based lending has become a credit allocation for all seasons

Credit investors with dry powder to deploy have the potential to capitalize on what could be one of the most attractive market environments in decades. The lagged effect of tighter monetary policy should allow investors to lend at higher returns with tighter covenants and lower advance rates. This points to the potential that lenders have to earn higher yield for lower net capital deployment. We believe it’s more important than ever to have a diversified strategy within credit allocations generally—and within private credit particularly. While middle market private credit has existed in institutional markets for decades, asset-based lending is just gaining traction among private investors looking to complement existing portfolios that exhibit relatively high corporate risk exposure with alternative yield sources, differentiated return drivers, and through-cycle investment strategies. Asset-based investments offer the potential for contractual cash flows backed by hard assets that are expected to retain value even in a higher-rate, inflationary regime. Investors allocating to the asset class now may benefit from the potential for high recurring income streams, low correlations with mainstream markets, and a degree of downside protection that’s potentially compelling compared with many other risk-bearing investments. We believe that few asset classes today can deliver such a compelling combination of characteristics.



1 Mortgage Bank Association, BBG Real Estate Services, Polaris Market Research, Urban Institute, Goldman Sachs Research, Federal Reserve Bank of New York, Bourne Partners, Deloitte, Bloomberg, Stifel Debt Transaction Database, Petrofin, and Marathon Asset Management, LP, October 2023. Estimate excludes corporate asset-based lending.

2 U.S. Federal Reserve, Marathon Asset Management LP, 4/1/23. Small domestically chartered commercial banks are defined as all domestically chartered banks outside of the top 25.

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