Asset Based Lending ABL – How Far Can Private Credit Stretch in this Market

Um let's let's delve into this uh extremely wide universe of assetbacked lending. Um that encompasses anything that that finances hard assets. Uh so plant equipment, planes, trains, buses, you name it. solar panels um through to financial assets. So uh receivables um being among those uh uh that are extremely common as well as uh intangible assets royalties whether it's music uh film or other media rights uh that that that can be financed and and emerging new uh activities like um influencers um YouTubers get uh get financed by by private credit uh and And that's one of those things that are really exciting about this uh space.

So what we'll do is is to begin um actually trying to survey this this this universe and starting with you Daniel maybe how do you look at that this space and what what's in it what's not in it and in particular how does that compare to uh the core private credit universe which really is sort of sponsorbacked cash flow-based lending. Well, it's been uh quite extraordinary to witness the expansion of what private credit really is to that point. If you think about post financial crisis when private credit really started to take off, initially it was around doing the types of financings that the banks could no longer do either because they were constrained in regulatory uh issues or uh they had suffered a lot of losses. So risk appetite sort of rescue financing, distress financing. Um but that quickly evolved into the more traditional private credit market that we have still today.

This is the biggest part of our business. Direct lending and some opportunistic credit. And why did that grow so substantially? Well, because borrowers saw the benefits of private credit, certainty, speed, um, uh, more flexible and customized, uh, solution, financing solutions, and investors saw excess spread. So, that's like the foundation for the growth uh, in that market.

And what's really been happening over the last you know five plus years now has been this expansion into financing the real economy far beyond the leverage finance market. So if you think about the traditional market has being focused on leverage finance non-investment grade um direct lending the expansion is into all of asset act finance which includes a huge investment grade component. So that's been a very big theme for us. We're talking about full capital structure investing now. Um and that's opened up opportunities with an entire new client base as well, especially insurance.

Um but it's really broad. I um the other day I sat down with a client and they said, you know, how do you define aspect finance? Because when we ask they did a poll of managers and the the they got 82 different asset classes. Okay, so I won't go through 82 different asset classes, but in all seriousness for us, it's very very big themes. You know, at Blackstone, we're long-term thematic investors.

We're talking about infrastructure broadly. Uh we're talking about residential and consumer credit, commercial finance, transportation, fund finance. These are some very very big categories where we uh envision deploying uh hundreds of billions of dollars in the coming decade. And what's really exciting to me is again coming back to your traditional world of private credit even though it's still the biggest um part of our business. It's about a call it two plus trillion market.

Now the addressable market for the broader aspect finance universe we think is 30 plus trillion. So we're still in the very early innings. You think of direct lending as being phase one of what private credit can do. I think all of this is phase two and uh and beyond. Uh and to us it's very exciting.

So a huge runway ahead of us.

A lot of runway

right. Um Kerry h how do you position yourself within this space?

Yeah. So I think very importantly, thank you for that Daniel because it is important that assetbased finance or asset based lending represents a very broad category of underlying asset types and investment strategies. Um I think the capital formation and what you see as the the more immediate investable opportunity has been overwhelmingly concentrated at the larger end of the matri u of the market. So much more scalable platforms um investments into collateral pools such as consumer and mortgage um you know more granular assets that lend themselves to securitization. um at uh the firm uh that that I represent, Cheney Capital, we have really seen this as an extension of the mid-market corporate lending financing toolkit where very specifically you know what you have seen and this is an important I think distinction from you know the preponderance of capital formation in private credit it has been overwhelmingly oriented to corporate direct lending and within corporate direct lending more than 85% of deal volume particularly in Europe has been oriented towards towards financing private equity sponsorbacked firms and organizations.

So predominantly leverage finance LBO financing. So notwithstanding I know Dan will talk about the investment grade private credit opportunity. But what we see particularly magnified in Europe is that this has left a very persistent and observable funding gap uh amongstmemes so lower core mid-market uh enterprises particularly in asset intensive sectors because that is where bank retrenchment has been um you know most uh most acute

right and and with the that the sponsor bank focused on on a lot of the let's say less cyclical sectors I guess That's anything that's more capex.

Correct. And there's been, you know, very meaningful need for expansion capex or indeed for a number of mid-market businesses that they need access to capital assetbased lending. So bilateral private lending against hard physical assets. So equipments um missionritical machinery plant and the like um provides them a way of unlocking liquidity and value from their balance sheets in order to fund their their operations. So yeah, a little more twist and and in in terms of the definitional uh discussion as in you know corporate lending can be both sort of cash flow based but also aspect in in in nature and but staying with you maybe Kerry um um h how do investors let's say find their way in terms of you know to you and your strategy um and and you know again how is that sort of complement the kind of the the core cash flow based lending that they might be exposed to already.

Yeah, I think it is important to emphasize that assetbased lending as you know Daniel quite like rightly emphasized it is a non-homogeneous asset class. It's a huge addressable market and opportunity. Um the way that our investors have particularly shown uh I think a very elevated level of interest in the asset class today is that they are looking for diversification from core private direct lending and again as I already mentioned that is overwhelmingly dominated by sponsorbacked lending and also skewed to really upper mid-market large cap and so they are looking for other ways to diversify that could be more opportunistic lending non-sponsored lending hybrid capital, junior capital, and they see assetbased lending as a downside protected uh attractive source of, you know, an alternative source of of return streams, but capitalizing on fundamentally the same opportunity, which is European bank deleveraging and retrenchment.

I completely agree. I think that's been a huge topic, the diversification angle that you can get from Mass Effect Finance because it's so much broader than the traditional corporate uh private credit market. And and for us it's been a lot about diversification also across the capital structure. I mentioned it briefly before but if you think about our client base one thing that has really attracted them uh to this space is the ability to also participate in private investment grade. If you think about the high yielding space and the traditional uh corporate credit related private credit market generally speaking the pickup versus liquid credit has been in the context of 150 to 200 basis points.

What's been quite extraordinary for our investment grade focused clients is that in private investment grade they have been picking up a similar uh premium 150 200 basis points and when you think about the absolute level of spreads obviously spreads have been coming in across the entire capital structure throughout this year um investment grade spends are are generally below 100 basis points. So if you're picking up 150 to 200 basis points beyond that for similarly rated um versus the versus corporates, it's just a massive pickup and it's very diversified.

And how do you get to the investment grade as in um is this always rated or do you have internal criteria to define investment versus non-investment grade? Um and is it easier or more difficult in the different let's say subsectors of ABS to to kind of make that distinction?

Yeah. So uh yeah, I should be clear that you know when we talk about investment grade it is proper investment grade rated by the same rating agencies that rate the public deals. Um the big three and uh and Croll and DBRS are also quite involved. Um but there's really no basis there. And so it depends a little bit on the different asset classes, the method rating of methodologies that they have for those asset classes.

Uh some asset classes as as Kerry was alluding to are a bit newer and and you mentioned as well. Uh I'm not sure there's a rating methodology for influencers yet. Um but in in all seriousness uh most of the asset classes because of the hard asset nature because of the quite predictable cash flow for most of the cash flow uh lend themselves very well to to rating call it 70 to 80% of most structures investment grade and it's literally the same criteria they would use for public credit

right maybe just to chime in on that too I think again you know we talk about why people are diversifying away from sort of sponsorbacked direct lending and that end of the market of course where the predominance of LBO financing. You know, you are looking at a more levered capital structure where you are heavily reliant on the sponsor and indeed the management team to deliver growth and cash flows to deliver on forecast synergies to be able to delever the balance sheet and ultimately um be able to refinance you at the back end of that of that facility. Of course in the context of a lot of the assetbased lending particularly where it is you know direct to the corporate as as we participate in but where you are these are amvertising facilities and that amortization schedule is matched to the productive life of that asset. So these are revenue and income generating assets which are essential to the borrower's ability to be able to uh to to generate uh earnings and they typically amortize down to zero. um and so they are self-liquidating in nature.

So that provides a very attractive source of cash flow um as well as a sort of a very different risk profile and I think that also lends itself and I think another reason why investors are looking at the asset class is because historically they have exhibited significantly lower defaults and substantially higher recovery rates um given that structuring consideration. Um other than diversification um I mean you talked about investment grade is there also investors seeking higher risks than let's say adjacent uh corporate credit.

Yeah sure. I think uh that's again part of the beauty of uh this asset class actually is you can do anything from investment grade down to very opportunistic um and some of these assets just given the the nature of the cash flows like very high quality resi mortgages for example they lend themselves to a lot of leverage if you want to put that that leverage on. So uh we definitely see clients uh across our investor base more on the institutional side than in insurance but also participating much lower down in the capital structure.

Right. Um so what you know if you were to uh think about some of the new developing ideas uh or markets you know you said 30 trillion um in in addressable market where do you see sort of fascinating growth? What are you sort of uh looking forward to build, let's say, in the future or compelling value?

Sure. Um, well, I'd say for us, we're long-term thematic investors. So, we like to really pick areas where we think there's a mega trend happening and uh we're going to be able to pursue it in in multiple ways. I think the trend of all mega trends right now is everything around AI,

right?

Uh so for Blackstone, that has really been three big themes. uh data and data centers were massive player in data centers globally both on the equity side and and on the debt side. Um it's been about power because they take a lot of power and uh and chips and so for us those themes have been huge themes and digital infrastructure basically is one of our biggest assetbased focuses uh right now. Again, actually one one thing that is in common with what Carrie was mentioning before is around how we do these financings. You know, we're working with some of the best tech companies in the world, the biggest hyperscalers who are spending, you know, the top four hyperscalers are spending roughly 400 billion this year alone on on digital infrastructure.

We're working with them. We're we're building these data centers together with them with longdated uh fully contracted cash flows. And when you do that, you end up with very high quality uh in investments. So uh for us, that's been one of the biggest trends I'd say everything around AI. Obviously, it's much broader than that.

I mentioned at the beginning how many asset classes there are, but that stands out in my mind just given the sheer scale and also the durability uh of how long that opportunity is going to be around. I think uh we're again still quite early in that.

How about you Krie? Any any themes within your strategy to to focus on? Yeah, I think there is a a broader thematic. I'd be interested, you know, Dan, what your thoughts are here, too. But I think it's one which is, you know, looking at the Europe and and and US side by side, similarly sized economies, but of course in Europe, corporates rely on banks for more than 75% of their corporate funding needs.

In the US, it's less than 20%. So you still have a very fragmented, less mature, less developed market that is serving the the corporate fund, you know, in terms of the corporate funding landscape. Um, and I think so there's a lot further to go in in Europe, particularly in in our segment and and what we're we're looking to achieve. I don't know, have you see something similar in terms of that bank disintermediation opportunity being more magnified in in Europe? Yeah, I think there's uh there's often a lot of noise about are we friends or foes with the with the banks in private credit.

My my view is that we're doing more with the banks than ever before actually because we're connecting them with them more broadly. uh and the opportunity actually thanks to assetbacked is very big with the banks because exactly um as you just mentioned the banks dominate Europe across these asset classes and non-bank lenders don't play especially in assetback finance don't pay play a big role and it's quite hard for them to actually establish themselves because the market is very fragmented and so uh we have been working with the banks across all of these asset classes um and across all of Europe we have uh uh various partnerships on the infrastructure side we've done a a large partnership uh and we're working on a few more. I think infrastructure out of banks has been one of the biggest themes actually because there's so much need in Europe in particular for infrastructure spend and the numbers are just staggering. So that they need additional capital. The themes for the from that we're working with the banks high level are really I say three-fold.

The first is they want to optimize uh their their origination, do more uh rotate their balance sheet and uh across all of Asetact finance really and so we're helping them with that. Uh the second is through the SRT market. Uh that's where banks buy protection on performing portfolios. Um we're really active on that. That's again across all different types of asset classes from corporate credit to infrastructure, resi, consumer, everything.

And the third is around helping banks where they have you know certain business lines that they'd like to pursue but they can't. So our capital can be very effective because they have the relationships on the on the investment banking side but they can't do certain transactions because maybe because of the risk tolerance or just their counterparty limits are full. Um and so that's been a a huge opportunity for us as well. But I think you're right there's just a huge amount still to do and come out of banks.

Right. It is actually much more of a peaceful coexistence complimentary and and and which I think is distinct because again not to sort of beat the dead horse but obviously to the that direct lending has been oriented towards upper midmarket large cap and competing headon with the broadest indicated loan market to provide credit. You know then the leverage leverage finance departments at banks are feeling like endangered species in that regard. But when it comes to assetbased lending again you know where we're talking about that sort of strategic assets equipment finance we're really stepping in where the banks aren't prepared to lend. So the banks are still there you know theme lending though they have their preferred products which is receivables financing you know very short duration.

Um it is to some extent RCFs and inventory finance where they are doing equipment leasing. They're only doing very vanilla structures very standard collateral types. Um but they really can't step in where it's a non-standard asset. By non-standard I mean anything which is specialized equipment, second life equipment, inuse equipment. Um and and the very distinction is that they're only looking to generate low mids singledigit returns.

So if we can step in and provide a customized solution in those situations, you know, we're able to generate double-digit returns by virtue of being able to to underwrite where the where the banks are just simply absent entirely. So if I'm an investor looking to uh diversify my portfolio into into asset back finance um what are the kinds of things that are different um you know we we you know use origination as one of the defining um dimensions of of what private credit is. Um h how is the origination channel important uh especially if it's you know is it important to have a proprietary one um and how do you deal with risk management and monitoring again given that the sort of the sponsor relationship is is is generally absent right

do you want to start yeah

as you're yeah as I said we we have really built our expertise and specialization in in special situations and complex credit investing that has meant that we've had an orientation and focus also towards non-sponsored lending. So there is no private equity sponsor um that is providing the governance framework or the institutional uh controls but that's where we're very happy to step in. So there are a whole host of really high quality multigeneration family-owned enterprises, entrepreneur and founder businesses and where we can provide some of that governance framework and institutional controls uh if they are in any way um lacking. Um I think the um the most important feature origination is absolutely essential. So proprietary sourcing does require particularly in Europe local presence, local offices.

you know, you have to understand that you are navigating distinct languages, cultures, and more importantly, we don't have a homogeneous legal framework in Europe. So, you know, distinct legal frameworks um and so you have to have the jurisdictional expertise when it comes to underwriting and structuring around these assets. And I think probably the only thing I'll I'll add there is to that extent I think more important than origination is that structuring and restructuring expertise because in the event that an asset doesn't perform in in accordance with with expectations being able to ensure that you have structured um the documents correctly perfected the leans to be able to um seize that those assets and and generate a very very high recovery and and I'll say this in as an example because my team we are essentially restructuring um that is our background, our bread and butter of of our business and where we have in some instances been stepping into a distressed situation where the operating company debt there may be an incumbent lender is priced at 50 cents. So at a significant haircut reflecting that the leverage profile of of the business is is no longer sustainable. If there is an assetbased lender that has the first priority ranking lean against their operating assets, you take them at a out of par and you take them out quickly because otherwise you can't I'll give you an example, an ice cream manufacturer in Spain.

If there is a priority lender against those ice cream, you know, manufacturing equipment, you can't make ice cream without it. So you you need to take them out at par as part of that homegation process. So I I think origination extremely important but structuring expertise um you know incrementally important in terms of the return outcomes.

I I agree. I think uh structuring is key. Origination is key. I mean for on the origination maybe I'll just say that um obviously we we have a whole team out there originating. uh we do also to the extent when there are situations where uh owning a platform really gives you particularly uh advantageous origination obviously we do that as well um but I I would say there's no one right answer a mix of origination channels is really the best way to make sure that you're involved across the markets

yeah I think that that's been the observation for a lot of our members is that um in in the assetbased space that there's that kind of self versus uh other originated um uh business tends to fluctuate differently by by jurisdiction depending on again the structure of the market. In the US, uh there's a lot of managers actually having their own granular uh mortgage uh origination businesses, student loans or or car uh loan origination businesses, whether that's not the case at all in Europe and you're going to have to be the partner with the

bankation in Europe. It makes it very difficult. You know, non non-bank lenders, if you start a non-bank lender in the US, the next day you you lend to an addressable market of over 300 million people. And in Europe, it's literally country by country. But I guess how that partnership is structured is super important in terms of just

um um so um a great overview of uh of an extremely diverse market. I I guess the uh the good news is that um the growth uh and the capacity here um are are still far from uh uh from from being fulfilled. Um uh the bad news is that there's uh too much choice almost uh and and investors will have to think very carefully about how they want to approach this asset class. Um but I would contend that that is a really nice problem to have. So uh join me in thanking my uh panelists and let's uh get ready for another session.

Thank you.