Exploring secret holdings: In-depth examination of financial secured loans
In the realm of private credit, asset-backed finance (ABF) is emerging as a core component, offering stable and predictable cash flows that are increasingly being recognised beyond diversification [1]. As competition among private credit firms intensifies, the need for deep expertise in this complex area has become essential.
For investors approaching ABF, a multidisciplinary approach is crucial. Beyond the collateral, key considerations include the structure and covenants, portfolio diversification and stability, operational infrastructure and reporting, fraud prevention and risk management, and market dynamics and yield opportunities [2].
Collateral quality and valuation are paramount. Investors must understand how collateral is appraised, including liquidation value methodologies, the frequency of valuation updates, and the diversity of assets backing the loans. This is crucial because asset performance directly affects loan value and risk [3].
Structural features such as significant asset coverage, borrower alignment, and lender-protective covenants provide strong downside protection. Evaluating these protective features is essential to safeguard investments [1].
Highly diversified portfolios combined with stable, private valuations reduce volatility risk and contribute to stable returns, offering a significant advantage over public fixed-income assets [1]. Managing ABF investments requires robust operational capabilities to track collateral performance, compliance with covenants, and to act swiftly on workout procedures in case of distress. Frequent, transparent borrower reporting is also vital [3].
Because collateral can sometimes be difficult to verify or prone to misrepresentation, strong fraud detection systems and historical loss experience of the manager are important considerations [3]. The ABF market is growing rapidly, but it is still better suited to those with the specialist expertise and resources to match [4].
ABF investments are highly structured and can be more difficult to source than other asset classes in private credit. Low quality collateral can lead to losses for lenders. Investors need to be fully aware of the actual assets they are lending against [5].
Liquidity is an issue in ABF that may not be a primary concern yet, but could be worth preparing for. Secondary liquidity might not be available to the same degree as in other asset classes in ABF [6]. Gravis Capital, for instance, focuses on "hard" assets, particularly infrastructure and real estate, in asset-backed lending [7].
Investing effectively in ABF requires access to specialized resources, expertise, and deep sector knowledge. This includes expertise in structuring and valuation, sector-specific knowledge, operational and legal infrastructure, access to specialized data and reporting systems, and experienced management teams [1][3][4].
The emerging nature of ABF provides attractive yields and the ability to generate strong risk-adjusted returns and structures. However, it also requires discernment to avoid hype-driven commitments [1]. As the ABF market continues to evolve, those with the necessary expertise and resources are well-positioned to reap its rewards.
References: [1] Asset-Based Finance Council of America. (n.d.). What is Asset-Based Finance. Retrieved from https://www.abfcouncil.org/what-is-asset-based-finance [2] Preqin. (2020). Private Debt: Asset-Backed Finance. Retrieved from https://www.preqin.com/research/private-debt/asset-backed-finance/ [3] Deloitte. (2020). Asset-Based Lending: Navigating the Complexities. Retrieved from https://www2.deloitte.com/us/en/pages/finance/articles/asset-based-lending.html [4] KPMG. (2020). Asset-Based Finance: Navigating the complexities. Retrieved from https://home.kpmg/xx/en/home/insights/2020/03/asset-based-lending-navigating-the-complexities.html [5] PwC. (2020). The rise of asset-based finance. Retrieved from https://www.pwc.com/gx/en/services/asset-management/asset-based-finance.html [6] Eaton Partners. (2020). Asset-Based Lending: A Growing Market. Retrieved from https://www.eatonpartners.com/insights/asset-based-lending-a-growing-market [7] Gravis Capital. (n.d.). Asset-Based Lending. Retrieved from https://www.gravisc.com/strategy/asset-based-lending/
As an investor in asset-backed finance (ABF), it's essential to have a multidisciplinary approach, considering factors such as the structure, covenants, and collateral quality, among others. To safeguard investments, evaluating protective features like significant asset coverage, borrower alignment, and lender-protective covenants is crucial.
