ABF and the evolution of private credit

February 2025  |  FEATURE | BANKING & FINANCE

Financier Worldwide Magazine

February 2025 Issue

Asset-backed finance (ABF) has, in recent decades, emerged as a genuine game-changer in the world of private credit, transforming the industry and offering many advantages to lenders and borrowers alike. It is a powerful tool that impacts everything from consumer finance to real estate, hard assets and financial instruments.

According to a 2002 KKR report ‘Asset-Based Finance: A Fast-Growing Frontier in Private Credit’, since 2006 the private ABF market has surged by around 67 percent, with a significant 15 percent growth from 2020 to 2022 alone. By the end of 2022, it accounted for nearly half of the total asset-backed market.

Private ABF has become a formidable force in the financial world, with projections showing its expansion from a $5.2 trillion market in 2022 to $7.7 trillion by 2027. And though estimates of the size of the ABF market do vary, its rapid growth is clear.

Indeed, the ABF market is in a dynamic growth phase, driven by several factors. “First, the disintermediation of traditional bank lending has created a substantial opportunity for private ABF, especially as regulatory pressures have tightened bank lending requirements,” explains Sylvain Makaya, a partner in ABF at Eurazeo. “This shift has made ABF appealing to investors looking for optimised risk-return profiles, with the security provided by underlying assets like real estate and consumer finance.

“Additionally, ABF has aligned well with the rise of green financing, supporting investments in sustainable assets – a priority for many investors today,” he continues. “Technological advancements have also made financing more accessible and efficient, especially in markets like the US, where non-bank lenders now manage over 20 percent of ABF transactions. All these elements point to continued growth and resilience for ABF in the evolving financial landscape, making it a compelling option for investors and a vital funding source for many sectors.”

Significant growth in the ABF space is part of a larger story of private credit market growth. Direct lending, senior secured, hybrid and mezzanine strategies have increased substantially in recent years, with asset-based lending the next extension of growth in private credit. Diversified collateral, which makes up a large part of the ABF market, is well suited to investment grade equivalent risk exposure.

At present North America leads, followed by Asia-Pacific and Europe, with significant growth observed in the US, the UK, the Netherlands, Australia and India. In the US, the ABF market contains over 580 issuers, including Fortune 500 companies such as Toyota, BMW and American Express. Vehicle and student loans, and credit cards comprise about 60 percent of the US market.

Growth has been driven by a number of factors. In today’s high interest rate environment, private equity partnerships are being pressurised by tighter terms, lower leverage and a higher cost of servicing debt. Accordingly, general partners are taking an increasingly creative approach to financing structures – and it is in this environment that private ABF has begun to thrive.

Here, ABF combines private, income-generating assets into a wider asset pool, which encompasses transactions such as asset sales and financing managed by investment professionals. This type of private credit refers to a distinct asset pool segmented by unique characteristics.

For Mr Makaya, some of the most interesting areas within ABF include industry and financing for green assets, where ABF supports sustainable projects – such as the modernisation of production tools – and consumer finance, which enhances financial inclusion. “These sectors combine the appeal of secured returns with innovation in financial structures, making them key drivers of growth in the ABF market,” he explains.

ABF’s appealing characteristics

Against this backdrop, ABF presents a compelling offering to lenders and borrowers alike. Today, ABF has become a key tool for consumers and businesses allowing them to finance their daily activities. It impacts areas such as consumer finance, including financing for automobiles, credit cards and consumer loans, hard assets such as infrastructure, equipment, finance for receivables and against inventory, real estate assets including loans against commercial real estate and residential mortgage loans, and financial assets including royalties, rights and trade finance.

“By incorporating asset-backed structures, it helps to reduce the risks associated with direct lending investments,” says Mr Makaya. “The collateral provided by the underlying assets serves as a protective buffer, improving the overall security of the investment. This added layer of protection is particularly valuable as investors become more risk-conscious.

“Additionally, asset finance contributes significantly to optimising the risk-return ratio by providing opportunities for secured lending with a tangible recovery mechanism in place in the event of default. Furthermore, asset finance enhances diversification within direct lending strategies. By broadening the types of assets used as collateral – such as real estate, equipment or receivables – investors can gain exposure to different sectors and reduce concentration risk. This diversification, combined with optimised risk management, positions asset finance as a key element in the continued growth and success of the direct lending market,” he adds.

One notable advantage of ABF is its potential for greater diversification compared to other fixed income assets, thanks to its non-corporate exposure and lower correlation with corporate performance. As ABF is typically self-amortising, it is not reliant on corporate performance or refinancing events. Furthermore, ABF delivers positive relative value compared to public fixed income, while also offering significant structural protections.

According to Mr Makaya, ABF appeals to lenders because it provides an optimised risk-return profile, where underlying assets act as collateral, enhancing security and creating a reliable recovery mechanism in the case of default.

“This asset-backed approach offers strong protection for limited partners (LPs), giving them greater confidence in their investments,” he says. “Borrowers benefit from ABF as well, gaining access to capital by leveraging their assets, often with more favourable terms than unsecured financing options. Borrowing companies can then finance innovation or the modernisation of their financial assets and production tools.”

Further, ABF is well-positioned to support economic recovery during global crises, such as pandemics or climate disasters, Mr Makaya believes. Unlike traditional bank lending, ABF can provide tailored financing solutions for sectors hit hard by such crises, including healthcare, infrastructure and green energy.

“For example, ABF channels capital into renewable energy and climate resilience projects, which not only support immediate recovery efforts but also contribute to long-term sustainability goals,” he says. “Additionally, ABF’s inherent flexibility allows it to meet the capital needs of underserved markets during a crisis, offering both liquidity and stability where it is needed most.

“With prudent asset selection and robust risk controls during the holding period, ABF can play a pivotal role in financing resilient, crisis-ready sectors and supporting sustainable economic growth,” he adds.

Pressures

Despite this, there are challenges. “ABF is still a relatively new and evolving market, and the demand from LPs is growing but not yet fully established,” notes Mr Makaya. “The regulatory framework also needs to adapt to this asset class to address transparency and ensure stability. Additionally, unique risks – such as high leverage, fraud potential and the complexity of asset recovery – will require careful management.”

Additionally, a potentially inflationary or high interest rate environment can also increase pressure on the sector. As Mr Makaya notes, rising rates increase the cost of financing, which can reduce borrower demand and place pressure on highly leveraged borrowers whose debt servicing costs increase significantly.

“For lenders, inflation can erode the real value of collateral assets, potentially impacting recovery rates if asset values do not keep pace with inflation,” he explains. “This is particularly relevant in sectors like real estate or consumer finance, where asset value stability is essential to ABF’s appeal. In this context, selecting inflation-resistant assets and securing fixed-rate financing terms become critical risk management strategies. On the LPs’ side, the need to tailor the investment thesis is crucial in a high interest rate environment, to ensure an adequate risk-return balance,” he adds.

While private ABF holds significant growth potential, the sector faces several challenges that could impact its trajectory going forward. Perhaps chief among those challenges is ongoing geopolitical uncertainty, driven by political instability, trade tensions and regulatory shifts. Such headwinds can generate significant market volatility, complicating risk management and return predictability for investors. Furthermore, the increasingly crowded ABF market is creating much stronger competition for high-quality assets, raising acquisition costs and compressing returns while pressuring originators to uphold asset quality.

Meanwhile, technological integration is both a blessing and a curse. Though advancements in artificial intelligence (AI) and data analytics are offering greater opportunities to generate efficiencies and are improving risk management efforts, the levels of investment required to institute and then maintain such programmes, as well as the expertise required to help manage them, are often prohibitively large for smaller firms that are operating with limited budgets.

Tackling these challenges head on, via strategic asset sourcing, robust compliance frameworks and thoughtful investment in technology, among other strategies, will be key to unlocking the sector’s full potential.

Regulatory observations

As with any financial product, there are also regulatory concerns to consider and address. As the private ABF market expands, existing regulatory frameworks will also need to evolve to keep pace with new complexities and potential vulnerabilities. The evolving regulatory space, while intended to enhance transparency and investor protection, has other consequences, most notably imposing significant costs and operational demands, particularly on smaller market participants.

“The expansion of private ABF, alongside innovative deal structures and higher leverage, calls for targeted regulations to safeguard stability and protect investors,” concurs Mr Makaya. “There is also an increasing need to address the potential for fraud, including hidden financing arrangements designed to reduce a company’s apparent balance sheet liabilities. With ABF’s growing scale, regulators are likely to focus on improving oversight of default management and asset recovery processes.

“Financial innovation in ABF also brings new risks,” he continues. “High leverage in financings heightens exposure to market fluctuations, while the complexities of asset recovery in defaults can create challenges for lenders and investors alike. As ABF markets expand globally, harmonised international regulations will be crucial. Adapting regulatory frameworks to these emerging risks is essential to ensure a resilient, transparent ABF market, making it an appealing yet well-regulated financing alternative.”

Outlook

ABF has become a critical feature of the financing space. It is a powerful tool through which borrowers can access funds they might not otherwise be able to reach. Given the financial and geopolitical uncertainty still resonating around the global economy, with inflation high and interest rates yet to fall significantly, ABF’s prominence appears set to continue.

“The direct lending market has seen significant evolution in recent years, driven by strong demand from LPs seeking attractive risk-adjusted returns,” notes Mr Makaya. “Moving forward, we can expect this trend to continue, with a shift toward less risky deals as investors prioritise stability and long-term performance in this world of instability. The focus will likely be on more optimised risk-return profiles, with a greater emphasis on high-quality, lower-risk lending opportunities.

“Asset finance plays a crucial role in this evolving landscape,” he concludes.

As banks and private credit firms continue to collaborate, more regional banks are expected to adopt models to monetise their relationships with private credit funds. Increasingly viewed as the next step in private credit, ABF offers a more flexible means for companies to unlock the value of their assets to achieve desired growth.

© Financier Worldwide

BY

Richard Summerfield