Asset-Based Lending 101
Kyle McCarthy: Hi, I'm Kyle McCarthy, a private credit specialist here at PIMCO.
You may have heard about asset-based lending and wondered what it’s all about. Let us help demystify this exciting evolution in private credit.
Asset-based lending, or ABL for short, refers to any kind of private lending that occurs outside the traditional corporate and commercial real estate lending markets. It is also referred to as asset-backed or asset-based finance, or specialty finance.
ABL provides critical funding across the global real economy in categories you interact with daily. In fact, it’s what enables us to finance a car purchase, or obtain a home mortgage, take a flight on vacation, attend university, or purchase goods on a credit card.
From an investing perspective, ABL loans are often secured by hard assets as collateral, which typically support the cash flows of the investment itself. This could be a house, a car, an airplane, or financial guarantees like business receivables and intellectual property rights, such as royalties, just to name a few.
At PIMCO, we estimate the ABL market to be over 20 trillion dollars. Much of this fixed-income-like universe is held by banks or pooled into securitizations. But a major shift towards private markets is underway, which we believe is creating a multi-trillion opportunity set for alternative lenders in the coming years.
PIMCO has been actively investing in various forms of ABL for decades, with our fixed income DNA crucial in making us one of the largest and most experienced investors in this space. Diverse and growing, we consider asset-based lending the next frontier of private credit.
We’ve mentioned some examples already, but at a high-level, the ABL universe can be broken down into three main categories: consumer, non-consumer, and mortgage.
The consumer category includes consumer-oriented credit and debt such as student and auto loans, credit card receivables, and other personal loans.
Non-consumer areas are more business-related, including aircraft leasing, heavy equipment finance, and royalty streams.
Finally, the mortgage category includes single-family residential mortgages in the U.S. and Europe, as well as home improvement loans.
As you can see, ABL is a highly diversified credit market. However, most investors remain underexposed to this asset class, particularly in private markets.
We think ABL is attractive for investors today for 3 key reasons.
First and foremost, ABL has a target-rich, rapidly expanding opportunity set that offers a compelling risk-return profile. Relatively high barriers-to-entry mean valuations today are attractive relative to historical levels. At the same time, ABL’s defensive qualities offer potential downside mitigation, as ABL loans are usually secured by hard assets, providing an often senior secured investment profile.
The second key benefit is portfolio diversification. Private credit has matured in recent years. In particular, corporate direct lending has seen elevated competition, with most private credit investors heavily allocated in this area. Adding private ABL to a portfolio could be highly complementary to investors’ credit allocation, given the idiosyncratic, low correlated nature of the underlying assets. ABL cash flows also tend to be front-loaded and amortizing, meaning they de-risk over time. This adds another dimension of diversification relative to corporate direct lending, where coupon payments are interest-only.
Lastly, ABL has a very compelling entry point today. Stress in the U.S. banking sector and tighter regulations have created large liquidity gaps left by banks pulling back. Private lenders like PIMCO are stepping in to fill the gap, partnering with banks looking to optimise their balance sheets by selling assets or seeking origination partnerships.
Scale, close relationships, and a deep understanding of these markets will offer strategic advantages for investors with flexible capital.
So, the next time you take a flight or buy something with your credit card, remember the critical role asset-based lending plays in the global economy – and the potential benefits it offers investors.