Asset-based finance: Why is it the next big thing in private credit?
Unlocking New Opportunities for Diversification and Growth
There is no alternative to equities
For most of the 2010s, this philosophy, TINA for short, was the prevailing view on the capital markets, for good reason.
With rock bottom interest rates — in December 2008, the Fed slashed them by an unprecedented 100 basis points and didn't revisit them again until December 2015 — and bond yields' ten year average a meager 2.26%, equities were the only instruments that could provide investors with meaningful returns.
As a result, the money flowed in, leading to the second-longest equity bull market in history: 132 months.
That's all changed over the past two years, thanks to the Fed u-turning in the opposite direction in an effort to curb inflation.
Between 2022 and 2024, interest rates jumped from a target range of 0% to 0.25% to a target range of 4.75% to 5%. Coupled with tighter fiscal spending, this has pushed TINA out of the picture, replacing it with TARA and CINDY, i.e. "there are reasonable alternatives," and "credit is now delivering yield."
The resurgence in demand for credit-based assets — whether for supplementing equity yields, greater diversification, lowering risk, or all three of the above — is an unmissable opportunity for both private credit providers and traditional loan originators such as banks and credit card issues.
In this three-part series, we'll take a deep dive into:
How the growth of credit-based assets is boosting demand for asset-based finance, and the scale and scope of the opportunity for private credit funds
The challenges standing in the way of private credit funds scaling up their asset-based finance operations
Why we built the HighFi platform, and how it helps private credit funds streamline every stage of the process: sourcing, underwriting, and post-deal management
Why the new dawn for credit-based assets is a boon for asset-based finance
While equities were hoovering up most of the investment capital available during the 2010s, a silent revolution was brewing in the wings.
An onslaught of regulations and banks' increasingly conservative approach to lending in the aftermath of the 2008 financial crisis meant that, for individuals with less than perfect credit scores and small-to-medium businesses operating in an increasingly long list of sectors deemed "too risky," credit was getting harder and harder to come by.
Enter private credit funds, which capitalized on banks' retreat and swooped in to bridge the lending gap.
By 2023, they held an estimated $2.1 trillion in assets globally, primarily in first lien loans to middle-market companies.
But as interest rates started rising and leveraged buyouts decreased by 37% due to ongoing economic uncertainty, private credit started expanding into other areas. And, with an expected compound annual growth rate of 10.3% between 2023 and 2027, asset-based finance is by far one of the most significant and exciting developments.
So what is asset-based finance?
And, more to the point, why is it an unmissable opportunity for private credit lenders?
Understanding asset-based finance
Asset-based finance (ABF) is a lending approach where credit is secured against assets like accounts receivable, inventory, or equipment, providing a flexible source of capital for businesses. For companies like Affirm, which has around $600 million in outstanding consumer loans, ABF allows them to leverage these loan receivables to unlock immediate liquidity without selling assets.
Consider an ABF arrangement that gives Affirm an 80% advance on its $600 million in outstanding BNPL (buy-now-pay-later) loan balances, totaling $480 million. This setup means Affirm can secure a $480 million line of credit, backed by its contractual rights to the outstanding balances.
From the lender’s perspective, ABF has two major advantages over direct lending: diversification and collateral independence.
Diversification: Rather than concentrating risk in a single borrower, ABF spreads exposure across the underlying assets — in this case, Affirm’s customers, who are responsible for repaying their loans.
Collateral Independence: ABF gives the lender rights to the future payments owed to the borrower, meaning they can collect directly from Affirm’s customers if Affirm defaults. This diversifies risk even further, reducing the potential impact of any single borrower’s financial troubles.
The asset-based finance opportunity for private credit funds
Global investment firm KKR has described the asset-based finance opportunity as "too big to ignore," with good reason.
For one, in 2022, the asset-based finance sector was already worth $5.2 trillion — 9.6% of the United States' GDP.
KKR's projected 10.3% compound annual growth rate means the sector will be worth $7.7 trillion by 2027: around 14.21% of the United States' current GDP and about twice the size of Germany and Japan's GDPs.
At the same time, the banking industry's increasingly conservative approach to risk management — following Silicon Valley Bank's collapse, regulators have started putting measures in place that will restrict direct lending even further — is creating a vacuum.
According to McKinsey, a high proportion of businesses in sectors such as aircraft, railcar, and equipment leasing, infrastructure funding, and even residential mortgages will be looking to transition to non-banks over the coming years.
These sectors have risk-adjusted yields which are extremely attractive to institutional investors. Aircraft leasing, for instance, has been known to generate up to 15% return on equity, depending on the fleet's age.
More to the point, private credit funds' ability to move faster and be more flexible when structuring deals, and access to long-term capital with which to fund these loans means they're ideally placed to make the most of this opportunity.
There's just one catch. Because asset-based finance doesn't work in the same way as direct lending, it creates a new set of challenges for private credit funds.
So what are these challenges? And how can private credit funds overcome them?
You'll have to tune in for the second instalment in our series to find out.