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The bankruptcy of First Brands Group has put a spotlight on asset-backed financing, one of the fastest growing areas of private credit.
Private asset-backed financing (ABF) involves lending to a specific asset, income source, or loan, rather than lending to a company based on cash flow. According to KKR, the private ABF market has doubled since 2008 and is now worth more than $6 trillion, making it larger than the syndicated loan market, high-yield bond market, and direct lending market combined.
According to KKR, the ABF market is expected to exceed $9 trillion by 2029. The global investment firm said in a report that while direct lending may have underpinned the growth of private lending over the past decade, ABF is now “following a similar path and attracting attention for its historically attractive yields, diversification benefits and huge market size.”
Asset-backed financing is often touted as being lower risk than direct lending. Since the financial crisis, while banks have been withdrawing from ABFs, there has been an influx of private direct lenders. Lenders pool ABF loans together and often use collateral against everything from financial assets (accounts receivables and consumer loans) to hard assets like aircraft, warehouses, and even music royalties. The pooled approach aims to provide a more diversified and safer portfolio of loans.
But some experts say the flood of capital flowing into private credit and ABF strategies has resulted in lower standards and more exotic assets being pledged as collateral. First Brands, an auto parts company, borrowed money against its accounts receivable, or money owed from customers. Some lenders have said in bankruptcy filings and lender reports that the company may have pawned the same debt to different lenders.
While some private credit companies, like Apollo, discovered potential problems with First Brands and even shorted credit before the company filed for bankruptcy, others failed to notice the red flags.
Donald Clark, president of Asset-Based Lending Consultants, said ABF is a “high-risk, high-return” loan that requires particularly rigorous due diligence.
Lenders, like regular lenders, not only need to understand the underlying business and complete business model, but also the specific collateral being pledged.
“First Brand’s failure demonstrated a lack of proper due diligence as lenders, both banks and non-banks, rushed to deploy capital,” Clark said.
He said given the rapid expansion of ABF and the influx of billions of dollars into private credit, he expects more problem loans to emerge, especially if a credit downturn occurs.
“Funding competition needs to be tempered by the need for proper due diligence on borrowers and proposed collateral,” he said. “Where there is a lot of money to lend, there is also a lot of money to lose.”
