Private credit providers walk a tightrope to balance raising capital and deploying it.
Some credit asset managers are meeting this challenge via portfolios of loans and demand from insurers, who are hungry for higher-quality and high-grade investments.
The trend toward asset-based finance (ABF) investing, some of which includes participation from insurance companies, has accelerated in tandem with increased competition in private credit for deals.
In late February, Blackstone Credit & Insurance and Barclays unveiled one such arrangement via a partnership related to credit card receivables. The ABF transaction is reflective of a growth area, alongside the burgeoning private credit segment, that involves many of the same market participants.
Under terms of the Blackstone-Barclays deal, Barclays Bank Delaware (BBDE) agreed to sell $1.1 billion of credit card receivables on Barclays-branded US credit card accounts to insurance accounts managed by Blackstone’s Asset Based Finance group.
For Barclays, the transaction is part of an effort to reduce risk-weighted assets and enhance lending capacity at BBDE, the company said.
For Blackstone, the deal fits into a larger strategy that matches demand for reliable returns from insurance companies with pools of diverse assets. The effort comes alongside the company’s significant push into private credit, or directly originated loans to corporate borrowers.
The deal is part of a larger Blackstone credit story that places ABF in the limelight: Blackstone in September announced the creation of Blackstone Credit and Insurance (BXCI), saying it aims to build another trillion-dollar business over the next 10 years by combining corporate credit, asset-based finance and insurance groups into a single unit.
Growth area
Those paying attention to credit markets may think ABF is coming up more frequently. It’s true, and the trend shows no sign of abating.
This is a new area for private credit providers. Private credit has its roots in lending to middle market companies. These companies are often unrated and viewed as riskier. Loans to them come with an illiquidity premium.
Helped by massive fundraising, private credit providers then moved into loans to larger companies that typically raised capital in the syndicated loan market, as well as deals that normally would have been financed in the high-yield bond market.
With leverage buyout activity and M&A volumes down for the past two years, private credit providers are further incentivized to push into new areas. Now, a comeback in recent months by the syndicated loan market has re-intensified competition.
“As the boom growth years for direct lending to corporates start to wane, private credit lenders are growing their footprint in asset-based finance, a type of financing that has historically been the domain of banks. This trend is still in its early stages,” said Moody’s in a March 5 research report.
“We expect alternative asset managers’ share of this market will continue to increase as they build out their own origination capabilities, while banks remain capital constrained. But these instruments — with a focus squarely on maximizing yield — will also push leverage levels in financial markets higher,” the agency said.
Moody’s estimated direct lending’s “addressable market” was roughly $1.5 trillion. But the broader private credit universe, including ABF, could have an addressable market of $40 trillion, the agency said.
Old show, new costumes
Packaging loans and then selling them off as entire portfolios to offload risk is not new. Whole-loan portfolios were in the spotlight during the 2008-10 credit crisis, when portfolios of subprime mortgages experienced sudden ratings changes.
The investments in the current crop of ABF transactions are both rated and unrated.
“For us to be able to rate an ABF fund, the ABF in the fund needs risk characteristics that we can assess. We have to understand the performance characteristics of the underlying assets, which means we need to look through the structure to discern portfolio credit risks and the performance of the underlying assets,” said Mark Wasden, senior vice president at Moody’s. “This is very much a developing area.”
Asset managers say that the current batch of ABF transactions are higher quality and have no relation to subprime mortgages, which were known for extremely low underwriting standards and scant documentation.
Insurance companies, which traditionally have high requirements when it comes to investments, need to agree. So far, it appears as if they do. In the case of the Blackstone-Barclays collaboration, insurance companies are expected to generate demand for the investments.
Insurers have become more involved in private credit in recent years.
Apollo Global Management, Brookfield and KKR & Co. are other alternative asset managers that have pursued majority stake purchases or full acquisitions of insurance companies, what Moody’s has called a “balance-sheet heavy approach.”
Apollo agreed to merge with Athene in 2021. In 2023, the company unveiled an asset-backed finance franchise and ATLAS SP Partners, a strategy to directly originate within the $20 trillion global asset-backed financing market. A subsidiary of the Abu Dhabi Investment Authority (ADIA) provided a cornerstone investment.
“Private capital continues to play a meaningful role in credit formation, and we believe asset-backed finance is the next big evolution of this market,” said John Zito, deputy CIO of Credit, Apollo, at the time of the announcement.
KKR announced an acquisition of Global Atlantic Financial Group in 2020. In 2023, Brookfield Reinsurance agreed to acquire the shares of American Equity Investment Life that it does not already own. Brookfield has also purchased companies under its Insurance Solutions business line. Blackstone and Carlyle have acquired minority stakes in insurers, highlighting the ability to earn fees without insurance risk.
What is ABF?
In ABF transactions, an asset manager buys a portfolio of loans.
Technically, ABF is lending supported by cash flows of a pool of assets owned by a limited-purpose borrower, and can include mortgages, consumer credit, receivables, aircraft lending and inventory finance, according to “Asset-Backed Finance: The Next Evolution of Private Credit,” a paper published by Apollo in October 2023.
The argument for ABF is that a single loan in the underlying portfolio won’t necessarily behave the same as another.
Put another way: “ABF has historically experienced lower losses than corporates due to the nature of its underlying structures: a) diversified underlying assets that mitigate single points of failure, b) strong documentation with covenants and cash-flow waterfalls, and c) credit enhancement through bankruptcy remote and ring-fenced collateral,” the Apollo research paper said.
The private ABF market expanded rapidly after the Global Financial Crisis, when banks retreated from lending due to increased regulation. Non-bank lenders picked up this business.
ABF is not to be confused with an adjacent type of credit, asset-based lending (ABL), which is extending loans to companies underwritten on hard assets or inventory. ABF does not involve “new-money” lending, as asset-based lending does.
Blackstone, Apollo, Sixth Street and KKR are active in asset-based finance investments. Assets vary, but are generally consumer-oriented loans.
In October, a consortium led by Sixth Street that includes funds and accounts managed by KKR, Bayview Asset Management and CardWorks agreed to buy credit platform GreenSky and related loan assets from Goldman Sachs. The transaction is due to close in Q1 2024. GreenSky is a credit platform that makes it possible for contractors to offer financing to consumers for home improvement projects.
That news stems from Sixth Street’s formation in 2022 of a dedicated structured financed business, led by Michael Dryden, the former global head of securitized products finance at Credit Suisse. The transaction enhanced the business at Sixth Street, which was already involved in the area prior to the 2022 announcement.
In December, affiliates of KKR’s ABF strategy agreed to purchase a $7.2 billion portfolio of super-prime recreational vehicle loans from BMO. BMO will remain the servicer of the loans and will still originate future RV loans. BMO purchased $6.4 billion of senior notes collateralized by the sold loans. Kennedy Lewis Investment Management participated in the transaction.
That news came on the heels of the June announcement that private credit funds and accounts managed by KKR would buy €40 billion of “buy now, pay later” (BNPL) loan receivables originated by PayPal in France, Germany, Italy, Spain and the United Kingdom.
Under terms of that agreement, PayPal is responsible for customer-facing activities, including underwriting and servicing, associated with its European BNPL products. KKR Capital Markets structured and arranged debt supporting the transaction.
“While the concept of split installment payments for consumer purchases has been around for decades and online consumer financing has been a strategic offering of PayPal since 2008, BNPL has dramatically increased in popularity over the past several years,” according to a June company statement from PayPal.
In FS KKR Capital Corp’s Q4 earnings call on Feb. 27, CIO Daniel Pietrzak said the company continues to see attractive ABF investment opportunities and that it expects a weighted average IRR of roughly 14%.
“Given the scale of our asset-based finance business, and the experience of the team, we were able to acquire this high-quality loan portfolio on attractive terms,” Pietrzak said.
More leverage, more concentration
ABF will result in an increase in leverage in several ways, Moody’s noted. Many of the underlying instruments are commonly used for financing. And, the asset manager acquiring the ABS securities may add more leverage by placing the investments in a leveraged fund, the agency said.
“In other words, the more layers of levered investment that are involved, the more scope there is for total leverage to multiply. As this happens, concentration risks will only grow, given that just a few large asset managers are responsible for a fast-evolving financial ecosystem,” Moody’s said.
“As private credit continues to evolve, this will only fuel their influence in the economy — meaning an ever-larger proportion of lending will be concentrated among a small group of large, influential asset managers,” the agency continued.
Recent related stories by LCD:
- Banks eye low-rated refinancings to claw back business lost to private credit
- Blackstone Credit to buy $1.1B of credit card receivables from Barclays
- Blackstone combines units to form Blackstone Credit and Insurance
- KKR’s credit business acquires $7.2B RV loan portfolio from BMO
- KKR closes $2.1B asset-based credit fund
- Apollo says changes leading to growth of private credit are just beginning
- Insurers, private credit team up for mutual benefit, but risks rise – Moody’s
- As private credit turns to ABL deals, a once-plain part of credit looks hot
Featured image: Todor Pungerov/Getty Images
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