Asset-backed finance
What is asset-backed finance?
Asset-backed finance (ABF) forms part of the private credit universe. The defining characteristic of ABF investments is that they are secured (or backed) by a pool of assets. The performance and total return on the investment are therefore primarily dependent on the cashflows generated by the asset pool, rather than external market factors that can create volatility in public markets such as stocks and bonds.
The term ABF is sometimes used interchangeably with asset-based lending, specialty finance or structured credit, and should not be confused with its more widely known cousin, the asset-backed security (ABS), which is typically a liquid, syndicated and publicly traded instrument. ABF investments by contrast tend to be less liquid, bilateral (one investor and one originator of the assets), and private transactions.
Whatever the term used, the basic principle such investments all share is exposure to an asset pool. Where they can differ is in how the asset exposure is obtained, as well as the legal structure wrapped around the investment. This could be via a conventional bond structure, a loan, or a guarantee, but all will be focused on creating, acquiring and taking exposure to a pool of assets and taking an income from the cashflows generated by those assets.
ABF investments aim to deliver a consistent, uncorrelated income, in addition to limiting downside since the regular repayment of the underlying assets naturally deleverages the portfolio and reduces credit risk over the life of the deal.
ABF at TwentyFour
TwentyFour is a well-known presence in European securitisation, active in both public and private markets right across the risk spectrum and working with policymakers to guide regulation in the sector. Our relationships broaden our ABF opportunity pipeline, improve our access to preferred assets, and enhance our ability to add value by working with trusted partners on structuring and pricing.
ABF at a glance
The vast majority of the ABF opportunity falls under either consumer or corporate debt.
The ABF investment universe dwarfs the rest of private credit (see Exhibit 1). The global ABF market is thought to total around $5.2tr, and this is expected to grow to around $7.7tr by 2027, according to data from Citi.
The European ABF market, about 20% of the global total, benefits from strict regulation, uniform consumer lending and conservative corporate lending, which have contributed to historically stronger credit performance than comparable assets in the US.
Asset pools range from €200m to several billion, containing thousands of loans. Investors have access to detailed, standardised, and decades-long historical data, supporting transparency, stress testing and performance forecasts.
Why invest?
Yield
Yields on ABF investments can generally deliver a material premium over other sectors of private credit such as direct lending.
Low interest rate risk
Investments tend to pay returns through floating rate coupons, reducing interest rate risk.
Tailored asset selection
ABF allows managers such as TwentyFour to select a jurisdiction, asset type, lender, and vintage of the asset pool, allowing powerful portfolio construction and risk control.
Downside mitigation
Asset pools tend to exhibit low default rates and strong recoveries through the cycle. ABF yields factor in an expected level of reduced cashflow from projected delinquencies, defaults and losses – this differs from direct lending where any such non-performance detracts from returns.
Diversification
Risk is isolated to the performance of the asset pool, and these tend to show a low correlation to broader financial markets. Mortgages, for example, are low risk consumer loans whose performance is typically less sensitive to cycles, sentiment and market noise.
Organic liquidity
ABF investments tend to be shorter dated than other private credit opportunities. This is because the underlying borrowers (mortgage customers, for example) are required to pay interest and partially repay principal on a regular schedule. While this creates a degree of reinvestment risk for the investors getting their capital back, it comes with two major benefits: reduced credit risk from continual deleveraging, and organic liquidity, which also reduces the need to dispose of assets at the end of life.
Related insights
Asset-backed finance: How does Europe stack up?
Asset-backed finance: Hiding in plain sight
Asset-backed finance (ABF) case study: Qander Consumer Finance
