Asset Based Finance: Standing on its Own Merit
March 24, 2023
An important part of private credit is private asset based finance (ABF). Market research predicts that the ABF market is expected to grow to $6.9 trillion by 20251. Of this, the consumer and small-medium sized enterprises segment accounts for 45% of the US market, 30% in Asia/Australia, 18% in Europe and 7% in the rest of the world. In recent times, the asset-based lending market experienced a boom during the pandemic period as enterprises began looking for loans to cope with the monetary challenges arising from the lockdown. Some of these companies switched from a cash-flow based credit facilities to asset-based lines of credit. Let’s take a look at some of the major segments of asset based finance, where the market stretches beyond consumer and SME segments.
Specialty Finance: This is done by non-bank lenders to commercial and consumer borrowers not served by traditional lending channels. The increased interest in specialty lending has been due to the higher number of pitch books received over the years. In this, aviation leasing is alone a $360 billion segment with the mushrooming of multi-strategy specialty funds. In specialty lending, structure is a key risk mitigant and the deals are generally bespoke. The loan is structured as self-amortizing, which means that both interest and principal are both paid back throughout the life of the investment. Specialty finance will continue to attract capital as investors bank on attracting risk-adjusted returns. The market size for specialty finance was around $14 billion2 in the third quarter of 2021 with a 4-year CAGR of 19.3%.
Litigation Finance: Also called litigation funding, it is an investment by a third party in a lawsuit or a basket of lawsuits, with no interest in the case. Although the investor does not control the litigation strategy, he receives a percentage share of proceeds from a judgement or settlement. Litigation finance provides funding for good cases which are sometimes not pursued due to lack of funds. In the US, litigation finance is a $3 billion industry, which provides capital and legal aid to those who cannot afford it. Litigation funding paid for research that linked Monsanto Roundup, grass and weed killer, to lymphoma and other forms of cancer. The global litigation funding market stood at $12.2 billion in 2022 and will touch $25.8 billion3 by 2030 with a CAGR of 9% between 2022 and 2030.
Royalties: When a patent or product is used by a third party, the user pays a royalty to the owner of the patent or product. The licensing agreement details the terms of the royalty payment. Factors such as exclusivity of rights and technology, determine the amount or percentage of royalty to be paid by the user. The licensor and licensee both benefit by royalty agreements. For example, in book publishing, an author receives 15% royalty on net sales of a hardbound book and 7.5% royalty on paperback editions.
Trade Finance: Trade finance supports the de-risking of transactions where considerable trust is required. Business conducted on credit requires immense trust between the supplier and buyer especially in cross-border trade. Insurance products, transaction structures, and financing solutions are some of the methods to facilitate free flow of commerce. Three common forms of trade finance include letter of credit, purchase order finance, and supply chain finance. Since trade finance involves various jurisdictions, players, and languages it is a fertile ground for fraudsters and conmen and therefore proper KYC and AML policies need to be placed. The global trade finance market touched $48.2 Billion in 20224. IMARC Group expects the market to reach $70 billion by 2028, growing at a CAGR of 6.2% during 2023-2028.
Transportation Finance: Transportation finance helps provide capital for the finance and leasing of rail, maritime, and the aviation sectors. Transportation finance services include customized payment structures that match customers’ cash flow and business requirements, providing competitive rates and fair residuals as also providing online application entry, fast credit approvals and funding, on-demand lease portfolio reporting, and so on.
In conclusion, ABF is a strategy that can stand on its own merits. Its attractive characteristics include access to a diverse and growing opportunity set fuelled by a widening global supply/demand imbalance for non-corporate credit and new technology-enabled innovations streamlining access to credit solutions.