TSL Express Daily News

Ares Management has been keeping its eyes peeled for rising opportunities in the asset-based credit market, a growing area of private debt.

The firm hopes to capitalize on the flow of bank asset sales, become a new capital partner to fintech lenders, invest in the sale-leaseback market, provide fund-level credit facilities, and finance digital infrastructure projects, said Keith Ashton and Joel Holsinger, co-heads of Ares' alternative credit group.

"The volume of activity overall has increased, largely because banks and securitization markets are not in a position to provide the capital that they were previously able to offer," Ashton said of the asset-based credit market, where lenders make loans secured by relatively liquid assets, which gives them more protection in a weakening economic environment. "That has significantly increased the opportunity set for folks in this market, particularly those with scaled capital."

The Los Angeles-based alternative asset manager last week closed a $6.6 billion fund targeting asset-based credit investments. Ares Pathfinder Fund II, which marks a 78% step-up from its 2021 predecessor, is one of the 10 largest private debt funds closed so far this year, according to PitchBook data. The fresh capital will bolster the firm's war chest, putting it in a good position to seize on these favorable investment trends, Ashton said.

Regional banks retreat

Funds might be deployed to pick up divestitures from regional banks, which are seeking to trim their balance sheets following this year's bank failures, an expected increase in nonperforming loans, and the pressure of stricter capital rules.

Many regional lenders are undergoing strategic reviews as they decide which assets to offload. They might sell floating-rate portfolios with short maturities or engage in capital relief transactions whereby banks seek to reduce their "risk-weighted assets'' by transferring credit risk to another party. Another option for banks is to divest noncore businesses.

"A number of banks are stuck with their assets because they have fixed-rate and longer duration assets, such as residential mortgages," Holsinger said. "They can only improve their capital ratios and liquidity with capital relief transactions and some limited securitization, which also acts as a form of capital relief."

Cash-rich private credit funds like Ares are ready to snap up these assets. In June, the credit manager acquired a $3.5 billion lender finance portfolio from PacWest.

Fintech consolidation

Concurrent with the transition in banking, there is an expected wave of consolidation in the fintech market, in which strong fintech lenders will devour their weak and unprofitable peers.

Fintech originators have been struggling as banks—which had been capital providers to those online marketplaces—stepped back to reserve capital in recent quarters. This gives private credit managers a chance to step up and become these fintech lenders' new capital providers, Ashton said.

Last year, Ares provided $250 million in debt and preferred equity to online consumer lender Avant, which ended Q1 2023 with only $52.85 million in cash and $1.15 million in equity, wiping out nearly all the cash it raised from equity investors, according to a Kroll Bond Rating Agency report. Avant has raised a total of $2.18 billion in debt and equity since its seed round completed in 2012, according to PitchBook's Q3 2023 Fintech & Payments Public Comp Sheet and Valuation Guide.

Sale-leasebacks

Another area that is becoming attractive is the sale-leaseback market. Facing expensive borrowing costs and shrinking access to credit, more companies—healthy or unhealthy—will likely choose to free up capital through this arrangement. In a sale-leaseback transaction, a company sells its property to an investor and then rents it back. The freed capital can be used to finance an LBO, pay down maturing debt, fund growth investments or pay back shareholders.

Deal activity for sale-leasebacks hit a record in 2022 when a total of 874 such transactions were completed, totaling $31.4 billion, up 11% by volume and 14% by value from 2021, according to advisory firm SLB Capital Advisors. In the first half of this year, the total deal value for sale-leasebacks stood at $9.86 billion, which represents a nearly 50% increase from the same period in 2021.

The cost of sale-leaseback transactions has widened to around 8% today, an increase of 150 basis points to 200 basis points in the last 24 months, said Scott Merkle, a managing partner at SLB. By comparison, interest rates on high-yield bonds and corporate debt have risen more than 400 basis points, suggesting that following the interest rate spike, sale-leasebacks have become a cheaper way for many companies to raise capital compared with other debt financing options.