- Higher interest rates, increasing capital requirements, and fundamental credit concerns are prompting a secular shift within lending—away from banks and toward alternative sources of capital.
- The hunt for yield has ended, and the hunt for capital has begun as supply-and-demand dynamics that once favored borrowers now favor lenders.
- Credit investors now have an opportunity to earn equity-like returns in asset-secured debts with strong documentation and covenants.
- Private investors looking to complement existing portfolios that exhibit relatively high corporate risk exposure with alternative yield sources, differentiated return drivers, and through-cycle investment strategies, have the opportunity to benefit from asset-based lending that has existed in institutional markets for decades.
Yesterday’s yield desert has become an oasis for today’s asset-based lenders
It’s a great time to be a lender. Credit dynamics have shifted over recent months, and the era of lower for longer is gone. While borrowers benefited from zero interest-rate policy (ZIRP) during the COVID-19 pandemic, one of the sharpest U.S. Federal Reserve tightening trajectories on record has since given lenders the upper hand—and that edge may prove enduring.
Higher base rates have lifted yields—where they’re likely to remain
Benchmark lending rates, January 2020–September 2023 (%)
Source: U.S. Federal Reserve, Marathon Asset Management, September 2023.
In addition to higher base rates, wider spreads have made all-in yields that much more attractive to those contemplating credit allocations. While the lender’s hunt for yield continued into 2022, we believe 2023 has become all about the borrower’s hunt for capital. Lenders are in a favorable position to negotiate attractive pricing with robust asset and structural protections. This investment environment favors disciplined credit investors ready to deploy capital.
It’s an even better time to be a non-bank lender
The regional banking sector is retrenching and pulling away from asset-based lending, neither financing nor originating the volume of asset-secured loans it once did. Regional banks play a critical role in extending credit to U.S. commercial real estate, residential real estate, and commercial and industrial loans, holding 68%, 37%, and 32%, respectively, of all loans and debt in these sectors.2
Share of loans held by small domestic banks by select sectors
Source: U.S. Federal Reserve, Marathon Asset Management, 4/1/23. Small domestically chartered commercial banks are defined as all domestically chartered banks outside of the top 25.
However, recent surveys of senior loan officers reveal that banks are lending less. Financial conditions are likely to tighten further with banks becoming subject to higher regulatory capital requirements as they continue to grapple with mismatched assets and liabilities. As a result, we are witnessing banks lending less, driving up the cost of taking out a loan or refinancing. While that’s bad news for borrowers looking for asset-based credit, we believe it’s good news for non-bank lenders that can step into the void left by banks across large swaths of the everyday economy.
Banks will be less likely to lend ... While that’s bad news for borrowers ... it’s good news for non-bank lenders that can step into the void.
Tightening bank standards point toward opportunity for non-bank lenders
Net % of banks tightening standards for commercial and industrial loans
Source: U.S. Federal Reserve, Marathon Asset Management, September 2023.
We believe that backdrop has set up a golden era of credit for disciplined alternative lenders. Instead of defending existing positions that were underwritten in a more relaxed, borrower-friendly environment, those who remained prudent providers of capital throughout the ZIRP era can now seize the day by offering bespoke asset-based financing solutions that contribute to investment portfolios through the potential for:
- Current income commensurate with historical total returns on equity
- Diversification and drivers differentiated from stocks, bonds, and other private credit classes focused on corporate risk
- Durability and stability amid a rising interest-rate and inflationary regime given the asset-based cash flows
- Downside protection through structural security backed by hard or financial assets
Asset-based lending has become a credit allocation for all seasons
Credit investors with dry powder to deploy have the potential to capitalize on what could be one of the most attractive market environments in decades. The lagged effect of tighter monetary policy should allow investors to lend at higher returns with tighter covenants and lower advance rates. This points to the potential that lenders have to earn higher yield for lower net capital deployment. We believe it’s more important than ever to have a diversified strategy within credit allocations generally—and within private credit particularly. While middle market private credit has existed in institutional markets for decades, asset-based lending is just gaining traction among private investors looking to complement existing portfolios that exhibit relatively high corporate risk exposure with alternative yield sources, differentiated return drivers, and through-cycle investment strategies. Asset-based investments offer the potential for contractual cash flows backed by hard assets that are expected to retain value even in a higher-rate, inflationary regime. Investors allocating to the asset class now may benefit from the potential for high recurring income streams, low correlations with mainstream markets, and a degree of downside protection that’s potentially compelling compared with many other risk-bearing investments. We believe that few asset classes today can deliver such a compelling combination of characteristics.
1 Mortgage Bank Association, BBG Real Estate Services, Polaris Market Research, Urban Institute, Goldman Sachs Research, Federal Reserve Bank of New York, Bourne Partners, Deloitte, Bloomberg, Stifel Debt Transaction Database, Petrofin, and Marathon Asset Management, LP, October 2023. Estimate excludes corporate asset-based lending. 2 U.S. Federal Reserve, Marathon Asset Management LP, 4/1/23. Small domestically chartered commercial banks are defined as all domestically chartered banks outside of the top 25.
Fund shares are illiquid and, therefore, an investment in the fund should be considered a speculative investment that entails substantial risks. Investors could lose all or substantially all of their investment. Shares of the fund are not listed on any securities exchange, and it is not anticipated that a secondary market for the fund’s shares will develop; therefore, an investment in the fund may not be suitable for investors who may need the money they invest in a specified timeframe. The amount of distributions that the fund may pay, if any, is uncertain. Annual distributions may consist of all or part of your original investment, and therefore may not consist of a return of net investment income. The fund’s use of leverage may not be successful and may create additional risks, including the risk of magnified return volatility and the potential for unlimited loss. Exposure to investments in commercial real estate, residential real estate, transportation, healthcare loans, and royalty-backed credit and other asset-based lending, including distressed loans, may also subject the fund to greater volatility than investments in traditional securities. Investments in distressed loans are subject to the risks associated with below-investment-grade securities. In addition, when a fund focuses its investments in certain sectors of the economy, its performance may be driven largely by sector performance and could fluctuate more widely than if the fund were invested more evenly across sectors.
Past performance is not a guarantee of future results. Diversification does not guarantee a profit nor protect against loss in any market. All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment, or legal advice. Clients and prospects should seek professional advice for their particular situation. Neither Manulife Investment Management, nor any of our affiliates or representatives (collectively Manulife Investment Management) is providing tax, investment, or legal advice.
This material is intended for the exclusive use of recipients in jurisdictions who are allowed to receive the material under their applicable law. The opinions expressed are those of the author(s) and are subject to change without notice. Our investment teams may hold different views and make different investment decisions. These opinions may not necessarily reflect the views of Manulife Investment Management. The information and/or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.
Manulife Investment Management shall not assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained here. This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment approach, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit or protect against the risk of loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management. Past performance does not guarantee future results.
This material has not been reviewed by, and is not registered with, any securities or other regulatory authority, and may, where appropriate, be distributed by Manulife Investment Management and our subsidiaries and affiliates, which includes the John Hancock Investment Management brand.
Manulife, Manulife Investment Management, Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.